Finally Facing It asks:
One of my projects for this summer is to finally face squarely our debt situation and deal with it. I’m totally of the stick-my-head-in-the-sand camp when it comes to money, and so is my partner, which is a very bad combination.
A few facts: We owe (big breath!) about $46,000 in credit card debt, some for good reasons and some not. We are a one-income family, plus my partner gets Social Security disability for a variety of health reasons. We own a house with a mortgage. My income is good, and our house is modest, but we live in a very expensive city. We don’t have extravagant tastes or habits, so we’re not adding to our credit card debt, but we haven’t been able to pay it down, and this has been going on for years now. Whenever I seem to be making progress, something like an expensive car repair puts me back to square one. I am contributing to retirement through my job and buying IRAs for my partner, so I have been “paying myself first” in terms of retirement planning.
So clearly my previous approach of “don’t have a plan, just send money to the credit cards whenever we have some extra in the account” has done bupkis, and I carry with me all the time the stress of this debt and the interest we’re paying. Time to do something!
What I’d really like to do is consolidate that debt so that we have one fixed payment per month, and I know what that payment will be, and I know that I’m making progress on paying it off (that is, I have a plan for how much above the minimum I should aim for). I’ve tried moving debt to new credit cards with 0% rate for so many months, but I’m still not making progress.
It seems to me that my options are as follows:
•Refinance our mortgage and take out enough cash to pay off the debt.
•Take out a home loan or a personal loan from the bank.
•Take out a loan from something like Lending Club or Prosper (but I don’t really know anything about these). [ed. Do not do this]
•Take out a loan from a company that specializes in credit card consolidation (but again I don’t know anything about these). [ed. Definitely do not do this]
Advice on any of these options, or do you have another option to recommend? I absolutely appreciate any and all advice you have to give! (And I did read through your archives on debt and have requested from the library a couple of the books you recommend. I know that one of the things I need to deal with is my emotions and mostly fear around money.)
If I can get all of our consumer debt into one place with a fixed payment and a lower interest rate, I know that the next steps are to make a budget and stick with it. I should have done all of this years ago, I know; I’ve just been so overwhelmed by the debt that I couldn’t face any of it. But I’m trying to be brave now.
Standard disclaimer: We are not professional anything other than academics. Discuss with a true professional and/or do your own research before making any life-altering decisions.
I then asked for some numbers. Zie sent me a very pretty spreadsheet:
||Current min. payments
*0% until 2/1/19, 16.40% after that
Credit score = 749 with FICO
Mortgage Interest rate current: 4.375%
Potential refinance rate ??. Refinance rates look higher than that right now
Zie sent me a picture of personal bank loans from hir local bank– the lowest rate was 8.85% APY for a 3 year loan, which seems like a non-starter given that HELOC loans look to be under 5% for a 10 year loan.
The generic rate I’m seeing online is 4.89% for a 10-year loan for $50,000. I put those numbers into a loan payment calculator and came up with a $528/month payment, which is already less than we’re paying in minimum payments to our credit cards, so I could pay extra each month.
Ok, there’s a lot going on here! And if we were MMM, we would also ask for a full accounting of income and every single budget item. And I am going to recommend that FFI sit down and figure all of that out as well, but I also don’t want to let the perfect be the enemy of the good. Focusing on one part of finances is better than getting overwhelmed and doing nothing, and debt repayment is a great first place to start.
Before I get into anything else, Step 1 is always the same. Figure out what all of your recurring providers are (internet, insurance, cell phone, etc.) and give them a call tomorrow and ask if they have any discounts available. FFI has a great credit score and providers are often willing to give good customers something for just asking. Do this also with the two Visas in the 16% range (especially Visa2– you should not be using that card unless they substantially lower their APY for you). See if you can get them to drop their rates while you’re figuring things out. Every penny you’re not giving them in interest can be applied to principal. It may seem like $50 here or there isn’t a ton, but it’s actually $50 PLUS all the interest you’re not paying on that $50 in the future. It adds up.
