Prioritizing Your Payments
Q: My husband and I are at a crossroads. We expect that the company I work for will pull out of our area and I'll be laid off. We've been saving diligently, putting money away every month to keep us afloat while I'm between jobs. Then we realized we have enough in our savings account to pay off all our debts (cars, campers, one credit card) except for our mortgage. Doing so would free up about $2,000 a month. Should we pay off everything and begin saving again or keep the money in the bank for the probable end of my employment?
A: Pay off the credit card, but don't pay off the cars and campers. I firmly believe that everyone needs to make it a priority to get out of credit card debt (see Preparing for a Possible Layoff). But you also need to keep enough money in your savings account to cover the mortgage payments if you cannot quickly find another job. If you deplete your savings to pay off the cars and campers, how will you be able to make the house payments if you are laid off?
That said, what you really need to consider is selling one or more of the cars if you can pocket enough to cover the loan balances on the vehicles. And those campers fall far short of being a necessity, so you might think about selling them, too. I know that getting rid of certain possessions is hard to contemplate, but hard times require sacrifices.
Q: My husband has a structured settlement from an accident he was involved in as a child. He sold ten years of that settlement in 2004, but in 2014 he'll start receiving monthly payments of $400. We have approximately $30,000 of debt, including medical bills, and we lease our only vehicle. These days we are having difficulty making payments on time. There is literally $1 in our savings account. We have a 7-month-old son and hope to buy a house within the next few years. We think that selling the rest of the settlement to pay off our bills will allow us to save for the home of our dreams. There's about $110,000 left; by selling it, we'd net $17,500. Would that be smart?
A: Structured settlements are a common way for people who have been injured to receive an insurance payout. The periodic payments provide ongoing income and reduce the risk of blowing a lump sum through poor financial choices. In many states, you can sell your rights to periodic payments to a company that will pay you a lump sum today. Doing so, I realize, is tempting, but it's typically not smart.
For starters, payments received in a structured settlement are generally tax-free; if you sell in return for a lump sum, you may owe state and federal tax, thus reducing the settlement's value. More important, the firms that buy your settlement are out to make money by underpaying you for its real value. The bottom line: Cashing out today can mean netting far less than you'd get if you kept the payments.
Let's do the math. Since you owe $30,000, a $17,500 payout isn't going to solve your problems. You would still have $12,500 in debt, and a car lease, and you'd be no closer to building a savings account, let alone coming up with the down payment for a home. I want you to dig out of debt without touching the settlement money. Your dream should be to get out of debt, not to buy a home that you have no way of affording right now.
If you need help tackling your bills and learning to live within your means, I suggest you contact the National Foundation for Credit Counseling, a nonprofit organization that will connect you with a debt counselor in your area. NFCC counselors will assess your situation, help you negotiate payment plans with your creditors when feasible, and, yes, tell you if cashing in your settlement is your best move.
I also want you to focus on what those tax-free settlement payments can do for you beginning in 2014. It sounds as though you have 20 more years of payments coming to you. If you were to invest the entire $400 every month in a Roth IRA for 20 years and earn a conservative 5 percent annual return, you would have about $165,000 in 2034. If you were to keep that sum growing for another 15 years—without investing another penny—you could have more than $340,000 by the time you retire. That's a dream that can be yours if you use the structured payouts wisely.
Q: After college my fiancé and I lived abroad and worked as much as possible. We started sinking into debt, and it took a while to get reestablished Stateside. Finally, we found a house, and though it wasn't expensive, my husband wasn't earning much. His salary has steadily increased to $120,000, but we are nearly $100,000 in debt in addition to our mortgage. The cost of living in our neighborhood is high, and my own contributions have been sporadic because I care for our two children and two ill relatives. We have a 401(k) and life insurance but no savings, and we often bounce checks at the end of the month. We have already borrowed against our house as much as we can. My husband gets frantic and doesn't want to spend at all, even for the kids. I feel bitter and shop anyway because it seems as if we'll always be broke no matter what. I'm afraid to open our bills. The panic is starting to affect our marriage. Is there any way to achieve financial equilibrium?
A: There's no reason you can't get by on your husband's salary. The problem is that you're sabotaging your family. I know that sounds harsh, but you need a serious financial wake-up call, and I'm sounding the alarm. Part of the reason you're doing this is that you're overwhelmed from taking care of everybody else. Subconsciously or not, you believe nobody is taking care of you. So you fill that hole by spending money, and then you feel terribly guilty. You deserve to treat yourself better than that.
Use your fear of opening those monthly statements as motivation to change. Whenever you're about to whip out your credit card for another unnecessary purchase, ask yourself: "Is this worth the horrible feeling I'm going to have when the bill arrives?" Keep a photo of your family next to the credit cards in your wallet; as you reach for one, think about whether the item is worth the possibility of losing their respect or, in the case of your husband, losing your spouse completely. That's where this is headed if you don't change. I know you have it in you to make the right choice.
Next: The ins and outs of a second bankruptcy