Ask The Money Coach

Archive for the ‘Loaning and Giving Money’ Category

This is a classic case of “which should I do first – pay debt or save more”? The answer isn’t really a matter of either/or. It’s a question of how to do both simultaneously because that’s the best approach. You need savings to avoid going into debt. After all if you don’t have a cash cushion, the slightest emergency – like a flat tire or a leaky roof – will send you heading for your credit cards. Also, you should pay off debt as soon as possible because you don’t want to pay unnecessary interest charges and be prevented from saving money for other future goals. The good news for your situation is that both of the loans you’ve taken on – school debt for your son, and a home equity line of credit – carry relative modest interest rates. You didn’t say when you got your HELOC, but I assume it’s in the single digits (i.e. less than 10%, and probably significantly less if you got the loan in the past couple years). Ditto for that student loan. So divvy up the available cash you have and work at meeting both objectives: knocking down that student loan balance and your HELOC and also adding consistently, month after month, to your savings nest egg. If I had to prioritize, I would say slash that HELOC debt first and put more emphasis on that than the student loan debt. If it’s a federal loan, the student loan debt may be subsidized (meaning the government is paying the interest on the loan while your son is in school). Lastly, because the healthcare reform bill recently signed into law by President Obama includes student loan reform as well, you can expect college loan costs to come down significantly. For instance, starting in 2014, student loan repayments will be capped at 10% of a borrower’s income. That means even if you can’t pay off that loan in five years, your son can start working on it — and it’ll be relatively affordable for him to do so.

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Yes, a mortgage company can send you late notices and tack on late charges to your mortgage when you don’t pay on time. Unfortunately, those fees can add up, because sometimes they include penalties, added interest, collection costs, and maybe even attorney’s fees if they have to get lawyers involved. It doesn’t sound like you’re at the point of foreclosure, but clearly you are in a very difficult financial predicament. Based on everything else you said to me, it seems that you bought your home in 1990 when you children lived at home, but now they’re gone. You described a roof problem which will take $3,000 to repair, and you also have the added financial burden of having recently taken in 3 of your grandchildren. I think you need to be realistic about your circumstances and consider whether or not you can afford to live in the home you currently have. Chances are, the home is too big for you all by yourself. Also, I recommend that you begin the process of telling your adult children that you can not afford to take care of their children. I admire the love and selflessness that you have shown in taking care of your grandkids, but this entire situation sounds like simply too much. Unless your children are providing significant financial support for you to keep their kids (which I doubt), I think you should unwind that situation and simply tell your family that you are being buried under a mountain of bills. You said that you have a car note, as well as credit card bills, some of which have been sent to collection agencies, so that tells me you are really struggling to keep your head above water. Since you are working, talk also to your mortgage lender and see if they have any options to offer you, such as a forbearance or deferment on your loan, or perhaps a loan modification. Also look into the Obama plan, www.MakingHomeAffordable.gov and see if you qualify for that program. Good luck!

It sounds like you and your mother can not only not afford your home, but the house itself is also severely underwater. I understand your desire to improve your credit and get your own place, but honestly, you must fix problems A, B, and C before you can move on to issues D and E. In this case, problems A, B and C are: getting realistic about your financial past and present, learning how to create and live with a budget, and dealing with your home dilemma. Until you first do those things, you won’t be able to pay off your debts (issue D) or improve your credit (issue E). Without tackling first things first, you’ll also put yourself at risk of losing another home simply because you’ve neglected to learn certain financial lessons.

So let’s start with the first thing: a reality check. You seem to have attempted to throw your mother a lifeline, only to wind up nearly drowning yourself. Your email said you bought the home from her back in 2004 to help her avert bankruptcy and foreclosure. Despite your best intentions, you also stated that you and her wound up 3 months behind on the mortgage and in danger of being foreclosed upon anyway. That’s what led you to seek out the $10,000 loan you’re not saddled with. What happened to during the time of your unemployment? Your message indicated that you were twice laid off and that you “made some not so smart money decisions?” Whatever those decisions were, you have to truly acknowledge them, and make sure that you don’t repeat them.

It sounds to me as if you had your mother have been stuck in a cycle of making repetitive bad decisions. I hope you don’t think I’m being too harsh on you. Because I’m telling you these things honestly out of care and concern for your situation. I can sense your struggle and I know it’s very hard to be in such a tough predicament. I’m just giving you a bit of “tough love,” however, because I’ve seen cases like this time and time again. The only way people get out of these dilemmas is by actively breaking the cycle and ending the behavior that landed them in hot water.

Now let’s move on to the second issue: having a proper budget. Unfortunately, most of us grow up never having learned to create a realistic budget. This is likely true of your mother, and it’s probably true for you as well. Read this article I’ve written on budgeting and this post too, to get some ideas on how to budget to better manage your finances. Additionally, read this post about budgeting and financial planning when you go thorugh a layoff or have reduced income.

So what about the house? The fact that you’ve both faced foreclosure at least twice, and have even refinanced twice since 2004, yet you have still wound up deep in debt and deeply underwater tells me that you can not truly afford this home. I assume you refinanced in recent years to take advantage of relatively low interest rates. But I also suspect that you took cash out of your home as well. I could be wrong. But that’s certainly what many people did during the heydey of the housing market. How was that money used? Did you pay off debt, set aside any savings, or do something else with it? I recognize, of course, that part of the reason your house is likely under water is because home prices have fallen greatly in many parts of the country. But the fact that you owe twice as much as your home is worth signals that something else was going on.

