Question for the experts

[Tetto]

Hi All,

I'm asking this question in regards to my friend at work. Shes a 51 year old woman who has a bit of consumer debt; about $13 thousand worth (cards@ ~20%+ interest). She makes about $60K/year and lives at her mothers multi family home with her daughter (14 years old). I know the Dave Ramsey method of eliminating debt, i'm not sure its right for her though. I asked her how she felt about taking a loan from the 401K at 3% and paying everything off, then pay her loan back through payroll deduction.

On the plus side, she's engaged to a guy who is a LBYM frugal type and is financially set- she hasn't told him about the debt and wants to get rid of it before they marry.

After I scolded her () about spending so much, she has put the cards away for emergency only. Any other helpful debt elimination tricks you can think of?

Thanks!

 

[mystang52]

There are so many good and practical ideas to pay off debt. In my opinion, though, these good ideas are akin to preaching to the choir. To wit, written by LBYM folks......unwittingly for other LBYM folks. I think most people in debt - and can afford not to be - simply don't have the willpower to do what is necessary.
With all that being said, I think Dave Ramsey's approach is the most practical. It is not the best dollar-and-cents approach, but the snowball effect he preaches gives the person ongoing positive reinforcement.

Edit: Also in terms of practicality, I think your 401K loan suggestion is a good one for her.

 

[pb4uski]

If she is saving more than the 401k match, she could temporarily reduce her contributions and divert the difference towards paying off the credit cards. In the meantime, she might be able to get a new credit card with 0% on balance transfers and then pay off the old card and avoid the ~20% interest on the old card balance.

She needs to be careful of fixing the problem and then falling back in the hole.

Your 401k loan suggestion is good too.

 

[Tetto]

Thanks for the input guys; It's difficult for her as she's divorced and has a real jerk for an ex-husband. I think she has seen the light though in regards to spending...I've tried as nicely and forcefully as I can to connect the dots for her. I can see why so many folks are in deep doo-doo when it comes to finance! No common sense!

I too believe the 401K loan is probably the easiest way out for her, reducing her input to the 401K is a good option, but she should prioritize her retirement savings, imo.

 

[W2R]

Being divorced might be helpful for her (or anyone trying to get out of debt), because she is now completely in charge of what gets spent on what.

After my divorce, I had debt to pay off too. My ex and I cut up our credit cards the last day we were together, and so I didn't need to worry about piling up more debt. I decided that I wanted to pay off my debt ASAP, and went into "cheapskate mode". I don't know if she can do that but if so, it does help. I started by cutting back so that I was living on less than 1/4 of my gross pay. I did without a lot of things that I didn't care about (for example a TV and a bed and lots more, which my ex got in the divorce). This would be harder for your friend, since she has a daughter to support. Oh well. Anyway, I got that debt paid off quickly and then continued being a cheapskate so that I could build a nice nestegg.

At some point I started spending more so that I was living on half my take-home pay and spending the rest to pay off the house or invest. Every other paycheck went to me, and I tried to save some of it too if I could. It's amazing how fast a financial turn-around can happen and that made me feel very happy and capable and independent, which is a good way to feel after a divorce.

 

[Red Badger]

Two minor points on the 401K loan. If she pulls $13K out, that $13K won't be compounding (the secret sauce in ANY 401K) until it gets back in. If there is even the slightest risk of getting laid off, the 401K loan is a huge risk (as it becomes due in full at severance). If not paid off, 10% interest is tacked on to the loan. A debt consolidation loan might be a safer approach. Also, on my last few installment loans (cars), the bank shaved a quarter percent if I sent up automatic payments.

 

[Hyperborea]

Your 401k loan suggestion is good too.

Only if she doesn't then run the cards back up again and is then sitting in the same situation as before but with a $13K loan to boot. If she got into the situation because she was a poor money manager then this could be a bad option. If she got into the situation because of real unavoidable circumstances that have now changed then it might be a good idea.

 

[mystang52]

Only if she doesn't then run the cards back up again and is then sitting in the same situation as before but with a $13K loan to boot. If she got into the situation because she was a poor money manager then this could be a bad option. If she got into the situation because of real unavoidable circumstances that have now changed then it might be a good idea.

Agree completely.

 

[Bamaman]

Such situations should have the credit cards literally cut up. If the card's not around, they won't have the temptation to use'em.

It's a shame that not everyone wasn't born with fisical common sense. My wife and I have sense, where our daughter has none.

We're going to have to set up a Special Needs Trust that insulates any present or future creditors from coming after any inheritance. Any real estate will be held in trust. And only expenses like insurance premiums and utility bills is about all she can withdraw from the trust.

 

[pb4uski]

Only if she doesn't then run the cards back up again and is then sitting in the same situation as before but with a $13K loan to boot. If she got into the situation because she was a poor money manager then this could be a bad option. If she got into the situation because of real unavoidable circumstances that have now changed then it might be a good idea.

Guess you missed this part on the line above what you quoted:

She needs to be careful of fixing the problem and then falling back in the hole.

 

[Tetto]

Thankfully she is not using the cards for anything! I said when she or the daughter needs something, why not just save up until you can buy it? It seems to have sunk in...apparently her parents are the same way, no common sense on how to handle money. And a bit of the keeping up with the Jones's mentality too��

 

[target2019]

Loans from 401k are more complicated. Before recommending that, I'd read up on all of the implications.

http://www.investopedia.com/articles/retirement/06/eightreasons401k.asp

 

[Aerides]

401k loan is good on the outside, not so good on the inside. Your payments back in are post-tax, so while you don't get the penalty, you have undone all that tax-free saving. Can she instead try for a lower interest CC?

