The sky has fallen, and a lot of us are in over our heads in debt and worry. But the recession doesn’t have to be a bad thing. Just as a company can emerge from a bankruptcy as a more stable, more efficient business, you too can use this economic downturn as a time to reflect on your finances and lifestyle and reinvent yourself for the better. After all, what doesn’t kill us will ultimately make us stronger. These tips will help you survive the tough times and come out smarter and stronger and ready to tackle the next bump in the road.

Cut Costs

Survive: Eliminate Nonessentials. Cable TV, landlines, data plans on your cell phone, broadband Internet, movie theater tickets, fast food, takeout, top shelf liquor at the bar, soda pop and everything else you don’t need has got to go. Believe it or not, you can live without these things. It may feel like torture to go the whole day without your morning soy chai latte, but it’s better to sacrifice these mini-luxuries now than to have your heat shut off next December. Start living within your means now.

Thrive: Better Yourself. In addition to being expensive, much of our nonessential habits and expenditures happen to be mind-numbing and unhealthy to boot. Instead of spending hours in front of the TV, visit the library and get a book or plant vegetables in your own garden. Instead of grabbing a burger at the drive-thru, have a nice, healthy home-cooked meal with some friends. Instead of watching 30 second clips of cats watching TV on YouTube, go for a run, or a walk or do anything to get off your duff and on your feet. Replace the time-wasting money drains on your life with educational and inspirational activities that will make you feel better about yourself and keep your finances in the black.

Give and Receive Free Stuff

Survive: Make Do Without New. With an eye towards conservation as well as thriftiness, now is the most critical time to be resourceful and innovative. New clothes, new cars, new TVs and anything else shiny and expensive are luxuries that few can afford, and, in reality, luxuries that few should afford. Furniture, computers, textbooks and numerous other essentials can be obtained on the cheap if you buy them used. And because others are eager to turn their possessions into cash, you can often find excellent deals when shopping around on Craigslist or eBay. You can also get items for free from services such as FreeCycle.

Thrive: Do it Yourself. Leaky faucet? Creaky door? Smelly carpet? Instead of paying a professional to come fix it, do it yourself. You’ll learn a new skill and save a substantial amount of money. If you are unsure where to begin, ask a friend to help or give you some pointers. You can also visit your library for books on home improvement and simple repairs. You can often rent any special tools needed or borrow them from a neighbor. Once you fix one thing in your house, you’ll likely be inspired to check off more of those items on the “Honey-Do” list. Maybe you’ll even increase the value of your home while you’re at it.

Clean Up Your Balance Sheet

Survive: Tackle Your Debt. Interest payments, late fees and dings to your credit rating are a vampire on your present and future finances. A solid debt reduction plan is a stake to the heart of the forces that are systematically draining your capital. Depending on your situation, you may need to consider debt counseling or debt consolidation. If you aren’t in too awfully deep, though, you can begin chipping away at your debt with a solid plan of action (consider the debt snowball method) and a newfound resolve. Pay down high interest debt first, don’t let any payments go delinquent and don’t rack up any more debt along the way.

Thrive: Build Your Emergency Fund. If you have your debt under control, the next step is to create a backup plan so you can avoid going into debt again. In these times, a bit of extra money to squirrel away seems like a vast luxury. But by cutting back on some of your discretionary spending – a coffee a day, a night out at the movies, a new electronic gadget – you can begin building up a solid cushion. Of course, don’t even think about stashing money in a savings account until you’ve paid down all your high interest debt. As long as the interest rate on your loans is higher than the interest rate on your savings account, CD or bonds, then you’re wasting your time.

Take This Job and Shove It Thank Your Lucky Stars

Survive: Keep Your Job, or At Least Keep In Touch. Now’s not the time to be picky. Bankruptcy looms everywhere. With the economic stress worldwide, your job may become especially taxing and your superiors may become increasingly irksome. But now’s not the time to complain or drag your feet. Be a team player and pitch in a little extra to help the company get through these rough times, even if there are no immediate rewards. Because in the end, the grand prize may ultimately be your job. If you do get the pink slip, don’t make yourself a victim. Being laid off is better than being fired – take the termination with class, thank your employer for the opportunity and stay in touch. Ask if there is anything you can do to help in the meantime, even though you won’t be employed and when things turn around, you’ll be at the top of their list to call back.

Thrive: Rise Above the Chaff. If you were lucky enough to survive the last round of layoffs, now’s the time to shine. Your company’s workforce is now much leaner and with so many vital positions cut, there will be ample opportunity for you to rise to the occasion. Pick up the slack where your fallen colleagues have left off and make your boss glad that he chose to keep you around. Your willingness to tackle extra responsibility will make you indispensable if the ax falls again, and will make you a shining star when it comes time for promotions.

