Ask Liz Weston

Get smart with your money

debt

Failed business loan strains couples’ finances

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Dear Liz: We took a home equity loan against our house to open a business in 2006. We also ran up credit card debt for the business. The business went under, and we’re struggling to pay off the loan, which is $150,000 (a $1,150 payment every month), and the credit card debt, which we got down to about $20,000 from $37,000. Is there any way to get relief from the loan since it was a legitimate business (a franchise we bought from another franchisee)? We don’t know what to do and have been taking money out of our savings to pay the debt.

Answer: Your home equity lender doesn’t care whether you spent the money on a “legitimate business” or an around-the-world cruise. The lender expects to get paid, and chances are it will, since you secured the loan with your house. Failing to pay a home equity loan can trigger a foreclosure.

If you have equity in your home, you may be able to do a cash-out refinance of your current mortgage to pay off the loan. You’d wind up with a bigger primary mortgage, but a longer payback period and a lower interest rate should reduce your total debt payments. Another option is to sell your home to pay off the debt so you can start over.

What you shouldn’t do is dip into your savings without a real strategy for resolving this debt. A session with a fee-only financial planner could help you understand your options. The planner also may suggest a consultation with a bankruptcy attorney.

Can you be too focused on paying off debt?

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It’s probably my Lutheran upbringing that makes me wary of extremism in any form. Moderation in all things, doncha know.

Lately, I’m noticing extremism when it comes to paying off debt.

People think they’re doing the right thing by targeting student loans and mortgages for early payoff. But they could be hurting themselves if they’re stinting their retirement funds or leaving themselves with too little financial flexibility.

Let’s take student loans. Their interest is tax-deductible. If they’re federal loans, they have fixed rates and a number of consumer protections, including the ability to delay payments if you run into economic hard times.

Once you prepay those loans, though, the money’s gone. You can’t borrow it back, as you could with a line of credit.

I just heard of another family that rushed to pay off student debt, only to face an emergency fund on fumes when the father was furloughed.

Mortgage pre-payers face a similar problem these days. Before the financial crisis, they could have opened a new equity line even if their incomes were diminished or non-existent. These days lenders are wary of anyone who’s lost a job, which can make borrowing against a home problematic when you’re facing a financial crisis.

One solution is to open a home equity line of credit and keeping it open and unused for emergencies. Another is to simply make sure your debt payoff strategy makes sense with your larger financial picture. If you’re not saving enough for retirement or emergencies, those should be your priorities long before you target low-rate, tax-deductible debt.

Monday’s need-to-know money news

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Help at financial crisisToday’s top story: How to work towards a debt free 2014. Also in the news: PayPal and credit ratings, finding the cheapest holiday gifts, and how to avoid financial pitfalls this Thanksgiving.

Tips for Paying Off Debt in 2014
Starting the new year off on the right foot.

Can PayPal Hurt Your Credit?
Conversely, could bad credit prevent you from getting a PayPal account?

Where to Find the Cheapest Holiday Gifts
Presents that won’t lead you to the poor house.

Have a Happier Thanksgiving by Dodging These Spending Pitfalls
The bourbon in the pecan pie doesn’t have to be top shelf.

The greatest, most underused credit card perk
Two words: price match.

Beware debt reduction offers

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Dear Liz: What is your opinion of debt reduction programs? I am constantly receiving mail from various companies, and I was wondering if they are legit. They claim they can reduce my debt, which sounds promising, but I am hesitant to get involved with them.

Answer: You’ve got good instincts.

Many of the companies sending out these solicitations say they can settle your debt for pennies on the dollar. What they often fail to mention is that the debt settlement process can result in your being sued by your creditors and having your credit trashed. That’s assuming they try to settle your debt at all, rather than just disappearing with any money you pay them in advance.

If you’re struggling with too much debt, you should make two appointments: one with a legitimate credit counselor (visit the National Foundation for Credit Counseling at http://www.nfcc.org for referrals) to see whether you qualify for a debt management program to repay your credit card debt, and another with a bankruptcy attorney (check the National Assn. of Consumer Bankruptcy Attorneys at http://www.nacba.org for referrals) to see whether a bankruptcy filing might be appropriate for your situation.

Why millennials have to be smarter than their parents

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Help at financial crisisNerdWallet recently published a fascinating study contending that high debt loads will prevent today’s college graduates from retiring before age 73. I have a few nitpicks with the study, but the underlying message is clear: millennials will have to be a lot smarter than previous generations if they want a decent, on-time retirement.