If she has a 20% rate, that indicates other credit issues beyond just total indebtedness.

She's engaged and hasn't told him about her debt? Yikes....not a good way to start. If anything, I'd be advising her to have some good honest chats with the fiance first and they can work out a plan that works for them both, unless she can magically pay it off in 6 months.

 

[Jerry1]

I would say that if she's committed to reducing the debt and changing her spending then the 401k loan is not necessary. Just get to work on it and it will be gone soon enough. If she's not committed, the 401k loan is the worst situation because the whole will be dug again only deeper. It might be worth it to reduce the 401k contributions but only if it doesn't reduce the employer match.

Money is so much like food. Diets don't work and quick debt reduction doesn't either. In both cases, you just need to embrace the new lifestyle and the rest will fall in place. Learn to eat right and never diet again. Learn to spend right and you will be out of debt and financially sound forever. It's hard, but not complicated.

 

[joeea]

On the plus side, she's engaged to a guy who is a LBYM frugal type and is financially set- she hasn't told him about the debt and wants to get rid of it before they marry.

Scold her for hiding her finances. That's a terrible way to start a new life.

You haven't indicated what her expenses are currently, so other than saying "spend less than your income and pay your debt off aggressively" I'm not sure what to recommend.

She should avoid a loan from her 401k if at all possible.

 

[zinger1457]

I would suggest your friend sit down with her LBYM frugal fiance and ask for his advice to solve her problem or he will likely be the ex-fiance if/when he finds out she's been hiding a serious debt problem.

 

[Mdlerth]

First world problem

I must have missed something in the OP, because it sounds like a minor kerfuffle. But the responders so far obviously think it's major.

The OP's friend has 13k in credit card debt. Okay, I comprehend that carrying a balance on credit cards is the third worst form of debt you can run up (after owing money to payday lenders or to the mob). But she earns 60k, so her debt is only 22% of her annual income. With a little discipline she should be able to retire that 13 large in a year or so.

She has one child who is years away from college. Also, she lives in her mother's house... am I wrong to conclude this means her housing costs are minimal? There are no data presented to indicate the friend is saddled with lots of non-discretionary costs which would make it difficult to prioritize debt reduction.

I have friends and relatives who have buried themselves far deeper in debt than the OP's pal and dug themselves out. One of my brothers racked up over 100% of his income on his cards. It took a broken engagement and a few years but he managed to pay them all off.

Dear Tetto, your friend readily has the ability to tackle her credit debt. If she puts $1200 toward it every month, the balance will be gone in about a year. If she can only muster half of that, it will take about two years. $600 per month is not an unreasonable commitment for an employed person; it's a car payment.

I do not recommend tapping her 401k; too many ways for that to end badly. Better just to tighten her belt and pay down the principal.

Am I oversimplifying the example? I'm perfectly happy to be educated if you think I have misinterpreted the story.

 

[CaliforniaMan]

In my opinion borrowing from her 401k is a terrible terrible idea.

It opens the door to using that technique in the future, if her bad spending habits return. She makes enough money to pay down the loan in a year without tapping her 401k. And she needs to be able to demonstrate to herself that she has the discipline to do it. Taking the 401k route just kicks the can down the road, and what insures that that she will ever pay it back?

No, she needs to develop the discipline to pay off her CC loans. The 401k is for her retirement only, nothing else.

Did I mention that taking a loan from her 401k is a terrible idea?

 

[Tetto]

I must have missed something in the OP, because it sounds like a minor kerfuffle. But the responders so far obviously think it's major.

The OP's friend has 13k in credit card debt. Okay, I comprehend that carrying a balance on credit cards is the third worst form of debt you can run up (after owing money to payday lenders or to the mob). But she earns 60k, so her debt is only 22% of her annual income. With a little discipline she should be able to retire that 13 large in a year or so.

She has one child who is years away from college. Also, she lives in her mother's house... am I wrong to conclude this means her housing costs are minimal? There are no data presented to indicate the friend is saddled with lots of non-discretionary costs which would make it difficult to prioritize debt reduction.

I have friends and relatives who have buried themselves far deeper in debt than the OP's pal and dug themselves out. One of my brothers racked up over 100% of his income on his cards. It took a broken engagement and a few years but he managed to pay them all off.

Dear Tetto, your friend readily has the ability to tackle her credit debt. If she puts $1200 toward it every month, the balance will be gone in about a year. If she can only muster half of that, it will take about two years. $600 per month is not an unreasonable commitment for an employed person; it's a car payment.

I do not recommend tapping her 401k; too many ways for that to end badly. Better just to tighten her belt and pay down the principal.

Am I oversimplifying the example? I'm perfectly happy to be educated if you think I have misinterpreted the story.

In retrospect, I think you're correct. The 401k idea seemed a good idea at the time after looking at consolidation loan rates and other credit card options. In the end, it's her that has to make this happen and I believe she has the ability to do it (if motivated...). I'm going to talk with her about it one more time, then i'm done. You can lead a horse to water and all of that...!

 

[Mdlerth]

In the end, it's her that has to make this happen and I believe she has the ability to do it (if motivated...). I'm going to talk with her about it one more time, then i'm done. You can lead a horse to water and all of that...!

Knowing when to step in and when to step back is the mark of a true friend. Good luck to you both!