Hedge Your Bets with a Paying Hobby

Survive: Hone a New Marketable Skill. You never know when your main source of income will disappear. Take the time now to expand your marketable skills in case you have to start updating your resume. To make it relevant, take a class or a pickup a book that can apply to your current job or hobby. That way you can justify the time commitment in the near term as well as appreciate the skills you’ve gained in the long run.

Thrive: Start a Side Business. Turn your hobby into cash by starting a side business. You’ll find it fulfilling as well as fiscally rewarding and you’ll have some extra income to fall back on if things go south with your main gig. Enjoy writing? Start freelancing for web and print publications or start a blog. Into crafts and collectibles? Start an eBay business. Good with computers? Start a computer consulting business. By monetizing something you enjoy, you may also be launching the career of your dreams in the process.

Keep Your Head Up

Lastly, it’s important to keep your head up. Count your blessings if you have them (and you most certainly do) and don’t despair. If you feel like you’re at the end of your rope, talk to someone. You may discover that you’re not alone and you may find inspiration and ideas where you never thought to look for them. An economic downturn – whether global or personal – will be the end of rampant spending and living beyond your means. But it isn’t the end of the world. Stay strong, stay diligent, and you’ll emerge as a savvier consumer and a happier person.

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The program caught my eye, because it looks like a fantastic arbitrage opportunity!

ARC Loan Program

The loan program offers loans to small businesses 100% backed by the small business administration. The idea is to help businesses experiencing hardship, which includes declining revenues; common for many small businesses right now. The loans are structured as follows:

Loan Terms. Loans up to $35,000, at 0% with no fees. No collateral is needed.

Repayment. The loan money is distributed over 6 months. Repayment begins one year after the last distribution and can last up to five years.

Time Frame. The loans will be offered until September 30, 2010. It will end sooner if all the funding is used before then.

ARC Loan Eligibility

To qualify for the ARC loan, businesses must meet the following criteria:

• Show profits in one of the past three years.
• Show cash flow projections for the next two years to meet loan payments.
• Established business, in operation for at least two years.
• Current on all debts, or no more than 60 days past due on any loan.

Arbitrage

I’ve been a fan of using 0% balance transfers for credit card arbitrage for a long time. This is another opportunity to keep that arbitrage wheel spinning!

You’ll need some current business debts to qualify, which can include credit card obligations. Since we’ve used business cards to super-size our credit card arbitrage in the past, we’ll have plenty of “business debt” to show.

Action Plan

Our business will hit the 2 year mark later this year, so I’m planning to submit an application. Because I’m taking time off this summer, I’ll have no problem showing a decrease in revenue!

What a fantastic way to convert some 0% balance transfer money into five years at 0%!

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Unfortunately, I’ve found that many of the details aren’t on the general MakingHomesAffordable.gov site. Instead they are buried in supplemental directives written for the lenders. Luckily, they are all available to us, so we can get the additional information we need.

Here are some of Laura’s questions about the loan modification. I’m sure that many of you considering the loan modification have some similar questions.

Loan Modification Q & A

We have about $10,000 in savings. Are we expected to use up all our savings before we will be considered for a loan modification?

Not necessarily. The loan modification program allows you to exclude an emergency fund, which they define as equal to three times your monthly debt payments. So if the $10,000 is your only cash reserves, then they will not require you to use it first.

We own two vehicles outright that are valued at around $10,000. Do we need to sell those before we apply?

Cash reserves are defined as cash, savings, money market funds, marketable stocks and bonds. Their is no mention of having to sell your vehicles before qualifying for a loan modification.

We have about $25,000 in retirement accounts. Do we need to raid those first before we can get a modification?

Retirement accounts are excluded from the calculation of cash reserves, so they will not expect you to use any retirement money before getting a loan modification.

I remember you had a post about you and your husband possibly applying for a loan modification (Would You Take a Loan Modification?).

But I would imagine that you are not having trouble paying your mortgage since you and your husband seem to be really smart with your finances. What would you write in your financial hardship letter? And do you know if it makes a difference that you leaving your past job was voluntary?

Thanks for the compliment. You are correct, we are not having trouble paying our mortgage. However, one of the hardship choices is a reduction or loss of income that was supporting the mortgage. It does not specify the cause of the lost income. I would reference that hardship reason, and be honest about the circumstances.

When I spoke to some of the servicers, it did not seem to matter that me leaving my job was voluntary (I can see light bulbs going on in people’s heads reading this!) However, three months after I left my job, the position was eliminated, so I would be sure to include that.

I’ll be writing more about our adventures with a possible loan modification in the future…. so stay tuned!

I am hoping to modify my mortgage because it currently takes up 51% of our gross income. We definitely qualify for a modification according to the numbers, but, we haven’t suffered any life changing event such as a job loss, loss of work hours, or sickness.

The hardship criteria is based on “are you having trouble paying your mortgage?” not necessarily a life event.

Here are all the types of hardship from the supplemental directive. You’ll notice that only the first four reasons reference a change of events. Options 5 and 6 reference a shortage of money, but no “life event” so there appears to be a lot of room in the hardship definition.

