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Too Much Debt

Question: I'm ashamed to say that I am one of those Americans who have used credit cards to make ends meet. Mostly they've been used for moving expenses due to health reasons, and financing school supplies. I'm now having trouble paying off these cards, and worried about calling those groups that advertize debt consolidation services on late night TV. Who do I contact to help me get the interest rates on these cards to a reasonable level and organized so I can make a single payment each month? Maureen

Answer: You have no reason to feel ashamed. At some point in our lives, most people take on too much debt. They end up with big credit bills for good reasons--medical bills, a move, a lost job, helping out a child--and not because they're living the champagne lifestyle on a beer salary.

The real question is: What lessons do we take away from the experience of carrying too much debt? In other words, will you leave your debt burdens behind and change your money habits? Or will you go on a roller coaster, zooming into too much debt, followed by a period of getting rid of it, only to take on more debt once your balance reaches zero?

Finally, you're so right to steer clear of the fly-by-night outfits that advertize on late night TV. Don't dial their 1-800 numbers.

I wish I could say that there's a magic wand to wave that will get you out of debt fast. There isn't. But here's a two-step formula:

First, get a copy of a book such as Gerri Detweiler's "The Ultimate Credit Handbook: How to Cut Your Debt and Have a Lifetime of Great Credit." It's in its third edition. Gerri is good at dealing with debt issues, and her book will give you a practical lay of the credit landscape. You could also check out Nolo, a leading financial self-help information organization. It's at www.nolo.com.

If you want to work with an organization--a good move for many people--I would contact the National Foundation for Credit Counseling (NFCC). It's the largest and oldest national nonprofit credit counseling service. You can find a branch near you at www.nfcc.org. If you like working online, by the way, I know that one branch--the Consumer Credit Counseling Service of San Francisco at www.cccssf.org--offers all the financial basics, plus an online debt counseling service and debt management plan.

Good luck.

01/28/08 by Chris Farrell

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College Choice

Question: My son, a high school senior, was accepted to one of Minnesota's private colleges. We have been fortunate in that we invested over the years and have saved enough for about 3 years of his education at this school. He also received scholarships to a different MN private college that would pay for about 66% of his costs for 4 years, leaving him with a substantial amount of $ at graduation. I have 2 questions. He wants to turn down the scholarship and go to the other school. There is a difference in the 2 schools, one has a very strong regional reputation and the other a national reputation. He wants to forgo the scholarship for the national reputation. From a long-term $ perspective, what advice would you give to him? Second, assuming that he forgoes the scholarship, I am considering keeping the $ we saved for him invested and taking out loans to cover the cost of the education and then paying off the bulk of the loans at graduation. Is that a solid strategy? The investment has averaged 10% over the long term. Thank you for your advice. John

Answer: This is one of those times when the outcome of a financial decision is positive no matter what, yet people strongly disagree about the answer. Some of my friends are adamant that it doesn't pay to attend the more expensive, nationally known school. They'd leap at the scholarship money. Over the course of a lifetime, the importance of that degree shrinks, and the dollars saved add up. Other friends believe the national reputation is worth it if the student expects to attend graduate school, move to another part of the country upon graduation, or enter certain professions, like investment banking. To them, the extra money you're paying is the price of an "option" on a particular career choice and geographic mobility.

So, where do I come down? What strikes me over the past 30 years is just how good college and universities have become, including small private liberal arts colleges. The gaps in performance and quality have really narrowed even if national rankings haven't kept up with the transition. But your son has also expressed a clear preference for the better known school. One way to make this decision is insist that your son "own" more of his education. If he goes to the regional school, he graduates debt free--and that is a genuine advantage these days. He'll be in a position to choose a job at graduation based on desire (and perhaps a low income) rather than face the pressure to take a less desirable job that pays more because he has student loan bills to meet.

If he still wants to go to the other school, then I would have him borrow at least some money to pay the difference in costs himself. He won't graduate debt free. Instead, along with his diploma he will get a student loan repayment booklet. I think making the decision this way is a good life lesson.

That said, I would limit how much he borrows so that he still has a choice at graduation. For one thing, you have the savings. For another, you don't want him too burdened by debt. By the way, it can be a good strategy to borrow, even if you have the money, if there is a reason to keep your options open. You can always help them pay off their student loans at that point.

