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Author: Mark0Young Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 308476  
Subject: Re: Me vs. My Parents $40K Debt (Long) Date: 9/6/2004 5:37 PM
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Kyle, it is good that you wish to help your parents. I am not going to tell you anything new in this post that hasn't been mentioned in other posts, but they are among some things to consider.

I have less than 1 month to get this plan organized and put into action.

Consider, though, that this is your plan, not your parents' plan. Unless both of your parents whole-heartedly embrace the plan, it won't work, especially once you move to the Virgin Islands and thus won't be able to provide encouragement.

Encouragement? You are still your parents' child, and you will always be their child. Many parents have difficulty learning a new life from their children. That means that many parents to take anything more than a mild encouragement as both nagging and medling, especially if the nagging is over an area where they haven't asked for help.

As another poster wrote, "You can lead a horse to water, but you can't make it drink." However, you can salt the oats (maybe give them a book that you think would be helpful), but they, or specifically your father, has to get the desire to change and maybe see how it is possible to change, or it won't happen.

Plan of Attack: New Jersey has a Pension Loan Program that I have recently discovered and I think it holds the key to tackling their debt.

No, not yet! It sounds good on paper, but in practice this is too soon, destructively too soon!

A study done for the FDIC found that of those who took out high loan-to-value home equity loans, 70% were back in credit card debt one year later. Reading posts over the years here on the Consumer Credit / Credit Card board have likewise supported similar statistics, not just with a HEL (or HELOC), but also with 401(k) loans, other inexpensive loans, windfalls and overtime pay.

The problem? The discussions here on Consumer Credit / Credit Card board provide more insight than a statistic from a study for the federal bank insurer: if one isn't committed to debt elimination, usually a source of inexpensive funds just becomes an enabler to get further into debt so one ends up with the restructured debt plus additional credit card debt, the result usually being worse than if no loan were taken out.

When does it work? When there is a definite plan to eliminate debt that the couple is actively pursuing, and the restructuring of debt is just a step in that direction, i.e., getting a lower interest rate so that more of each payment can go towards the principal so that the same-sized payments are taking care of more of the debt.

From what you have posted, it doesn't sound like your father has started living below his means. Changing one's lifestyle is initially a struggle because one is learning to avoid most impulse buying, a certain amount of self-denial (probably not abstinance, but still a reduction on discretionary spending), and learning new habits of spending. And, like many habit changes, it is too easy to give up early in the process until one gets comfortable with it. Until your father has made it through a few months of living below his means and concentrating on consumer debt elimination, borrowing against the pension is just too risky.

So this is what we are thinking:

...
5)Learn to LBYM... probably the most difficult of all the tasks listed.


This is the first thing that has to be addressed. Without this, everthing else will be a temporary fix at best. And, yes, this is the most difficult of the tasks listed because it involves change in behavior: the reduction of discretionary spending, fighting impulse spending, maybe even taking steps that would otherwise be considered "stupid" by those who haven't had a spending problem, such as maybe taking the credit cards and making them very inconvenient to use (e.g., locking them up in a safe deposit box at a credit union or bank, or freezing them in a block of water in the freezer), or making a "debt chain" (a paper chain where each link represents a specific amount of debt, e.g., if each link represents $500 of debt, a $40,755 amount of debt would be 81 paper links, and as the total consumer debt goes down past a threashold, break the corresponding link).

Besides LBYM, I would recommend:

- making sure every card receives at least its minimum payment at least by the due date,

- all balances be kept below the credit limits (with at least enough "available credit" so one month's interest doesn't push the balance over the credit limit).

The elimination of over-balance fees and late fees will help the situation as long as the elimination of such fees don't have a corresponding increase in spending. (Yes, LBYM ends up affecting all of one's finances!)

"Snowballing" would be my recommended approach once the above is in progress. ("Snowballing": paying at least the minimum due on all debts except the one target debt, and pay as much as one can towards the targeted debt. Typical suggestion is to target debts that can be paid off in one or two months so one has an early victory, and next target the debt with the highest interest rate because the highest interest rate debt will have the most "bang for the buck" in the form of saved interest and thus becomes the most economical approach when looking at the portfolio of debts.)

Another thing your parents may want to consider is whether they are living in "more house" than they really need, maybe consider downsizing if that makes sense for their situation, or considering renting out a room or two if that makes sense for them to do so. (Renting may open other issues, particularly if they live in an area that has strong renter protection laws. But if it works it may help the "M" part of LBYM.)

1)Call the credit card companies and ask for a reduction in rates.

Good! And if the rate is lower than other cards, your father might also ask about balance transfer offers. This is more likely a possibility a cuple months after that card got paid off: the card issuer knows once the card is paid off that the customer is far less profitable, so they often do have a balance transfer offer so they can start collecting interest again.

Ask again every six months.

4)Try to roll the remaining balances onto a lower rate card immediately

Yes, but also good later in the process. Watch those credit limits! And and ask about waiving balance tranfer fees.

2)Take out the full $30K, pay off the highest rate cards with the $30K

I addressed that earlier in this message. Briefly: while great on paper, the majority of the time it just becomes an enabler to get further into debt unless one is whole-heartedly pursuing a consumer debt elimination plan and this restructured debt becomes part of the debt to eliminate.

3)Cut up said cards, close accounts.

Closing accounts can be counter-productive on several fronts:

- If the credit report shows negative information like late payments, if the accountis open, the late payment info will probably drop off after a couple of years, but once the account is closed it will be 7 years before negative information is dropped off. The negative information in the credit reports will be one of the factors on the interest rates your father is being charged, both on current cards and on potentially new cards.

- If a card is paid off, after a few months the card issuer may have a decent balance transfer offer, which is an opportunity to reduce the cost of carrying a balance while working on getting it paid off. Even if only part of the highest-interest-rate card can be transferred, overall such a strategy can potentially save money.

- Other information going into the credit score (besides late payments) include the total used credit to the total credit limit, the larger the ratio, the worse the score (and thus the highe the interest rates one is likely to pay). If a credit card is closed, it is treated as zero available credit and thus can adversely affect the used/limit ratio and thus adversely affect the credit sore. Likewise, the age of the accounts are considered--the older the accounts, the better.

While I normally don't recommend obsessing about one's credit score, having some knowledge on how one's actions can affect one's score can help avoid some of the larger pitfalls that would make one look unnecessarily risky to current and potential lendors.

For more information abut credit scores, go to http://www.myfico.com/ and look in the "Credit Education" section. I would also recommend your father request credit reports fro all three major credit reporting agencies so he could double-check what the lendors are reporting as well as cleaning up outright mistakes.

* 30 year mortgage (No data yet for this)

This may be a good reason to take a very close look at the credit reports and maybe even pay extra for the credit scores.

If the interest rate on the mortgage is high, it might make sense to refinance the mortgage at a lower rate. However, mortgage interest rates, unlike many other loans, are very sensitive to credit scores (best rates with FICO score of 720 or better) and the good loans are usually not available if there are unpaid collections in the credit report. So, if the credit reports show bad information, refinancing might not be an option. And, like I tried to discourage pension loans above, a cash-out refinance can be as equally financially destructive.

While I don't want to rain on your efforts, I think having a good appraisal of the options and tradeoffs would help you (or rather your father) to fit the options best with the situation. It is hard enough for someone to face a bad financial situation, harder to reveal that to another party but, once faced, it is good to know the most helpful options and their tradeoffs.

I wish you well!
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