Old Debt, Young Debt
Posted by Gail | Filed under Debt Traps, Gail Club News, Money Management
Common wisdom among those in the money world holds that “debt” is a young person’s disease, and that “asset acquisition” – building up your nest-egg — is something that you do as you hit midlife and beyond. I’m not sure who makes up the rules for how things should work. Personally I haven’t lived by the rules and so I’ve never placed much stock in them. And I’m here to tell you that this piece of common wisdom couldn’t be more wrong.
I am getting loads of questions like the next one, and they are a reflection of the fact that people, no matter their age, are in a bind because they don’t have Clue One about how to manage their money.
My husband and I are both in our early 50s. My husband has had financial difficulties combined with bad luck during the past 10 years so we have struggled financially. We have really fell behind financially and not is the time to own up to our debts and pay up. We have been mortgage free for that period of time however now we hvae been to the Bank and are seriously considering mortgaging. Our total debt is $65,000.00. I worry whether this is our best option to repay our debts? I worry about mortgaging when so many are losing their job. Our monthly mortgage payments would be very affordable as compared to the monthly payments we would have to make to eventually pay off our debts. We ideally want to pay our debts before we retire. What would you suggest?
I could tell this woman to go ahead and do the mortgage. After all, in their early 50, she and her hubby have time to get that $65,000 paid off, and the ease to their cash flow would feel good. They’d pay a lower interest rate in the short term. And life would stabilize.
And yet I find I am loath to say, “Go ahead.” There must be an underlying problem with her budget for them to have accumulated this kind of debt. Yes, there have been “financial difficulties and bad luck”, but when you hit a wall the answer isn’t to move your spending to credit, the answer is to Stop Spending.
If I give this woman the okay to move her consumer debt to her mortgage, will she go right back out and start spending on credit again? Will her husband sigh with relief and think they’re in the clear. After all, a $65,000 is not a huge burden. And when you’re retired you have to live somewhere, so having a small mortgage is not the end of the world.
Of course, it could simply be a case that this couple rushed through their mortgage payment to get mortgage free, without ever looking at the credit they were using to supplement their cash flow. I see this all the time. People, in their mad dash to be mortgage-free give no thought to how their doubling-up and massive prepayments are affecting their budgets. Stealing from Peter to pay Paul, they end up with higher interest payments so they struggle to keep up.
If I could actually see this woman’s face, if I could see how serious she was about being debt free, if I could see how much she and her husband were together on this, I might be able to assure myself that the mortgage idea could work. And this comes to the crux of the problem I have.
So many people say they want one thing, and then turn around and do something else that totally undermines what they say they want. “I want to be debt free,” they say. Then they go right out and put $200 on their credit card for dinner. “I want to set up an emergency fund,” they say. Then every time they have an expense that’s a little out of the ordinary, rather than cutting back somewhere to take care of the expenses, they dip into the “emergency” fund. “I want to help my kids through school,” they say. Then they dip into their child’s educational savings, promising themselves they’ll replace it as soon as things get better.
It’s as if we have no stick-to-it-ive-ness. We can’t hold a thought. We’re a bunch of Financial ADDs who MUST react to whatever stimulus is currently coming our way.
If this woman closes every form of credit she has and swears on her dog’s head that she’ll never ever put anything on credit again, then I’d say, “Go ahead with the mortgage.” Of course that would also mean she’d have to make a budget, track her spending daily, and never buy anything that was a Want when there were still Needs to be taken care of. There would be no excuses, no exceptions.
She would also have to get a job. I’m assuming from her letter that she does not work outside the home since she never mentions having an income. Even if she does have an income, to pay for the mistakes they have made, both these people need to find a way to Make More Money to deal with the long-term interest cost of the mortgage. So they must find a way to make at least an extra $500 a month net, so they can make an annual $6,000 prepayment to offset their mortgage interest costs.
There, that’d do it for me.
Now it’s your turn. For those of you who love case studies, here’s one for ya:
Vic works full time and makes about $50,000/yr. Vic’s partner wants to return to school in about 18 month and the program will last two years. That’ll mean the family income will go down by 50%. They have no car payments, and about $3,000 in consumer debt, and have been making extra payments against their mortgage of about $300 a month. But since they’ve been in their home for under a year, they haven’t built up much equity yet. Vic knows things will have to change, but is desperately afraid of them getting in over their heads. What would you tell Vic?
Gail Club News: There are people in both Hamilton and Saskatoon who would be interested in joining or starting a Gail Club. If you would like to link-up in Hamilton or Saskatoon, email me at getgvo@gmail.com and I’ll pass on your contact info. For those of you who are interested in starting a Gail Club and don’t know where to begin, read the blog that started it all.
January 29, 2009 at 7:37 am
Good morning!
Regarding the couple in their 50s, it’s the common case of always having to get to the root of the problem. As always, excellent judgment you made, Gail. A doctor can’t necessarily answer a question online regarding an illness. They have to find the history, assess and observe, among other things about the scenario.