01/31/08 by Chris Farrell

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Too much Debt

Question: I'm 54, earn about $80,000/yr and plan to work for 10 more years. I have $100,000 invested with Edward Jones in growth funds and would like to use some of that to reduce my $140,000 home equity loan. I have another $500,000 in 401k & IRA savings. And I don't have any other debt -- no car loans or mortgage.

Currently I am in a loan plan with my bank where I only pay interest on the debt. That plan continues for 4 more years. The interest rate is ~6.7% or $850/month. I have not paid anything on the principal in the last year.

I know I earn a comfortable salary, but after enormous increases in property taxes and some unexpected house maintenance spending, it seems I live from pay check to pay check...even though I'm a pretty frugal person.

I contribute the maximum amount to my 401k--$17,000/yr. My friends say I put too much money into my retirement, but I plan on doing some spendy playing when I retire: ski, travel, hike the Sierra Mountains and Wine country etc.

How should I manage by debt and savings? I'd appreciate your advice. Sincerely, Mary

Answer: Mary, many people are in similar financial circumstances. Like you, they're carrying too much debt, but hardly living the champagne lifestyle. I wish there was a magic-wand-suggestion for eliminating debt. But there isn't. But there are trade'offs to consider. Here are some thoughts and suggestions.

You need a budget, but that's not the same thing as bookkeeping. Budgeting is really all about bringing goals, expectations, and money into accord. Ask yourself, where do you want to be a year from now, 5 years from now, 10 years from now? Then map out a way that will get you there. The real trick here--I can't emphasize this enough--is that you don't want to go through all this work to get rid of debt only to start building it up again.

Once you've gone through that process, and only then would I tap into your savings to pay down a chunk of your home equity loan. You can get rid of the rest of it over time with a budget. So, play with the numbers, and see how much you want to take out of savings (and pay capital gains tax on) and how long it would take you to get rid of the debt.

One other reaction: I'm with your friends. It's terrific that you're aggressively saving for retirement and that you have all these plans for what you want to do in your Golden Years. My fear is that you're denying yourself too much today to pay for your dreams tomorrow. Ease up a bit to shore up your finances now--and for tomorrow.

03/06/08 by Chris Farrell

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Co-signing a Loan

Question: I have a very good credit rating and am considering co-signing on a loan for a family member who has a very poor credit rating. Will her poor credit rating affect my credit rating in any way, if I co-sign the loan? Thank you, Bette, Richfield, MN

Answer: Her poor credit rating won't immediately affect you on co-signing--assuming that she then pays her bills on time. But if she defaults you're on the hook to make good on the debt. The lender will go after you for the money she owes. Your good credit rating could be ruined. It's understandable that you want to help out a family member, but co-signing a loan is very risky.

03/27/08 by Chris Farrell

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Mortgage Accelerator Programs?

Question: My husband & I are both retired. We have parent loans for our 3 children's college expenses. We have a $20,000 home equity loan but no other debt. Recently we were approached by a friend to look into u1stfinancial as a way of paying them off sooner and decreasing interest. Do you have any information or advice regarding this company? Carol, Pine City, NY

Answer: We've been getting a lot of questions about United First Financial and its Money Merge Account. Full disclosure: I'm not a fan of the product.

Here's how the company describes the money merge account on its website.

The Money Merge Account system is a powerful tool that enables homeowners to pay off a 30-year mortgage in as little as one-third of the time, without refinancing their existing mortgage or increasing minimum required monthly payments. The system incorporates the homeowners' checking and savings accounts with an advanced line of credit (ALOC), then helps to strategically and incrementally position their money where it provides much more financial benefit than "sitting stagnant" in a standard checking or savings account until it is otherwise needed. Complex financial details programmed into the Money Merge Account software help to better educate the homeowners and assist in some of the greatest time and interest savings possible.

Got that? There are a number of comparable products on the market. The bells and whistles may differ, but it looks like the basic idea is the same. You set up a special home equity line of credit off the value of your home (which is getting harder to do and more expensive these days, thanks to the credit crunch. As I understand it, you could use a personal line of credit or a credit card, but the latter at least sets off all kinds of alarm bells.) When you get your paycheck it goes into the line of credit, decreasing your mortgage balance and, after paying your bills from the account, the remaining money keeps your mortgage balance down. The software costs for $3500 for the Money Merge Account, and other programs also charge for their software.