With that out of the way:
With money, as you note, there are always two systems. There’s the rational money system — what you should do if you’re homo economicus rationalus, and there’s the emotional system. The emotional aspect of money is different for everyone even if the numbers just based on money are the same. So definitely read the excellent introduction to Suze Orman’s otherwise terrible book about how to deal with the emotional aspects debt. She gets emotions. I don’t know how to help you sort through your emotions with money… for me, whenever I feel helpless and sick to my stomach I go into overdrive to fix things (this is why I’ve been doing so much political activism lately), but it is far more normal to try to ignore things when they get overwhelming (this is true! there’s research!). So it’s great that you’ve taken the first step and actually looked at things and realized that you can handle this. The only question is going to be how quickly you can get that $791/month back in your pocket, and that’s going to take some sacrifice and some self-knowledge.
If you had no emotions, you would consolidate all of your debt into a HELOC sometime before February. You would make those phone calls today and put every penny saved directly to debt. You would go through and see what in your budget could be cut for the duration and you would send that money directly to your debt. You might go through your house and see if there’s anything you could sell, and you might pick up a little bit of freelance work. You might even save mental resources by doing a temporary spending ban of one kind or another (why does this save mental resources? Because the answer is always, “no.”). You would put on hold the IRA contributions and all job-based retirement contributions except for what is needed for an employer match (because a 5% sure investment in debt repayment is better than a ~5-7% risky investment in the stock market).
But we are human and we have emotions. So you’re going to need to think about what motivates you, what demotivates you, and what causes the most and least amount of pain.
Consolidate or not?
First off, if you think there’s any chance that you’re going to put that money in a HELOC and end up with another 46K in CC debt at 16% interest a few years from now, do not do the HELOC. That may seem crazy, but that’s what happens to either a slight majority or a substantial minority of people (I can’t remember which) who consolidate high interest credit card debt. Since you haven’t been adding to your debt, you’re probably not in that population (though we can think of former bloggers who look at their credit limits as the answer to the question of how much they should spend). If you believe you are likely to just get into more debt, then cut up or literally freeze (in a block of ice) your credit cards now. Similarly, a person in that situation could still consolidate to a HELOC, but as soon as the debt is transferred, should immediately cancel all but one or two of hir CC and call the remaining CC companies to limit their credit to just what could conceivably be needed for emergencies. Again, it doesn’t sound like that’s you, but it is something to keep in mind.
Should you consolidate? That question also has mechanical and emotional parts. Mechanically, the answer is of course you should. Emotionally, people seem to have an easier time killing off debt when it’s a several debts rather than one big debt. That’s true if they use Dave Ramsey’s snowball method of killing the smallest debt first or the mathematically “highest interest rate first” strategy. The motivational benefit isn’t unlimited though– large differences in interest rates will swamp the motivational benefit from cutting up the debts. And I think 11% is a pretty large difference in interest rates– would being able to debt snowball or highest interest rate first make a difference of ~5K/year (46Kx0.11)? Probably not. One thing I would suggest is keeping your mortgage separate from the HELOC and to kill off that HELOC rather than putting them together and adding years to your mortgage. Alternatively, you could find some more 0% interest transfers and kill off those debts one at a time, but I get the sense you’re tired of doing that, and it’s not like 0% interest transfers are free or last very long. Cutting consumption and paying interest now will have big dividends in the future if you don’t just push it off to your future self.
Note that you may not be able to get a HELOC approved if it pushes you under 20% equity, or if it is approved the interest rates may be higher. So keep that in mind when deciding how much to consolidate.
Ok, so so far it looks like we’re recommending consolidating your debt to a HELOC, assuming you can get one under 5%. (You will probably still want to do this if it’s under say, 8%, but with more fire under you to pay it off ASAP. More than that and you’re going to have to look harder at transaction costs and how much it would cost to do more 0% balance transfers etc.) If you find you can’t get approved for a HELOC, or it takes time to get a HELOC, don’t give up hope. You can still get that debt down.
