Paring down debt should be a priority in these tough times
By Michelle Singletary
By Michelle Singletary
When times are good, some people still struggle to keep up with their credit and debt payments. In a downturn, bad gets worse because, for some, there's less money to devote to debt.
In a recent online discussion, about a fourth of the questions I received had to do with debt issues. This gave me a window into how some unemployed folks are getting by and how others are fighting to hold on to their good credit name. Here are some of those questions:
Q. I'm in a tough situation. My dad and I co-own a home. My dad has the first mortgage, and I took a second mortgage based on the home's equity to improve the house since my credit was much better. My dad pays for the second mortgage, too. Because of the economy, my dad may declare bankruptcy and the house will be foreclosed. I can't afford to pay the second mortgage. Does this mean my credit is shot?
A. Unfortunately, one of the downsides to co-signing is that if the loan goes into default, all that bad payment history gets reported on the co-signer's credit report. So yes, in all likelihood your credit is shot.
This is why I warn people about co-signing. As economic conditions continue to deteriorate, a lot of people who co-signed will learn this lesson the hard way.
When you co-sign you are not agreeing to be a backup, you are agreeing to be equally and wholly responsible to pay back the loan.
In the case of the second mortgage, you were completely responsible if your dad didn't co-sign. Never take a loan for anyone if you can't make the payments yourself.
If you want to try to avoid trashing your credit, negotiate with the second lien holder either to settle the debt for less or to lower the payments to an amount you can afford. Because it isn't likely you'll be able to sell the home under these market conditions for a price that would even cover the first mortgage, you actually have some leverage.
Q. I'm using my tax refunds to pay my credit card bills. I want to wipe clean my credit card debts before I go on maternity leave. My income will be cut in half while I'm out. But even with the tax refunds, I'm still a couple of thousand dollars short. Should I take it out of my savings?
A. It's great that you have an emergency fund. Typically in such a case, I would recommend you take all the refund money and pay down the debt. However, I'm a little concerned about your income being cut. Be careful about paying down debt until you get a handle on what it's like to live on half your income during your maternity leave.
If you have at least three to six months saved in your emergency fund, that will help cover household expenses you need to pay while your income is down. With the savings in place, you could go ahead and use the tax refunds for the debt. But keep your savings until you return to work full time.
Q. I'd like to change employers. Although I have a bachelor's degree, I've found I need to get an MBA. My family has about $32,000 in debt (credit cards and student loans). Should I just get a loan for graduate school? I don't want to wait four to five years when our debt will be eliminated to start school.
A. I have two words for you: delayed gratification.
You need to wait. You don't need to change jobs, you want to change jobs. You need to pay off that $32,000 instead of irresponsibly sinking your family into more debt, especially in this economy.
Q. I recently lost my job. I have run out of money in my savings account and must now either start using my home equity line of credit, credit cards or IRA in order to pay monthly bills. I have enough credit to last almost three years so I'm not hurting. What's the best short-term source of money until I find a new job?
A. The best short-term source of money is a job. Any job. Or apply for unemployment insurance if you're eligible. Unless you are in dire conditions, you certainly shouldn't touch a tax-advantaged IRA. Between the income taxes you have to pay and the 10 percent penalty for early withdrawal, you could end up taking a 30 percent to 40 percent hit on that money.
As for using the home equity line and credit cards, you should do everything in your power to avoid tapping that debt for your everyday living expenses. Let's just say conservatively your monthly expenses come to $3,000 a month. After three years of living on credit, you would have racked up more than $100,000 in debt. In just six months, you would have $18,000 in debt.