Carol, as I mentioned above, I'm not a fan. In essence, I think these programs boil down to a complicated and expensive way to keep a household to a very tight budget. If that's what you want to do there are other, cheaper ways to map out and maintain a frugal lifestyle. Perhaps more important, I worry about homeowners pouring so much of their discretionary income into their home. It's nice to own your home free and clear, but it's also important to build up a well-diversified portfolio with a well-funded emergency cushion.

And if it makes sense for you to pay off your mortgage early, well, you can do it on your own without paying for special software. Just make extra payments to pay down principal. A classic approach is to make an extra monthly payment a year. By writing 13 monthly mortgage checks instead of 12 you'll pay off that loan faster. Just be sure to tell the bank in writing to put that extra payment toward principal. Last, Carol, these mortgage loan accelerator programs seem to violate a time-honored financial motto: Keep It Simple.

05/02/08 by Chris Farrell

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Cash or Loan?

Question: Hi, I have to replace my roof (sooner then later). Should I pay cash from a money market savings account, or take out a loan? Thank you, please get back to me rather sooner then later :) Gabriele, St. Paul, MN.

Answer: This is really a money management question. The baseline answer is pay for the home improvement with cash from savings. This way, you don't take on any debt. Plus, the interest rate you're getting on your savings is probably a paltry sum anyway.

However, there may be some good financial reasons for you to hoard savings right now. If that's the case, then by all means take out a loan. The best loan is probably a home equity loan. It's ideal for a lump sum payment such as a new roof, and you're preserving the value of your home. The rate of interest is fixed, which makes it easy to plan. You could take out a home equity line of credit, but the interest rate is variable. It's a loan option best tapped for projects that are done in batches or over a long period of time.

05/05/08 by Chris Farrell

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Roth vs Pay Down Debt

Question: I'm 26 years old, and have no credit card debt, no car loans, no student loans. I max out my 401(k), and have a six-month emergency fund. Pretty good, right? But I also have a mortgage and a $40,000 second mortgage (which is structured as a home equity line of credit).

Over the past year, I've saved up about $5,000. My question is, should I put this money into paying off the home equity line of credit, or should I start a Roth IRA? I know the Roth IRA has higher returns over the long-term, but in my gut, I REALLY want to knock off that home equity line of credit. What should I do with the $5,000. Seattle, WA

Answer: First of all, I admire your financial acumen. I know that I was nowhere near as financially savvy as you are at your age. You're saving for retirement. You have a nice emergency stash. And no debt other than your mortgage and home equity line of credit. It's great.

If I were you, I would pay attention to your instincts: Go ahead and tackle that home equity line of credit. It's a smart move.

05/06/08 by Chris Farrell

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Credit Counseling? Bankruptcy?

Question: My husband and I have been offering budget counseling to friends and family for about 2 years now. It is rewarding to help people find their way back on track. Recently though, I'm afraid we've strayed out of our league and know it. We're trying to come up with a budget for a family with 40,000 in credit card debt that has eaten away at the monthly salary. Their mortgage is 50% their monthly income and they're a large family. I can't send them away empty-handed though, so what are some resources we could share with them and when (as homeowners) is it time to think about filing for bankruptcy? Thanks, Jacqueline, Sacramento, CA.

Answer: It's great that you help out family and friends with their money issues. It's also smart to know when someone needs more expert advice than you can offer.

That said, there are a lot of scams at worst and incompetence at best in the consumer credit counseling and debt management business. The organization that I like is the nonprofit National Foundation for Credit Counseling. NFCC has a search engine at its website for you to find an accredited Consumer Credit Counseling Service near you. (To be sure, the quality of the advice varies across the country with some offices better than others, but the service is legitimate.) I took a quick look and I didn't see a CCCS in Sacramento. I do know that the Consumer Credit Counseling Service of San Francisco (www.cccssf.org) offers credit and bankruptcy advice over the phone and the Internet.