Respectfully,
Josef
January 29, 2009 at 7:39 am
I would tell Vic that if their household income was going to drop by 50% that they should start living immediately as though their income had already dropped by 50% so they can make sure it will be feasible while his partner attends schhol and use the remaining 50% of their income to pay down their consumer debt and build up emergency savings (if they haven’t already).
Have Vic and his partner set aside the money necessary to pay school expenses for two years? If not, hopefully they will wait until they can pay for school without using credit or student loans. Will it be possible for Vic’s partner to continue to earn some income while in school?
The $300 per month that is going toward their mortgage should be redirected to their consumer debt (their consumer debt is likely at a higher interest rate) or to their emergency savings if they don’t already have a funded emergency fund.
January 29, 2009 at 8:56 am
I think it’s true that our culture doesn’t encourage or value stick-to-it-ness as perhaps it used to. I don’t have that problem with finance, but I do sometimes with food and I think it’s the same kind of self-sabotage..
January 29, 2009 at 9:29 am
They should immediately stop paying the extra $300 a month towards the mortgage and instead pay off the consumer debt (assuming they have a $1000 emergency fund built already, otherwise do that first and then pay off debt). Next, and don’t shoot me gail, apply for a line of credit while still employed in case they need one. The next two years aren’t really about debt avoidance, they’re going to be about survival so like Money Minder above says, live on that 50% of income immediately and see how that goes. And lastly, just double check that (a) the schooling is for a career that the partner really wants and (b) that the income/happiness factor is worth the pain/squeeze factor. Send the partner to spend a day in the life of doctor/lawyer/whatever. This experience kept me from attending law school personally — I thought it would be all Law and Order and instead it was writing 20 page briefs that will probably never see the light of day.
It can be difficult to save the money needed for an education if as the older you get the usefulness of the degree decreases (think getting a law degree at 45 and interning at 46) so it may not be possible to pay for it in cash, but the key thing here is to ensure the house and the relationship survive the next two years.
January 29, 2009 at 10:06 am
The first thing I would say to Vic is that the family seems to be in a pretty good position — better than that of the ESL teacher who wanted to go back to school in the last scenario. As Money Minder noted above, they need to live for the next 18 months on the income they’ll have while the partner is in school.
I’m not clear about whether or Vic’s is the only income. If so, they’ll be living on $25,000/year, which means they’ll have $37,000 over 18 months to pay down their very minor consumer debt, save for school costs (tuition, books, etc.), and build an emergency fund. They should stop making extra mortgage payments. They’ll have a tough time managing on 50% of their current income, and they’ll need that $300/month. The budget may be tight, but if they can’t do it now, they can’t do it while the partner is in school.
If the partner is going into a program that’s likely to increase his/her income after graduation, and if he/she qualifies for a student loan, it might be worthwhile to apply for one. (If the education isn’t likely to increase income, they should reevaluate whether or not the financial sacrifices they’ll have to make will be worth it). If possible, the partner should continue working while in school, maybe even continuing to work full-time while going to school part-time. If the program can only be done full-time and working’s not an option, they’ve got plenty of time to get used to living more frugally.
Vic shouldn’t worry about getting in over their heads. They’re not bogged down by consumer debt and they’ve got time to plan and make choices. 18 months is a good lead time — by the end of a year they’ll know more about whether this is do-able or not.
January 29, 2009 at 10:10 am
Geoff, you’re’ hilarious… Law & Order. It’s so true, we get ideas about what a career will look like, often galmourizing the situation.
I agree that the spouse needs to make sure that she (or he) is really doing this to enhance her career that will give her a return on her investment. Now is not the time to give up an income to pursue a frivolous passion that should stay a hobby. She should research current salaries in that field to have a good idea of what to expect.
I would second the motion to start paying down that debt faster. They should also have a healthy emergency fund.
Also, the partner should maximise her income now – take on OT, an extra job, whatever she can to save as much money as possible to pay tuition and other costs and avoid taking student loans. She should definitely work part-time while in school as well.
January 29, 2009 at 11:30 am
I think the student loan would be a viable option since no interest is owed while the student is still in school. However, from personal experience, the government sends no notice after the 6 month grace period ends, and even though I had set aside enough money to pay off my loan, I had to pay that six month interest charge because I had not kept track of my repayment date. Just a thought
January 29, 2009 at 12:31 pm
Sorry for the length of this…
Vic and his partner should take the next 18 months before the partner goes back to school to pay off the debt and build up their savings. They should live off of Vic’s income starting immediately and any income earned from the partner or from either person getting a second job or extra income, along with those extra mortgage payments (see notes below regarding this), should be used for emergency funds, debt repayment and creation of a “school fund”.
Also, they should figure out a current budget and one for “during school” as there could be different “life” costs that aren’t a factor right now (different transportation costs, etc). If the “during school” budget is going to require more than Vic’s income, it’s better to know that going in and figure out ways that the income can be earned. For example, is there a part-time job that can be obtained now that will be sustainable through the education period? If the economy gets worse and jobs are harder to come by, already having the job in place will be easier to maintain than trying to get the job when nobody is hiring.