First, my nitpicks.  NerdWallet contends the current average retirement age is 61. It’s actual 62 for women and 64 for men, according to the most recent research by Alicia Munnell, director of the influential Center for Retirement Research at Boston College. (Munnell authored another interesting brief showing that the “real” Social Security retirement age is now 70, which gives people the same expected length of retirement they had back in 1940. Furthermore, an argument could be made to move it to 73 for millennials, who will live even longer than Boomers. I won’t make that argument, though, since I wouldn’t have to wait that long…I’m sure most others wouldn’t, either.)

The NerdWallet study also assumes that paying off student loans inevitably will prevent millennials from making significant contributions to their retirement funds for the first 10 years of their careers—years when they would get the most benefit from retirement contributions. Thanks to the miracle of compounding, $1,000 contributed to a retirement account can grow to $20,000 or more by retirement age. Wait 10 years to contribute that first $1,000, and your growth is cut by half, to $10,000.

So here’s what millennials should know:

Retirement contributions can’t wait. Retirement really has to be your top priority from the time you get your first paycheck. You can’t get back lost opportunities to save and nothing—including debt repayment—is more important than this.

Don’t be in a rush to pay back student loans. Federal student loans, especially, are flexible debt with a ton of consumer protections. If you can’t pay your student loans and contribute to a retirement fund, then consolidate your loans to a longer payback period so that you can put some money away for tomorrow. Yes, you’ll pay more interest on your loans, but that cost will be swamped by the growth of your retirement accounts once you factor in the tax breaks and compounding you’ll get. If you have a company match, the calculation’s even more of a slam dunk.

Get a better 401(k). Beggars can’t be choosers, and many millennials will have to take what they can get in this very tough job market. As they build their skills and networks, though, they should start looking for positions with companies that offer good 401(k)s with generous matches. In the meantime, they should contribute to any workplace plan that’s offered. No plan? Set up an IRA with automatic transfers to fund it. You’ve got to find a way to save if you want to quit work someday.

Helping family led to unpayable debts

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Dear Liz: I have $40,000 in credit card debt due to home healthcare I had to provide for my mom, who lived with me for six years before she passed away in 2011. I filed a Veterans Affairs claim on her behalf but just got a VA check for $344 with no explanation about whether this was all it was going to allow. If it is, I need to file for bankruptcy. I owe $18,000 on my mortgage and $32,000 on a home equity loan I took out in 2001 to help my son get on his feet after he finished graduate school and had his first child. I also had some credit card debt from helping my brother in 2009 when he had cancer and could not work and his wife left him so he had no income. I also have $20,000 in a money market account that I call my retirement fund. Is it protected if I were to file for bankruptcy? The economic downturn caused me to have to take a $700-a-month pay cut the first of this year that will reduce my annual salary to $55,000 if there are no more cuts or layoffs. If they were to close the business completely, my Social Security benefit will be $1,900 per month, compared with $3,400 that I take home now. I have always paid my bills, but Mom’s medical expenses really have taken a toll on my finances.

Answer: Your debt exceeds your income, and few people in that situation manage to pay off what they owe. But bankruptcy isn’t a get-out-of-jail-free card. Your home equity and your savings could be at risk. Had you actually put your money into a qualified retirement account, such as an IRA or a 401(k), it would have been protected from creditors. Just calling an account your retirement fund offers no protection whatsoever. A bankruptcy attorney familiar with the laws of your state can tell you what to expect. You can get a referral from the National Assn. of Consumer Bankruptcy Attorneys at http://www.nacba.org.

You also need to call the VA at (877) 222-VETS, or (877) 222-8387, to find out whether you can expect any more help. The VA does offer some long-term care benefits to veterans and their spouses who qualify for the aid. The time to request help, though, was when your mother was still alive.

Which leads us to the problem of your spending money you didn’t have to help people who may well have had other options. If your mother couldn’t get VA help, she may have had assets that could have paid for assistance. If not, she might have qualified for long-term care benefits through Medicaid, the federal healthcare plan for the indigent. Your brother also may have qualified for federal or state benefits. Your son may have had a rough time getting established, but he had a degree and a working lifetime ahead of him.

That doesn’t mean you should have thrown family members to the wolves. But it’s not clear you considered any other options before turning to credit. Sites such as Benefits.gov and the Eldercare Locator at http://www.eldercare.gov could have connected you and your family to resources that might have helped. Other family members may have been able to pitch in, or the people involved may have had assets to tap. If there truly were no other options, your assistance should have come out of your current income. If you have to borrow, then you really can’t afford to help.

As it is, your generosity has left you at the threshold of retirement with little savings and big debts. Let’s hope your family is as willing to help you in your old age as you were to help them.