If your friends would like to do some research on their own, one of the best consumer- friendly guides to bankruptcy and credit is offered at Nolo.com (www.nolo.com.) Their books are good. Your friends can profitably spend some time on their website gleaning information.

And they can always consult with a bankruptcy attorney to talk through their options.

06/02/08 by Chris Farrell

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Heloc vs. Student Loans

Question: Is it better to use money remaining in our HELOC, money in our savings account or to take out student loans to pay for our daughter's college tuition ($49,000.00)? Linda, Los Angeles, CA.

Answer: We've been getting many more questions about equity loans recently. When it comes to paying for college my approach is a mix of student loans, work-study, and parental savings.

I am wary of parents taking out home equity loans for college. The reason is that for most of us one of the best financial moves we can make is to enter our retirement years without a mortgage (or at least a minimal mortgage). This way the home is a critical part of our financial safety net.

In sharp contrast, your daughter has a lifetime of earnings ahead of her. It makes more sense for her to borrow for her education, and for you to help her out along the way (perhaps even after she's graduated) so that she doesn't end up with too much debt.

06/03/08 by Chris Farrell

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Home Equity Loans?

Question: A) Love the show. B) In these uncertain economic times, am I better off getting a Home Equity Loan, or a Home Equity Line of Credit? Oh, and, what the sam-hell is the difference? Joel, Milwaukee, WI

Answer: I'm glad you love the show. Let's do the definitions first. A home equity loan (also called a second mortgage) is a lump sum of money. You pay it back on a regular basis over time, just like a mortgage. A home equity line of credit allows you to write a check (or use a special credit card) whenever you need to borrow against the equity in your home. The interest rate is typically fixed with a home equity loans, and the rate fluctuates (depending on the market environment) with a home equity line of credit. In both cases the equity in your home acts as collateral.

In general, a fixed-rate home equity loan is tailor-made for major remodeling projects, such as a new kitchen or bathroom. The variable-rate home equity line of credit is better for smaller projects that are accomplished over a longer period of time.

Now, I'm in the camp that says the money borrowed against the equity in your home should go toward improving the value of your home and the joy you get from living in it. This isn't money you tap for expensive vacations.

However, one additional advantage of a home equity line of credit is that it can be part of your emergency savings. In case of a financial emergency, say a major medical bill or a lost job, you can use the line of credit to help tide you over.

06/05/08 by Chris Farrell

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Bankruptcy? Credit Counseling? Where to Turn?

Question: Hello Chris, I am a thirty year old male living in Asheville, NC. I currently have over 20,000 debt to a private student loan lender (Loan to Learn) which is a consolidation of a previous loan plus an additional amount from L.T.L. The school I attended did not participate in the Federal student loan program or I would certainly have opted for that instead. I have not been in school for the last year but have filled out the FAFSA for the 08-09 school year and am considering going back. I am in serious default of my private loan right now and in no financial state to 'catch up' in the manner they wish. They allowed me to apply for forebearance, then denied me due to being in default. I have been regularly ignoring their daily phone calls for some time now. I am wondering, if I return to school is it possible to transfer or consolidate my private loan over to a federal loan where I would have drastically better interest rates, lower payments and the possibility of forebearance? Are the re any other options to begin working this matter out? In addition I also have two small credit card debts. They are far more feasible for me to deal with right now and the cards have been destroyed. Should I consider bankruptcy?? I am engaged to be married soon and hope to start a small business with my brother in the next couple years. In other words, I am thirsty for any knowledge about how I can begin to relieve myself of this awful financial dilemma! Thank you for your time! I really hope to hear some feedback! Sincerely, Ryan, Asheville, NC

Answer: A few specific points: Declaring bankruptcy won't get rid of your student loans. You can't "discharge" student loans in either Chapter 7 or Chapter 13 personal bankruptcy. You never want to mix private student loans and federal student loans in a consolidation. The reason is that federal consolidation loans offer far better benefits than private ones, and you don't want to lose those by putting the two very different species of student loans together.

You could also visit with a credit counselor to get advice. In earlier posts, I've recommended the Consumer Credit Counseling Services with the National Foundation for Credit Counseling (www.nfcc.org). There is an office in Asheville, the Consumer Credit Counseling Service of Western North Carolina (www.cccsofwnc.org).