If the education obtained is going to enable the partner to earn more income after school is done, they should forego the extra mortgage payments for now and once the extra income is beign earned, make $600/mth payments to catch up to where they would have been. If the education is only going to get her a “happier” career with the same level of income as before, they may want to consider keeping the extra mortgage payments going, AS LONG AS their budget can handle it and the other savings that is necessary for this change to happen is not affected, this way, when the partner does go back to work, and they are still only able to make the extra $300 payments, they don’t feel as if they’ve lost out on any time. Another option would be to decrease the extra payments say by half and catch up with $450 payments after… whichever way is chosen, it will all depend on the ALMIGHTY BUDGET and what they can afford to do.
Also, Vic needs to make sure that he is comfortable with this decision and that there will be no resentment that he is primarily supporting them financially until the partner is done school, as this can be a breaking point just as much as other financial factors in a relationship.
So far this couple is not in a terrible situation; they have time to pay stuff off and plan ahead for the coming change. They should try to avoid taking on a student loan as much as possible. Just because it’s “smart” debt, doesn’t mean that you should take it on if you could have avoided it in the first place, cause that would just turn it into “dumb” debt.
January 29, 2009 at 4:31 pm
The basic rule of lending/borrowing money:
SHOW ME THE BUDGET!
January 30, 2009 at 1:03 am
Here’s what I would tell Vic:
Since their income is going to decrease by half (Rough guess, approx $40000/year net) for 2 years, they better start saving. First of all, put the $300/month onto their consumer debt. They can have it paid off in a year, then put that money aside from months 13-18 and they have an extra $1800 in the bank.
Can they increase their income in the next 18 months? An extra 500/mo would amount to $9000 in the bank after 18 months. (I know a part time job isn’t always a joy, but it’s this option, or reduce their budget even further.)
Can they reduce their budget? They’re going to have to! That’s the price you pay for going back to school and not getting into debt. If they reduce their budget by 25% immediately (I’m talking net, so $20 000/year) and put that into savings for the next 18 months, they will have another $30 000 in the bank.
If their budget is reduced by 25% when the partner is in school, they will only be short $16 400/year from the lost wages (since they don’t need to keep saving that $300/month during this time), or $32 800 over the 2 years. But guess what?! They already have $40 800 in the bank, which means they have an additional $8000 in the bank which can be used to help pay for tuition costs.
Then they can up those mortgage payments again when they are back to a double income family and all is good!
January 30, 2009 at 11:27 am
Some good ideas for Vic here, especially stopping the extra $300 on the mortgage and clearing up consumer debt instead, but I’d question the student loan. I think it should be a measure of absolute last resort, no matter how lucrative the new career.
If Vic and his partner are going to spend the next 18 months focusing on consumer debt and savings, why not direct savings to the partner’s RRSP until it reaches at least $20K?
That way, the partner can make Lifelong Learning Plan withdrawals (a total of $20 K over four years, max $10K in any one year; otherwise similar to the Home Buyers’ Plan, if you’re not familiar with the LLP).
This has a cost in foregone growth in the RRSP, but it amounts to making a student loan to yourself, and of course there’s an up-front tax break on the original contributions. In the long run, it should be at least as advantageous as an interest-free loan. And that alone makes it better than a student loan.
If the partner’s income is significantly lower than Vic’s, Vic can contribute to a spousal RRSP. He gets the tax break, but his partner makes the LLP withdrawal(s) and makes the repayments in the ten years following graduation. (I’d double-check with the government that this is allowed, but it works for the home buyers’ plan, so it should work for the LLP.)
If Vic’s partner already has $20K or more in an RRSP, I’d stash the savings in both partners’ TFSAs. Either way, I’d of course keep these savings in low-risk vehicles, because capital preservation is paramount.
Save, save, save. Do not take a student loan.
January 30, 2009 at 11:59 am
To correct myself: it seems Vic can, if he wants, make LLP withdrawals from his own RRSP to fund his spouse’s education. No need to mess with spousal accounts etc.
January 30, 2009 at 4:54 pm
I would recommend that Vic and his partner sit down together and have a good heart to heart first about the schooling and then with their budget. Vic should share his concerns about managing financially and Vic’s partner should share their dreams/goals. Being open and honest will ensure that that they’re on the same page and that there is no resentment or guilt about who gets to follow their dreams and who has to be responsible.
The money talk should look at their current debt, their savings, their ability to pay for school, and their ability to keep health and home together. They should review their budget to make sure there aren’t any leaks that would contribute to their consumer debt. Then they should adjust their budget to see how it works on just one income and then live it. As stated above, instead of the extra $300/month going to the mortgage put it to their consumer debt, and at the same time Vic and his partner should build up the emergency fund, a savings fund, and a school fund. Vic’s partner should look into grants, scholarships, and bursaries to help pay for school. Vic’s partner should look into working part-time while in school full-time.
Above all, they are in this together and they should support one another in both the finances and in the schooling.
January 30, 2009 at 9:58 pm
Ideas for Gail Clubs:
- host a garage sale together in the Spring (start collecting and pricing items now and as you accumulate them), share the cost of any ad(s) and then host the sale together at the person’s house that has the most traffic going by
- coupon-swap; cut all of the coupons you see and then when you get togehter, swap the ones you wouldn’t use with others who have coupons they don’t need that you can use…