Hardship Affidavit

Every borrower and co-borrower seeking a modification, whether in default or not, must sign a Hardship Affidavit that attests to and describes one or more of the following types of hardship:

1. A reduction in or loss of income that was supporting the mortgage.
2. A change in household financial circumstances.
3. A recent or upcoming increase in the monthly mortgage payment.
4. An increase in other expenses.
5. A lack of sufficient cash reserves to maintain payment on the mortgage and cover basic living expenses at the same time. Cash reserves include assets such as cash, savings, money market funds, marketable stocks or bonds (excluding retirement accounts and assets that serve as emergency fund – generally equal to three times the
   borrower’s monthly debt payments).
6. Excessive monthly debt payments and overextension with creditors, e.g., the borrower was required to use credit cards, a home equity loan, or other credit to make the mortgage payment.
7. Other reasons for hardship detailed by the borrower.

Making Home Affordable Lender Information

Want to find out all the other details about Making Home Affordable? Check out the materials and website that are targeted to the lenders:

• Home Affordable Program Administrative Website for Servicers
• Supplemental Directive 09-01 – Home Affordable Modification Guidelines
• Supplemental Directive 09-02 – Home Affordable Modification Guidelines

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The government has determined that even if you receive a loan modification on your first first mortgage, having an unaffordable second mortgage could still put your at risk of going into foreclosure.

Second Loan Modifications

Here’s how the second loans will be modified:

Amortizing Loans

• Reduce interest rate to 1% for 5 years, then step up to the rate on the first mortgage after modification.
• Extend the term to match the term of the first mortgage after modification.
• Provide principal forbearance in the same proportion as the first mortgage.

Interest Only Loans

• Reduce interest rate to 2% for 5 years, then step up to the rate on the first mortgage after modification.
• Adjust the amortization time period.
• Provide principal forbearance in the same proportion as the first mortgage.

Second Lien Program Details

Incentive Payments. In addition to the modification, borrowers can receive $250 incentive payments per year for 5 years, applied to the first mortgage.

Loan Forgiveness. Instead of a modification, lenders can also opt to extinguish the second loan all together for a larger incentive payment.

HELOCs. There is no mention of including second liens when there is a home equity line of credit instead of a loan. We’ll have to wait for more details to see if they specifically include them or exclude them.

Helpful Links

• Second Lien Press Release
• Second Lien Fact Sheet
• Second Lien Case Examples
• List of participating Lenders
• MakingHomeAffordable.gov

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In a weird twist of events, it looks like we qualify (on paper) for the loan modification program.

Home Affordable Modifications

To find out of you are eligible for the Home Affordable Modification you need to answer these questions from MakingHomesAffordable.gov:

1. Is your home your primary residence?
2. Is the amount you owe on your first mortgage equal to or less than $729,750?
3. Are you having trouble paying your mortgage?
   For example, have you had a significant increase in your mortgage payment OR reduction in your income since you got your current loan OR have you suffered a hardship that has increased your expenses (like medical bills)?
4. Did you get your current mortgage before January 1, 2009?
5. Is your payment on your first mortgage (including principal, interest, taxes, insurance and homeowner’s association dues, if applicable) more than 31% of your current gross income?

Ironically, I can answer yes to these questions since I left my job. Number 3 has some gray area, since technically, we did have a significant reduction in income, but it was voluntary on my part.

However, because my job was actually eliminated a couple months after I left, I did confirm with the housing counselors that it would qualify. Their definition of “trouble paying your mortgage” is based solely on income from a job (or self-employment) and doesn’t include all of our alternative income sources.

Do We Need It?

No. When I left my job, I set aside money in CD Ladders to cover our yearly expenses.

The bank’s requirement of “31% of your current gross income” doesn’t include passive income, living off of retirement income (unless you are actually of retirement age), or the use of CD ladders. Ultimately, it would never occur to a bank that all of a household’s income doesn’t come from a JOB in their underwriting.

So while it looks like to the outside world that we can’t afford our mortgage; we’re perfectly fine. I realize we’re in a very unique situation, though.

How Much Would We Save?

Just for fun, I calculated the after tax savings if we were to use the loan modification program. It would save us over $60,000 over the first five years. And because the rate only adjusts 1% each year after that, there would be more savings in years 6-8.

That’s not small change!

Ethics of a Loan Modification

I have lots of questions about the ethics of using this program. Where does this program fall?

For example, many people will get to take advantage of the $8,000 First Time Home Buyer Tax Credit, who were planning to buy a house anyways. Is this along the same lines?

If we were to use the modification, does it take away the ability for others to use it who really cannot afford their mortgage due to losing their job?

I’m a taxpayer who reports all my income, so I’ll be helping fund this very program with my tax dollars. Does that make a difference?

Your Thoughts

My lender isn’t participating anyways, so it’s not possible for us to take advantage of the program, whether it’s right or wrong.