You have a lot going on: A big debt burden, a desire to head back to school, getting married, starting a business with your brother. My advice is to slow down. There is a season for everything, and it seems to me that you need to make some priorities. Right now, the big priority in your life is to sit down with your fiancé and go through all the financial options. The two of you should gather information together (such as both of you visiting with a credit counselor). The two of you need to come up with a mutually agreed upon plan for handling the debt and getting you to school.

06/06/08 by Chris Farrell

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529 Plans

Question: My husband and I had our first child in February. Our budget has us paying off our student loans and credit card debt in the next 16 months. We'd like to put the money we currently spend on our student loans ($500 a month) and place it in a 529 fund for our daughter once both debts are paid off. I've seen a lot references to 529s, but was wondering if you could recommend some sources that provided guidance on how we can review the various states' 529 plans and their pros and cons. By the way, we plan on spending the money we've budgeted monthly on paying off the credit card debt to restore our savings as I stayed home on unpaid FMLA to care for our daughter after utilizing all my paid sick leave from work. We were able to finance the unpaid leave from our savings, which also depleted it (but was well worth it). Jennifer, Spring, TX

Answer: What a good use of savings. You had the money to do something important for your family. Bravo. The reason I'm posting this question is that your approach toward debt-and-savings is one I highly recommend: Pay down the debt, and when it's extinguished keep on setting aside the same amount of money into savings. It's a sound strategy for replenishing and building up savings.

The best resource for learning more about 529 college savings plans is at www.savingforcollege.com. It offers a good overview section for free. You will have to pay a modest price to get access to the detailed information. Check it out.

06/09/08 by Chris Farrell

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Co-Signer Rights?

Question: I am trying to negotiate with Sallie Mae to settle the loan amount: to get some principal forgiveness and in return I will pay them off in full on the settled amount. My purpose in this is simply to reduce the loss I have to take on this.

My question to you is, what are my rights as a co-signer? What can I reasonably expect Sallie Mae to do for me. They are not very responsive, it is hard just to find someone who will return my call. So, I just would value your comments on what I should, and should not, expect from them in the way of help. Your response would be very much appreciated, thank you. Jeff. Irvine CA

Answer: You're now responsible for the debt as co-signer. Go ahead and try to negotiate with Sallie Mae. It can't hurt. But since you signed a legal document you're on the hook for the full amount. Maybe they'll cut you a break. But it is under no obligation to make a deal with you.

I know it's too late, but your experience is why everyone needs to think very carefully about the financial risks before co-signing a loan. There are other ways to help someone out with their student debts (or any other debt for that matter) without taking on the obligation imposed by co-signing.

06/12/08 by Chris Farrell

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Merging Finances, Including Debt?

Question: I am 37 and getting married in three months to a gal who is 10 years younger than me. Financially, we're at different places in our lives and I am wondering what I need to do as we merge our lives together to protect my modest wealth and assets in case of a financial disaster on her part.

I've had my hard financial knocks in life, but have gotten to the point where I have a good job, good credit, own a condo, own a car, have money in retirement accounts, and my credit card debts are very low and manageable (and could be paid off quickly if needed). My fiancée has huge student loan obligations ($100k+) and damaged credit because she declared bankruptcy three years ago. Her debt is almost entirely student loan debt, so that does simplify things.

How would you proceed into such a situation? Please do not use my name if you answer this question as I do not want friends/family to be able to identify us should they hear or see the question. Thank you! Washington D.C.

Answer: Ah, romance. Poets, philosophers, and songwriters have long struggled to capture the mysteries of love and marriage.

That key question is this: Are all the financial issues out on the table, discussed, and the approach toward dealing with debts bought into by both of you? Are you on the same page about handling her student loan debt? Your credit cards? How much is each of you going to set aside in retirement accounts? What you need to do is really gain an intimate understanding of each others desires and fears about managing money as you go into this marriage. The rest is financial technicalities.

