I have a friend who confided in me about his credit situation and has asked me for his assistance because he and others said I have good financial sense (a lot of which comes from just reading this board) . He currently has about $4200 of what I would call bad debt (credit accounts). These bad debts cost him about $200/month in payments. Some are as high as $35/month while others are low at around $15/month. He has one account with no balance for a card that can be used at one store but fortunately he doesn't shop there much and it is his oldest account. He has never been late on a payment and has pretty good credit. Looking at his income ($2000/month) and expenses ($1807/month) he has less than $200/month for necessities and ends up having to use the little credit he gets on the accounts to buy things. It's like dirty cycle. This is what I would advise him to do: 1. Close all accounts except the oldest one with no balance on it. 2. Borrow the $4200 against his retirement funds. 3. Pay off all the closed accounts with the loan. Pros: The result would be an $80/month payment vs. $200/month which he is currently paying and the bad debt would be gone. Plus, I believe the interest you would pay on this type of loan goes back into your retirement account, since he is basically borrowing from himself. The loan comes at 8% interest while the credit account have 20-30% interest rates. Cons: Borrowing against your retirement can be a bad idea because if you default you can get taxed on it and face other penalties. I normally wouldn't advocate borrowing from retirement funds but honestly I don't see how he can get out from under this burden. I'm really not sure about this though. He asked me because I worked my way out of bad debts that I acquired when first entering college but then again I was still at home with the parents with no real bills too and then was taught the positives and hazards of credit but he does not have that advantage. Normally I think people and I wouldn't advocate borrowing from or against you retirement but I just don't see any other way around his burden.
A few things: - Closing accounts may negatively impact your credit score, especially if he has been making timely payments. - If his payments are only as 'high' as $35, I suspect he is only paying the minimum? If that is the case, it will take a long time to pay off those debts. - I like the idea of borrowing against a work 401K as long as it is for a relatively small amount (I consider $4200 a relatively small amount). I'd never do it for a home loan (unless desperate) or a large amount. He just needs to be aware of the potential pitfalls and be able to deal with them should he get laid off, for example.
Tell him read Dave Ramsey's book and/or listen to his radio program. Tailor-made for situations like this. What kind of car does he drive? If he drives something fairly valuable that he doesn't owe more than it's worth, he can use the difference to pay off some of the debt and buy a cheap POS car to drive for a while. Then use what he was paying on his car note to pay off the debt and eventually save for a better car. Other than that, sell anything he can. Anything valuable that is not a necessity can go on craigslist. If he spends a lot on food/going out, he can stop going out until his debt is paid off and sacrifice on some spending on the grocery store.
The hidden downside to borrowing from a 401K is you end up paying income tax twice on the amount of the loan. You pay the loan back with after tax dollars and then you must pay the tax again when you withdraw it in retirement.
Well wouldn't you advocate closing at least a few, maybe some of the ones with a higher balance so he doesn't fall back into a similar situation? He has made pretty much all of his payments on time, at least for the past two years the report shows. Yes, he is only paying minimums and the bills I have seen show it taking anywhere from a little under 2 years to as many as 5 to get these accounts paid off. (The new CARD Act made that feature available I think). I'm the opposite, I wouldn't advocate it no matter how small it is and I am only doing so in this situation because it appears desperate. I'm also doing it because I think he can handle getting the payments in on time, every time and if he were fired/laid off/whatever he could handle getting the payments taken care of. He is very punctual about payments and does things I wouldn't to make sure they get taken care of (ex. working in fast food restaurants in addition to his job). I also thought of this scenario: Have them take out a smaller amount and pay off some of the higher interest/payment accounts then shift the money that was going to them to the other accounts. I'm not sure that would really work though because although it does take away some payments, you'd just be shifting that money to other accounts while adding another payment you just have to pay back as well.
I actually already suggested he look into this after reading it on another thread here. He drives a 2001 Pontiac Grand Am but it is paid off already. Doesn't really have anything he can sell for quick cash.
Lil Pun Any suggestions I make are with respect to folks that have since learned financial discipline. He could always leave the accounts open and simply destroy the cards.
Doesn't it work that way with any loan? I suggested a loan because if he just withdrew it from his retirement he gets taxed on it now then at tax time too. This way he doesn't get taxed on it and the interest actually goes back into his retirement fund.
I think your plan is good but if he has a tendency to go into debt for necessities, it may not do much good. He likely needs to review his budget, and possibly use some of the tricks to curb spending -- like cash only...etc. 1800 committed on 2000 seems pretty tight.
Yeah, I gotcha I just don't think he is one of those people. Like when I was doing it, I sent my credit cards to my aunt in Houston to ensure I wouldn't use them and I actually gave her access to them to make sure I didn't and that worked for me. I think he would just get a card re-issued later on. He is good about paying his debts but not good about thinking about what he can actually afford comfortably. Like when I was looking for a car last year (think I started a thread on here), I wanted a newer Nissan Murano but it made more sense financially to get an older model so I settled on a 2003 Chevy Tracker. Although I could have made the payments, I chose to go the easier way. He doesn't think like that, he thinks "I can make the payment, even if I struggle so I am going to get it".
What exactly does he spend $1800 a month on if his car is paid off? Does he live in NY or LA? That seems a little high to not have any other expenses he can cut back/eliminate (ie cable/internet, sacrifice on food for a while). $4200 is not anything to get too drastic over, but if it's just going to continue to grow out of his control he could consider finding a cheaper place to live. Or pick up a second job on nights/weekends just waiting tables or something. Just throwing these out there...I know I would have a hard time doing either of these, especially if I had a family with kids. But, it's better than letting the debt get out of control.
$550 living expenses $200 utilities $300 misc expense (student loans/cable/Internet/gas/food/etc.) $400 child support $200 credit accounts $150 car/renter's insurance
what does the $1800 he spends a month comprised of? i bet there's something there he can cut that would decrease his expenses which should go to paying off his debt. being in debt has more to do with how much you spend than how much you make.
if he's serious about getting debt free, cut the cable and internet pronto and use that money towards the CCs. that's at least $100/month which would significantly reduce the amt of interest and months he'd have to pay.
I always find it amusing when folks are seriously in debt, yet they have cable TV, high speed Internet and cell phone service.
He already has the lowest tiered cable and Internet plans and that costs him $58/month. I doubt he would want to drop them but I can suggest. He has tried, believe me but nobody is hiring, at least none of the places he called or went to.
His cable and Internet plan only runs $58/month. Like I said, I could suggest but I doubt he would do it.