But I thought it would be a great topic of discussion. I’m sure many of you have very strong opinions on the topic!

Would you take a loan modification if you qualified?

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How to Get Your Free Credit Score

1. Enroll at Credit Karma.
2. Verify your email address and personal information to obtain your score.

Really, that’s it! It took me less than two minutes to sign up!

Additional Credit Information

Once you get your score, you can utilize additional fun features:

• Credit Compare: View what percentile your credit score falls in for all Credit Karma users, your state, and your age bracket.
• Credit Simulator: Predict your future score by changing some of your information. For example, what will closing some cards do? Obtaining a new loan? Inquiries?
• Credit Snapshot: Find out your adverse action factors. These are the reasons your score is what it is, and you commonly see them listed on adverse action notices from financial institutions.

Credit Karma Credit Score

There are thousands of credit scores available, so this one isn’t going to match the one your insurance company uses, or the ones your bank uses, since it’s not a FICO score. But chances are, it will be close enough to give you an idea of your credit worthiness. The Credit Karma score is based on a scale of 300 to 850.

I didn’t have my FICO score handy when I enrolled at Credit Karma, so I’d be interested to hear some data points for those of you who check your Credit Karma score, and FICO score on the same day!

Credit Karma Details

Underlying Credit Report. Credit Karma uses the TransUnion credit report to calculate the score.

Credit Karma Blog. Credit Karma also operates a company blog.

Credit Reports

Credit Karma doesn’t give you access to your credit report. If you want to get your credit report along with your credit score, you can check out the following options:

• Free FICO Scores & Credit Reports
• Free Credit Report and Scores

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There are two components for home owners, refinancing and loan modifications. Participation is voluntary and the lender has to choose to participate. Details of both plans are below.

Home Affordable Refinance

Borrowers who haven’t been able to refinance because their home value decreased now have an option to refinance into a 30 or 15 year, fixed rate loan.

Eligibility is as follows:

• Your loan is is owned or controlled by Fannie Mae or Freddie Mac.
• You are current on your mortgage payments.
• You have stable income to support the new mortgage payments.
• Your first mortgage will not exceed 105% of the current market value of the property.

Want to find out your FICO score before you refinance? Get your Free FICO Scores & Credit Reports.

Home Affordable Modifications

Requirements for the loan modification program are:

• Your loan must have been obtained on or before January 1, 2009.
• Have a first mortgage with a balance less than $729,750.
• Be owner occupied in a one to four unit property.
• Document income with signed IRS 4506-T, two most recent pay stubs, and most recent tax return.
• Sign an affidavit of financial hardship.
• Modify by December 31, 2012.
• Have a mortgage payment that is no longer affordable, examples include significant change in income or expenses.
• Go to counseling if household debt is more than 55% of income.

The loan modification will lower the interest rate to make the payment (principal, interest, taxes, insurance, and home owners association dues) 31% of income. After five years, the rate will adjust 1% each year until it reaches the prevailing market interest rate on the date the modification.

In addition, there may be an incentive payment for borrowers for on time payments. Over five years the total principal reduction is up to $5,000.

Making Home Affordable Program Plan

Complete details, and a tool to find out if you are eligible, are listed at Financial Stability.gov or MakingHomesAffordable.gov:

• Borrower Q&A
• Summary of Guidelines
• Fact Sheet

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One of the sad things I found when helping my brother-in-law get out of debt, was that he couldn’t even remember where he spent most of the money. Without knowing where the money went, it’s hard to make the connection to your daily life and your debt.

Emotional Debt Payoff

In How to Pay off Credit Card Debt, we discussed some common methods to pay off debt, including paying the highest interest first or the smallest balance first.

Here’s a different approach, one that helps you make the emotional connection to your debt.

1. Itemize. Go through your debt to find out exactly what you purchased.
2. List Amounts. Make a list of each item with the amount.
3. Rank Your List. The first item should be the one that bothers you the most. Now that you know you’re paying 15% interest to sit on your new living room couch each day, how does it make you feel? If it’s lousy, pay it off first. Or if you have $100 worth of charges from dining out, and it kills you to know you’re in debt for food that is gone, make that first on your list.

   Here’s an example of what your list might look like:

• Dining out: $100
• Lawn Mower: $200
• Furniture: $900
• Kids Toys: $50
• Clothes: $600
• Interest and Late Charges: $250
4. Print Your List. Hang it where you will see it often.
5. Pay It Off by Item. Here’s where we skip the traditional payment methods and get creative. Attack the debt with the biggest emotional impact first (the item ranked first on your list).
6. Brainstorm Strategies. Find ways to pay off each category faster. For example, don’t allow yourself to purchase any more kids toys until you’ve paid off the ones on your debt list first. Or put a freeze on dining out until you’ve paid off that category. Could you sell the lawnmower on craigslist and buy a cheaper one to get the job done? The more connections you make between your debt and daily activities, the more you’ll succeed.
7. Celebrate. As you pay off each item, you’ll be able to celebrate the victories, both in terms of money and emotional attachment.
8. Follow Up. Mark a date on your calendar three months out. Compare how far you’ve come, and rerank your list if necessary.