Don’t wait for the consolidation to go through to start finding more money to throw at the debt.
As you’re reading the various books on how to pay debt, you’ll want to be thinking about your money as a whole. I can tell you, not having to deal with a 16% interest rate drag is really freeing– all that money going to debt servicing can be used for goods, services, savings, etc. later and without any guilt. But to get there, you may need to make more temporary sacrifices than feels comfortable. You will want to look deeper into your budget and see if there are big or small changes that can get you closer to debt freedom. (If refinancing/HELOC were closer to 2 or 3 percent, I wouldn’t be pushing this, but 5% is still a drag on finances and it would be nice to just not have that.) Don’t just think in terms of monthly payments, but also in terms of how much you’re losing each month from debt (unless you find that really demotivating) and how much you save by paying it off.
An update from FFI:
We are looking into budgeting apps tomorrow so that we can figure out what we spend each month. One of the things that keeps me from paying more than the minimum is that I tend to keep hefty cash reserves because I never know what else we’re going to need to pay out during the month, which is one reason that I’m always in a panic. So we’re going to lay out all of our fixed and variable expenses. And I’m totally going to adopt your blogged strategy of an “allowance” for each of us each month. And I may, at least temporarily, adopt an envelopes-of-cash system for things like groceries and our allowances for each month.
Great! Get that monthly spending predictable. There are a lot of ways to do this. I’m lazy so I use MINT, but MINT sometimes screws up, so it works better as a back-up. While you’re just starting and while you’re in debt repayment mode, you will probably want to write down everything as you spend it (this will also cause to you to think twice about spending on luxuries, much like writing down what you eat increases your broccoli consumption while decreasing your donut consumption) or do a cash-only system like the one you are suggesting. If you do cash-only without a full month’s audit of what you spent the previous month, you will probably end up a bit short because you forgot some expenses– don’t let this discourage you. Think of the first couple months as practice. You’ll also probably forget a couple annual expenses that will come as surprises. Don’t beat yourself up too much when that happens, but make a note for your budgeting for next year. Here’s our omnibus budgeting post.
Once you know what you’re spending on, you’ll better be able to look at what you’ve been spending on and get your future spending to align with your values. You may see some things that are obvious– maybe you didn’t realize you were spending so much on lattes, to use the stereotypical David Bach example. It probably won’t be lattes, but just getting the numbers may be enlightening. If you don’t find easy places to cut, think in terms of what will hurt less. Or let your future self figure it out on the fly with the allowance or cash-envelope.
It sounds like just throwing extra money at the debt hasn’t been working, and you’re right that making debt repayment a regular extra bill (and smoothing out your spending) is probably what will work for you. While you’re feeling energetic about fixing your finances this summer, you will probably want to also throw extra money here and there at the debt– the earlier you pay off principal, the less you will be paying in interest in the long term. Some people get additional motivation from doing things like sticker charts (but without the stickers), or other ways to gamify the shrinking of the debt by celebrating each additional payoff.
Where do you get that extra money?
You mentioned overlarge cash reserves. Rationally, when you have debt at 16%, you should not have an emergency fund to cover anything you can put on a credit card. That money should go to pay the debt and new debt should be incurred in the event of an emergency. Emotionally, however, having an emergency fund can keep people from opening the credit card floodgates. One of the things you will want to examine is the size of your emergency fund. When you’re in debt-repayment mode, you probably want to keep this somewhat lower. Enough to say, handle a two week late paycheck or late travel reimbursement, or whatever is something you would not be wanting to grab your credit card to pay. After you’ve figured out your standard expenses and a way not to go over except in cases of true emergencies, you may want to re-direct some of these cash reserves to debt repayment. (Refill the cash reserves after you dip below your specified amount.) If you consolidate to a HELOC, that may be the point at which you no longer want to take the CC out for emergencies, in which case keep those cash reserves higher. Do what is best for your psyche even if it isn’t mathematically optimal.