This is where a prenuptial agreement can help. Now, most people don't like the idea of a prenup. It isn't romantic. It has an aura of preparing for failure in the marriage. But look at it this way: A prenup can be a critical part of your money discussion. The beauty of a prenuptial agreement is that it is a vehicle, an impetus for full financial disclosure. Many couples like to write their own wedding vows. A prenup allows a couple to write their own marriage contract. It should cover all assets, including property and difficult-to-value holdings like stock options, businesses and professional practices, and academic degrees. You should also cover all debts, potential inheritances, and spousal support.

A prenup is a binding legal contract. That means you'll need lawyers to help both of you understand the document and to make sure the prenup does not violate any laws. Another way to handle it is a more informal, do-it-yourself approach. It isn't a legal document and it won't hold up in court, but it's a written understanding between the two of you. It's a way of getting both of you on the same financial page. The value lies not in the contract, but in the process.

Two books that might help your financial relationship: For Richer, Not Poorer: The Money Book For Couples by Ruth Hayden (Health Communications), and Prenups for Lovers by Arlene Dubin (Villard Books).

06/17/08 by Chris Farrell

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What Debts to Pay Off

Question: My husband and I will receive about $50,000 inheritance. He wants to use the whole sum to pay down our mortgage. I argue that we should pay down the higher-interest credit cards and car loans (about 6k in the former, 28k in the later). He argues that the sooner we build more home equity, the better. I say that we're losing lots of money on these higher interest products. I'm right? He's right? Split the difference? We're in our 40's, both employed in education, and have (hopefully) good retirement accounts. Nancy, Columbus, OH

Answer: First of all, in this case neither of you is wrong--or right. You'll be better off financially whether you decide to pay down the mortgage, get rid of credit card debts and car loans, or compromise on a mix of the two strategies. The bottom line is that you're getting rid of debt and your household balance sheet will be healthier.

That said, I'm with you on this one: From a financial point of view the best use of the money is to get rid of the credit card debts and car loans. Both have a higher rate.

Now, you'll still have some inheritance money left over if you eliminate the short-term debt. You could put that toward principal on your home. Or, in light of the recession, you might want to consider setting it aside in a safe place just in case you need it. You can always invest it in your home once the economy looks better.

06/19/08 by Chris Farrell

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Social Security Do-Over?

Question: This morning, rushing my kids to get them ready for school and myself to work, I overheard someone talk about borrowing from his/her own social security account, interest free. Please, Is there such a thing? Is there a website? I don't have a crises, though I lived below Houston and to the west of Christie Street when 911 happened, but I never looked for any help related to that. I'm a person in lots of debt, credit card(divorce) and student loan, single mother with two kids trying to start a new career, possibly start a small non-for-profit cultural center - lounge in my neighborhood. A loan such as this could be the answer. Thank you, Malu. Brooklyn, NY

Answer: What you heard was a report by Bob Moon. He looked into what can be called the Social Security "do-over." But it doesn't involve borrowing from your Social Security account.

When people retire early, say, at age 62, they take a reduced monthly benefit. Well, it turns out that you can change your mind, reapply, and get the bigger payments that go to those who wait to collect benefits. The catch? You must send the government a check covering the benefits you've been paid (But that payment is without interest or adjusting for inflation. That's probably where you heard the word "interest".)

For others that are interested in the Social Security do-over, they can check out the website of Laurence J. Kotlikoff, economics professor at Boston University. He's also the head of the financial-planning software company ESPlanner. (It's at www.esplanner.com.)

For instance, he ran numbers for me a while back for a couple who retire at 62, have $300,000 in savings, and an additional $100,000 each in retirement assets. They want their money to last until they're 100. If they apply for benefits at 62, each gets $17,921 a year. Fast-forward eight years. Had they waited until age 70 to file, they would get $31,005 each, for a total of $62,010 a year. To get those higher payouts now, they'd each write a check for $118,957. That's a hefty sum. But the cost of getting that same payout by buying the cheapest commercial annuity would be 40% higher. When you include earnings from the couple's other assets and factor in their 30-year time horizon, Kotlikoff calculates that their annual aftertax spending can go from $58,765 to $70,420.

Your concerns are far different. I would suggest that you get in touch with the National Foundation for Credit Counseling (NFCC) to deal with your debts. It's the largest national nonprofit credit counseling organization. Their website is www.nfcc.org.

06/23/08 by Chris Farrell

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