My Story

I actually used this strategy when I took money out of savings to cover my last maternity leave. I wanted to build back up the savings, but just looking at a $10,000 number wasn’t very motivating.

When I put it into the perspective of purchases, I was able to work much harder to build back up our savings. You can see how the strategy would work for either replenishing a savings account or paying down debt.

Emotional Attachment

While we can all say that it’s purely math and money, the truth is that debt takes an emotional toll on your life; especially now, when many people are feeling the effects of the current economy. The more emotional baggage you can shed, the better. By dividing your debt into individual purchases and paying off the debt that disturbs you the most, you’ll be happier.

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Because his credit report was trashed from late payments, collections, and settlements, he wanted me to check into the statute of limitations for credit reporting. Originally, we didn’t explore an avenue of disputes or other credit repair, since all the negative actions were correct. Five years ago, we discussed that he would have to “wait it out” for him to prove that he can handle credit again.

Obtaining His Credit Report

He got a free copy of his credit report from Annual Credit Report. In addition, he wanted to see his credit score, so I showed him the offer for Free FICO Scores & Credit Reports. Armed with the information of his financial past, he was ready to take some action.

Statute of Limitations

For all debts after December 29, 1997 the reporting period is 7.5 years. The clock starts ticking on the date of the last missed payment; 7.5 years from that month, the negative trade line remarks must not show on the credit report.

It’s common to believe that taking action on the debt will start the clock over, however, that’s a misconception (one that I didn’t know about either!)

The following events do not restart the clock:

• The creditor writes off, sells, or transfers the debt.
• You sign a payment agreement with a collection agency.
• You dispute the debt or negative remark with the credit bureau.
• You make payments or other activities on the account.

This point is worth restating: if you make payments on the debt, it does not restart the clock!

Please note, that some states have their own laws. Be sure to check your home state. In addition, the reporting laws for bankruptcies are different.

Once the reporting time period expires, it’s OK if the trade line still shows up on your credit report. It’s the negative trade line remarks from the action that began over 7.5 years ago that cannot show up.

Next Steps

Now that he has the information for the statute of limitations, he can dispute any negative remarks from over 7.5 years ago. As time goes on, his credit will be restored, and he can begin house shopping!

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Originally they were able to keep them current and had good credit ratings. Unfortunately, when the husband lost his job last summer, they fell behind on the credit cards and the penalties are piling up. Now they are considering bankruptcy. Brenda wants to help, but doesn’t know how.

Meet My Brother-in-Law

I thought this would be a great time to share with you the story of my brother-in-law. He was in a similar situation, racking up credit card debt.

When he found himself without a job, he stopped paying on the cards. Collection agencies, phone calls, sky high penalties and interest made it almost impossible for him to recover, even when he found a new job.

Back in 2004, he called me for some help. After a very open and frank discussion about how we would need to handle this, he gave me power of attorney and access to all his accounts.

Getting Out of Debt

Once I took over, here’s what I did:

• Get organized. The first step was to try and figure out how much he even owed and to whom. He gave me a box of papers and unopened mail, and I pieced together his financial world for the first time.
• Make a list. I listed every credit card and debt, the amount owed, if it was past due (or in collections), and the interest rate.
• Figure out a budget. I put my brother-in-law on a strict budget, giving him only enough money each week to keep food in his stomach. Until we could get things under control, there wasn’t any money for entertainment or frivolous spending. It was rather harsh, but it was temporary. The rest of his incoming money was earmarked for getting the debts under control.
• Keep paying on current cards. Any card or loan which was current, keep it that way. It’s one less account that will have a negative history on your credit report. If all the cards are current, you can use How to Pay off Credit Card Debt as a resource.
• Call on past due accounts. For the accounts that hadn’t gone into collections, but were a month or two late, I called to find out how much it would take to bring the account current and paid it immediately, if he had enough money. If he didn’t have enough I asked how many days we had before it would be turned over to collections.
• Forget about bankruptcy. He wanted to declare bankruptcy, and even saw a lawyer. I told him that wasn’t going to happen, so forget about it. The long term repercussions from declaring bankruptcy would be much more harmful; in addition, it wouldn’t have taught him anything about the responsibility for his actions.

Dealing with Collections

Once an account went into collections, it seemed I was playing a whole new game. Here’s how I handled that part.