If I were you, I would investigage the prospects of a short sale or a deed in lieu of foreclosure. I don’t know where you live, but it’s highly doubtful that your home will “come back” in value anytime soon. Unfortunately, short sales and deeds in lieu of foreclosure do have negative ramifications for your credit. But these are short-term hits from which you can recover, if you’re prepared to move on and do the right thing financially in the future.

You asked about the loan you got while you were unemployed. I don’t know of any way to legally get this loand eliminated or removed from your credit reports. Just because someone loaned you money at a time when you weren’t working doesn’t make the loan a “predatory loan.” Unfortunately, scores of lenders all across the country did this — both reputable lenders and not-so-reputable ones. Honestly, I don’t know which camp your lender falls into.

Nevetheless, again, I want you to be willing to take responsibililty for your own actions, and not put the blame elsewhere. You stated to me that you knew you shouldn’t have applied for the loan in the first place but that you were “desperate.” Plus, the reason you applied for the loan was because you were in arrears on your mortgage. That’s certainly not the fault of the lender that gave you the $10,000 loan. So it’s not fair to now accuse them of “predatory” lending. Predatory loans are characterized by unreasonably high interest rates, abusive pre-payment penalties, or excessive loan fees including enormous commissions for lenders or mortgage brokers.

Don’t worry about paying off 5-year-old debts at this point. You’ve got enough on your plate to try to pay your current bills. And trust me: In the long run, you will be far better off if you take my advice and deal first with these issues before you attempt to pay off old debts or improve your credit rating in order to try to get another place to live.

Unfortunately, student loans aren’t like mortgage debt. You can’t simply “walk away” from student loans — at least not without very, very severe consequences, and not without those loans haunting you, literally, for the rest of your life. You see, student loans have no “statute of limitations.” So your lenders (whether private lenders or the federal government) can come after you and/or your daughter forever to try to collect. Read this article on how to pay student loans fast, and the links on these posts on student loans too, for some ideas about how to eliminate that student loan debt.

Frankly, I wasn’t aware that student loan companies or loan servicers were willing at all to “negotiate” lump sum settlements for student loan debts. Frankly, why do they have to, considering the power they wield over debtors? They can report your deliquency to the credit bureaus, they can garnish your wages, they can take tax refund checks, and student loans have no statute of limitations, meaning that creditors can chase you down for this debt until you retire. And even then, they can snatch any pension or social security check you might get. On top of all this, you can’t even wipe out student loans in bankruptcy court. With all this leverage, I’m shocked that some company has entertained the idea of a lump sum settlement.

To be honest, I don’t think you should do a “settlement” because of the many drawbacks to settling a debt. In a nutshell, when you settle a debt, your credit takes a hit, because the obligation gets reported as a settlement or partial payment. Any reporting to the credit bureau that shows you didn’t pay as agreed will lower your credit score. And isn’t that one of the benefits you’re getting from going through loan rehabilitation? Rehabbing a student loan wipes your negative credit history out in terms of past due student loans that were reported to the credit bureaus. Settlements will put some black marks back on your credit records.

Additionally, when you negotiate a settlement with any financial company or government agency, they send you a 1099-C. This reports the amount of debt canceled or forgiven. That “forgiven” amount is considered gross income and is taxable by the government. So if you do get a settlement for, say, $40,000 on that $80,000 in student loan debt, the other $40,000 that is purportedly wiped out in the settlement agreement is taxable at your ordinary income tax rate.  If you’re in the 25% rate, that means you’ll be stuck with a $10,000 tax bill.

Finally, I’m just suspect about this whole deal. What recourse would you have if you fork over tens of thousands of dollars to a company and then they say “Sorry, but we never had a deal.” You can reduce this risk, of course, by getting an agreement in writing upfront. But my point is that the student loan company, or collection agency, could probably rightfully show a judge (if it got that far) that you did, in fact, owe $80,000. There’s certainly no law that
requires them to reduce or settle your debt.  Then you’d be on the hook for the remaining balance — even after thinking you had a properly agreed-upon “settlement” deal.

I think a better strategy, especially since you have supportive parents, is to let your parents help you make a hefty lump sum payment, but to bite the bullet and pay the $80,000 that you owe. Let’s say you pay $40,000 in a lump sum. All of that money should go toward your principal balance. That will knock out a huge amount of interest charges – more than $15,000 in interest, according to the financial calculator at www.FinAid.org. Visit that site and play around a bit with various loan repayment options. At first glance, it may sound foolish to pay $80,000 when you think you can possibly pay $40,000. But look at it this way: that $40,000 lump sum settlement will really be $55,000, when you factor in taxes. Now take a look at the hit to your credit for the next seven years.

In my opinion it’s worth it to pay the other $25,000 to preserve your credit. If you can keep a good credit rating, you’ll probably save way more than that “extra” $25,000 if you have to get other loans, like a mortgage, credit cards, auto loan or other student loans.