Sidenote: After the debt is gone, you will want more cash reserves because you won’t want to put emergencies on credit card anymore. You’ll want this to be your last revolving CC debt if possible. While you’re paying debt off, you’re trading off savings account interest for higher debt interest. When debt is done, you’re trading off savings account interest for spending or uncertain investment returns, so keeping cash reserves makes more rational sense than it does when the alternative is paying off debt.
Retirement is another potential place to get money, but for your situation we do not recommend it. We agree with you that it’s better for you to keep investing in retirement for the duration. Mathematically it doesn’t make sense to keep investing for retirement (above the match) while carrying high interest debt. But in reality, getting out of the habit of saving for retirement and then getting back into saving for retirement sometimes means that you don’t get back into saving for retirement right away. If you were unable to reduce the debt from 16% to 5%, I might recommend you put all retirement saving other than what it takes to get an employer match on hold. If you were at 25% or more interest rates, I would definitely recommend it. Conversely, if your debt were all below 5% then I would say to definitely keep investing in retirement. With the information you’ve given me, I’d say keep doing what you’re doing with retirement unless you can’t get that HELOC.
If your math suggests you’re going to be paying off for the long-haul, another trick is to put any and all raise or bonus money directly towards debt. You’re unlikely to miss it (at least until grocery prices start going up…).
When you’re in debt repayment mode, there are also things you can do temporarily that we mentioned tongue-in-cheek earlier. These are gimmicks that nevertheless help people (especially if you blog about it as a challenge!) These all come under the header of “spend less” or “make more.” Temporary no-spending or “compact” (where you buy only used) challenges can be fun and enlightening, especially when they’re voluntary. No-spending days are pretty useless, but no-spending (or compact) months (or quarters or semesters or years) can help you figure out what you really value, what was just a habit (now broken) and how you can get creative about reducing consumption. If you’re at all LA, you can think of it as a spending cleanse. I also love reading about them on people’s blogs (when they’re actual no spending challenges and not ones with so many exceptions that they end up buying more luxuries than we do– those frustrate me). Selling used designer clothing on Poshmark is “in” on a lot of the blogs we’re reading about now, and craigslist and ebay sales are also popular. Even just a garage sale could generate a couple hundred dollars to throw at debt. (I wouldn’t do this kind of thing regularly, but if you’re jump-starting a massive debt-repayment, why not?) If you have marketable skills, you can try picking up some freelancing or contract work in those areas and dedicate that money towards debt repayment (minus estimated taxes). Dave Ramsey recommends any kind of side hustle, like delivering pizzas or waitressing, but we’re not going to suggest going that direction unless it’s something you enjoy or that helps your main career (if you had bad credit and couldn’t get those interest rates down, we’d be pushing side hustles harder, but you’re going to be ok, you just want to get rid of that almost $800 drain on your finances each month).
Final words of encouragement!
This is definitely doable! Every dollar you use to pay off the debt principal is money is freeing up money you would have wasted on interest. The sooner you pay it off, the sooner you will have more money to spend (or save) completely guilt-free. When my DH came into our marriage with unsubsidized high interest student-loan debt, I would look at how much money we would be losing on debt servicing (unsubsidized loans keep growing in graduate school even if you don’t pay them off!) and it motivated me to get rid of it. I wanted that money back! You too can get that money back! It may take some temporary sacrifice, but it will be so nice when that drain is gone. And the great thing about debt is that the more you pay, the easier it is to pay the rest because you’re no longer servicing the entire amount of the debt, only a fraction. The more you pay off, the less interest you pay, the more money you have to pay off more debt. It’s completely unlike food diets. You can do this!
Do you have words of advice or encouragement for FFI? Do you love a good debt repayment story?