• Do your research. I spent a lot of time doing research at the Credit Boards forum, specifically the beginner index (you need to register to access the index). The transcripts are a little difficult to follow, but there is a “Cliff notes” for each transcript that helped summarize the information. Since I hadn’t ever been in a similar situation myself, I needed all the help I could get.
• Calculate Actual Charges. For each debt that was in collections, I calculated the actual charges versus the interest, late fees, and over-limit fees. He felt that he was responsible for paying what he actually bought. What I found was that many times the actual purchase was less than half the total debt. It was sad to see that a $900 purchase could turn into a debt over $2,000 in just a few months.
• Save Up. Each month I took all his leftover money after paying the current accounts and put it into a savings account at ING Direct. Once I had saved enough to cover the actual charges, I called the company and offered to pay that amount in full that day to settle the account. Every single time, they were more than willing to accept it. One by one, we settled each account.
• Wait it Out. It takes time. A lot of time. It took time to build up the debt, and it takes time to repay it. At the end of the year, when I turned his accounts back over to him, we’d made a huge dent, but he still had a long way to go.

Taxes and Retirement

Taxes. Taxes are a big part of settling debts because the forgiven debt is considered taxable income. It’s something a lot of people don’t realize when they settle accounts.

Retirement. I felt is was very important that my brother-in-law not only pay off his debts, but begin saving for his retirement. At the same time that he was aggressively paying off the debt, I enrolled him in the government TSP program and opened a Roth IRA.

The contributions to the retirement accounts allowed him to lower his tax bill substantially, because he was able to qualify for the the saver’s credit.

Next Steps

I’ll be back later with Gettin’ Out of Debt: Part II in my brother-in-law’s gettin’ out of debt story!

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Here’s the situation that he is dealing with (see the story for all the details):

• Personal Line: $3,500 balance @ 15% – $7,000 limit
• Credit Card #1: $2,300 balance @ 9.6% – $5,000 limit
• Credit Card #2: $6,600 balance @ 8.5% – $8,000 limit
• Credit Card #3: $1,900 balance @ 18% – $2,000 limit

He has $1510 available each month for payments and $9300 in company stock and upcoming bonus money available.

What I Would Do

I promised that I would put together a plan for him in paying off the debt. If it were me, here is how I would handle the payoff.

1. Pay the minimums on all cards.

It’s important to avoid late fees, overlimit fees and other penalties for not paying the minimum. Make sure that each month all minimum payments are made before any other strategies are used.

2. Evaluate the utilization percentages.

This is a key piece of debt paydown that many people skip. People often believe that they can’t get a new card with a lower interest rate; however, a few key changes to utilization could make all the difference (assuming there are no adverse credit report problems like bankruptcies, late payments, etc.)

Credit card #2 has used 82.5% of the limit and credit card 3 has used 95% of the limit. Ideally, his balance should be less than 50% on all cards; they should absolutely be less than 90%. Pay $980 on credit card #3. This will lower card #3 to less than 50% utilization.

3. Pay cards with highest interest rate.

After paying the minimum, and the high utilization card, use any leftover money toward the card with the highest interest rate. Each month, continue to direct all extra money toward the card that has the highest rate. First pay extra on credit card #3 at 18%, then the personal line at 15%.

4. Ask for a reduced interest rate.

Call all the companies and ask for a reduced interest rate. The worst they can say is no, right?

5. Check your credit report.

A few days after the end of the billing cycle for card #3, order your credit report to be sure that all the cards have the utilization updated. You should see a bump up in your credit score too.

6. Use a 0% balance transfer.

Here’s where adjusting the utilization and checking your credit report will pay off. Use the list of 0% Balance Transfer Credit Card Offers to identify 2 or 3 cards with different companies. Apply for the cards (on the same day). Once you are approved, transfer the highest interest rate balances to the 0% card in this order: (1) Credit card #3, (2) Personal Line, (3) Credit card #1, (4) credit card #2.

Be sure to check the terms and watch for maximum balance transfer fees. You may be able to have the balance transfers deposited into you checking, where you can avoid multiple fees.

7. Evaluate stocks separately.

Determine what percentage of your portfolio the company stock makes up. If it’s significant, you may want to sell. You can then decide if you’d like to use it to pay off debt. It’s important to keep a balanced asset allocation with or without debt.

Be sure you know the impact that taxes will have on selling the stock and set aside the appropriate amount to cover and capital gains taxes.

8. Aggressively pay off the debt.

Because he has a goal to be debt free in November, I would pay the cards down as fast as possible. I’m just guessing here, but I’m thinking that purchasing a house may be in the plans for November. It will be best to be free of all credit card debt before then.

At this point, hopefully all the balances will be at 0%. If not, continue to pay the highest interest rate. Once you have all 0% balances remaining, pay off those with the smallest balance first to get the “emotional high” of eliminating debt.

9. Avoid future debt.

Once all the cards are paid off, continue setting aside some of the money you were using to pay down debt into an emergency fund.

10. Earn rewards.

He mentioned that credit card #3 is a JetBlue Card from American Express that he’d like to use to earn free travel. Use the card for necessities, and be sure to pay off all charges every month.

Another Approach

For another idea and some number crunching comparing two payoff options, check out what Steward would do in this situation at My Family’s Money.

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A recap of the situation (see the story for all the details):

• Personal Line: $3,500 balance @ 15% – $7,000 limit
• Credit Card #1: $2,300 balance @ 9.6% – $5,000 limit
• Credit Card #2: $6,600 balance @ 8.5% – $8,000 limit
• Credit Card #3: $1,900 balance @ 18% – $2,000 limit

He has $1510 available each month for payments and $9300 in company stock and upcoming bonus money available.

Here are some highlights of what readers have suggested:

1. Use a 0% Interest Card

Transfer all the credit card debt to a 0% interest card and decide on a set amount to pay each month. -John

Get a 0% credit card and put $14,300 on it. Pay himself $1166 each month into ING. Pay minimums on the card each month out of the ING account and pay the remainder off next year right before the 0% comes due. This will allow him to earn interest on the money, stop throwing away interest, and avoid selling company stock. – Julie

2. Make Equal Payments

Treat each account as if it was an installment loan and make equal monthly payments that should leave him with a zero balance at the end of four months. He can pay $902.51 each month on the personal line of credit, $586.55 a month on credit card 1, $1679.32 on credit card 2, and $492.95 on credit card 3. This is a total payment of $3661.33 each month. He ends up paying around $350 in interest on all the accounts over that time period. The main advantage to this method is that it’s fairly simple and everything is paid off at the same time.
- Jon

Five months of interest isn’t enough to sweat the details. The advantage is light at the end of the tunnel – a few months of serious ratcheting back then he’s done! It also seems silly to sell off stock in this short term plan, unless he absolutely cannot payoff otherwise and MUST be done by November. – Jay

3. Pay Highest Interest First

He should pay the minimum payments on the personal line and credit cards 1 & 2. He should sell his stock that he receives and use his bonus to pay off credit card 3 first. Then use the extra money to pay of the personal line, credit card 1, and finally credit card 2.

It’s best to pay off based on interest rate and not on balance or type. Why keep the stock? He won’t, on average, earn more on the stocks than he will be paying interest on those accounts. – Joshua

Use stock to pay off the personal line with the remaining $300 to credit card 4. Pay minimums to credit card 1 and 2 with the rest going to credit card 4. In August payoff credit card 4, and use the stock towards credit card 2 and 3. – deepali

4. Pay Smallest Balance First

Liquidate all non-retirement assets (including company stock and future bonuses) and throw it at the credit cards, in addition to any extra monthly money he can cash flow. Pay the credit cards off smallest balance to largest balance. – Frugal Dad

5. Avoid Future Debt

He should cut up all but one of his cards and decide to never carry a balance ever again. It sounds like he’s fairly intelligent so he should be able to do some ‘light’ reading to educate himself about debt and it’s compounding effects. – Brad

6. Subtract Charges Immediately

Once the cards are paid off, I would suggest on his rewards card that he wants to use for gas that when he charges an item to write it down in his check book (debit it) so that when the bill comes he has already accounted for the charges and the bill can be paid in full. – Dawn

7. Watch out for Tax Ramifications

One way would be to sell your stock, but you should be very sure of the tax ramifications of doing so before selling it. – Beating Broke in Debt Plan: My Dollar Plan Reader

My Thoughts

I’ll be back soon with a plan for him. All of these ideas are great, and I’m incorporating many of these points and some others. Stay tuned!

Update: Here’s my thoughts on the situation 10 Step Plan for Debt Elimination.

This article included in The Carnival of Personal Finance: American Flag Edition.

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Debt Details

Here are the details of his debt:

• Personal Line: $3,500 balance @ 15% – $7,000 limit
• Credit Card #1: $2,300 balance @ 9.6% – $5,000 limit
• Credit Card #2: $6,600 balance @ 8.5% – $8,000 limit
• Credit Card #3: $1,900 balance @ 18% – $2,000 limit

Card #3 earns cash rewards so he’d like to use it for gas and groceries once all the debt is paid off.

His Lifestyle and Money

You’d probably like to know a little bit about him to put the situation in context. He’s single, in his 30s, about two years out of college and works for a mega corp in the Pacific Northwest. I’m not certain on his exact salary, but it should be in the very high five figures.

He is currently paying the following:

• PL: $210 per month
• CC #1: $0 per month
• CC #2: $1,200 per month
• CC #3: $100 per month

In addition, he has the following sources of income that he could use:

• $3,800: company stock that was awarded to him.
• $2,500: company stock that will be available in August.
• $3,000: a possible bonus in September. However, if possible, he’d like to use this for something else.

What Should He Do?

What he’d like to know:

1. Should he sell his company stock and use it to pay off debt?
2. How much should he pay on each card each month?
3. In which order should he pay off the cards?

Share your thoughts. If you were him, how would you pay off the debt? I’m going to put together a plan for him early next week. I’m open to including any of your suggestions!

Update: Check out some of the reader ideas in 7 Ways to Payoff Credit Card Debt and what I would do 10 Step Plan for Debt Elimination.

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Here’s a recap of the sale process and a summary of what worked and what didn’t.

Getting the Car Ready for Sale

Clean up the car. Before listing my car, we made a small investment and had the car detailed. It was $129 of the best money spent because the car looked like new afterwards.

We considered doing a tiny spot of touch up (where my husband backed into the bird bath!) but found it to be so minor that it wasn’t necessary.

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We chose three options for listing the car:

1. Autotrader. The cost was $60 and it was the biggest waste of money ever. All we got were scammers and dealers, no genuine inquiries.
2. Craigslist. We had lots of interest for the car, lots of low ballers, but this was ultimately the way that we sold the car.
3. Fliers. We posted fliers at work and in our neighborhood. We had a few calls and I think it was a great way to get the word out.

The Sale

Holding the car. I recently mentioned that we accepted a 2.5% downpayment to hold the car. This ended up working out just fine and this is who we sold the car to in the end.

Find the title first! Ten minutes before the buyer arrived to pick up the car, we realized we had lost the title in a bunch of boxes when we moved a couple years ago. We frantically tore apart the boxes looking for it. Luckily we found it, or we probably would have killed the entire deal!

The New Car

After I solicited advice for the next car to purchase, we decided on a Mazda5 “mini” minivan. The Honda Odyssey seemed to be the favorite, but the Mazda is cheaper, gets better gas mileage, and is a little sportier.

It meets all my criteria: safety, gas mileage, fits an expanding family (3 car seats), and is relatively inexpensive.

Used Versus New. We’ve been keeping our eye out for a used one, but unfortunately there aren’t many used ones for sale because they’re not very popular in the U.S.

Because we can use the corporate discounts program to save a bundle on a new one, the used ones (with relatively low mileage) are actually turning out to be more expensive. I’m still keeping my eye out for used ones, though. If we find a good one in the next couple weeks, we’ll buy it.

Otherwise, as soon as we finish our refinance we’re planning to buy a new one. We’re waiting on the refinance because we plan to finance the car (the current financing offer is 1.9%, which is cheaper than paying cash as I can put my money to work elsewhere.)

Until then, we’re borrowing an extra car from my parents (thanks Dad!)

Tips on Car Colors. A tip I found when selecting a new car: Pick the color based on resale! For the Mazda5 it looks like blue and silver will have more value than the other colors. Since the color isn’t a factor in the initial sale price, it’s best to choose the one with the highest value.

This article featured in the Carnival of Personal Finance.

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What could you be doing with this wasted money instead? Well, if you have debt, you can use it as part of a debt reduction plan.

Aggressive debt reduction is a way of planning to use your wasted money each month in order to get out of debt and then start saving. Here’s how it works:

Step one: What’s your budget?

The first think you need to do is take an honest look at your income and your expenses. How much do you make? What do you spend your money on? Take a couple of months and write down everything you spend your money on. Tedious, I know. But necessary. I keep track of my money using a computer program. It makes things easier to keep track of, and you can categorize things as “snacks” or “unnecessary.”

After keeping track, sit down and go through everything. Do you have any money left over at the end of the month? How much have you been “wasting” on things you don’t need? Figure out which things you don’t need and add that amount up. That is your “waste.”

Write down the amount of money you waste, plus whatever you have left at the end of the month. Now we’re going to take that money and get it to work for you.

Step two: What are your debts?

In the first step, you should also have included minimum payments you make to your creditors. Now, get a list of your debts out, and write down your balances, along with the minimum payments, on a piece of paper. I like to order them smallest debt to largest debt. Be honest.

Your list may be something like this:

• Credit card: $2,500 Min. $35
• Credit card: $3,300 Min. $42
• Car loan: $9,700 Min. $215
• Private student loan: $11,100 Min. $150

Step three: Take your waste and apply it to your debt

In order for this to work, you will have to change some things about your lifestyle. You have to make a decision to stop wasting your money for this debt reduction plan to work.

Take the amount you wrote down at the end of step one. Take 25% of it and set it aside as savings (preferably in a high-yield savings account). Take the other 75% to use for your debt reduction plan. For example, if that number is $200, your savings amount would be $50 and your debt reduction plan amount is $150. The amount isn’t that important. What is important is that you are planning a lifestyle change.

When you go to make a payment on the first debt, add that $150 to the $35 minimum for a total payment of $185. Keep paying the minimum on all your debts. This will help you get the ball rolling. If you find you can contribute more each month, do so.

After the first debt is paid off, move on to the next. You can see why I like doing the lowest balance first. It is encouraging to pay off a debt, and the smaller one will be paid off faster, in general. Take that entire $185 and apply it to the next debt, so the payments on your second debt would be $227. Pretty soon you’ll be on a role.

And, once your last debt is paid off, take the entire amount and put it into savings each month.

This is a guest post by Miranda Marquit. Miranda is an editor for DestroyDebt, an informational Web site about debt consolidation. She also writes about personal finances on Yielding Wealth.

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