I received the following email from a reader. Although his situation isn’t good, it could be a lot worse. One thing he mentions in the email stood out to me like a sore thumb. Let’s see if you can spot it:
I was contemplating taking some retirement money to pay off some debt, which would reduce monthly payments so we will get out of the cycle of coming up short of money every paycheck, thus taking on more credit card debt. My debt started 9 years ago (mid-30s). Coincides with buying a house, getting married, and having children in fairly rapid order. Before that the only debt I had ever had was one car loan and a student loan. Well, when I bought my house 9 years ago I borrowed from my dad so I would have 20% down. That is long paid off. I have a wife & 3 children: 6, 4, 2.
I should add that since I wrote the first time, I cashed in about $6,550 in a 401k program from my current employer. The program was ended a few years ago when they switched to a new program, and I never rolled the old one over. Iâ€™ve set aside 35% of that distribution for taxes and the 10% penalty. I didnâ€™t like doing that, but Iâ€™m running out of options, at least it seems that way to me.
Here is my financial info:
- Fixed mortgage 5.875%, $76.5k balance, pay ~$620/month. I bought the house in 1998 for $79.5k, refinanced 3(?) yrs ago for the lower interest and reduced payment (not really a significant decrease). Reportedly the house is worth $150K or more now, but I donâ€™t trust that number.
- $50k LOC variable 7.99% $43.5k balance, minimum 1% of total for payment per month. I got the loan a year ago, rate hasnâ€™t moved (yet).
- CC 17.5k balance, most is 4.99% fixed, some is 3.99% fixed (until Iâ€™m late on a payment of course). Payment currently ~$350/month.
- Car loan – ~$1,200 balance, 5.something interest (6-yr loan, term up this December), ~$293/month. This is one that I want to pay off early. Even though itâ€™s not the highest interest, the monthly payment doesnâ€™t change and the balance is getting low, so the drop in monthly payments is significant).
- $1,000 on a credit line, no interest if paid by January 2008.
- $6,000 for my 4-yr-oldâ€™s pre-school, $3,000 due at the end of this month, $3,000 in December. This is our big extravagance. Education is a top priority, but our youngest (2-yr-old) isnâ€™t going to pre-school because we canâ€™t afford it.
Other monthly payments:
- Phone (land & cell) – $40
- Auto Insurance – $130
- City fees – $45
- Electric – $50 winter, $175 summer
- Natural Gas (home) – $30 summer, $125 winter
- We go through about 7-8 tanks of gas per month
- One income, net $1,800 every 2 wks (while paying $333 health insurance, $13.75 optional life each check), plus quarterly bonuses that net about $1,100 each.
- SEP IRA $14,000 balance (from self-employed days)
- Trad. IRA $1,300 balance (from self-employed days)
- 401k matching $10k balance â€“ my current job. I havenâ€™t taken advantage of the program in three years, since we learned we had a third baby coming. I anticipated financial trouble coming as soon as I found out. I keep hearing what a sin it is not to take the free money, but it seems worse to incur high-interest debt just to contribute to an IRA.
- no savings.
I would appreciate your highly esteemed advice! If this is a bad idea, what to do? My wife hopefully will be back to work in a year or so, but probably needs some training to do what she wants, so it may take longer and require more payments for training first.
Where to start?
This reader didn’t give me ALL of his information but here’s what I gathered from the information above:
The first rule in personal finance is you have to live within your means, which means you have to SPEND LESS than you EARN. Although this might be hard to stomach, the FIRST thing I would do is give up the $6,000 per year preschool. I understand that education is important but things like preschool are luxuries and should be used ONLY if there are means to provide them. This family cannot afford it. That $6,000 per year would go a long way towards getting this family back on the right track. Besides, I seriously doubt that forgoing preschool will have a negative impact on the child. Take them to the library and museums instead.
Based on what I can tell, this family’s immediate needs are:
1. An emergency fund. They have nothing right now, which means any emergency that comes up will have to be funded with credit cards or debt of some sort. I know from experience just how tough it is to be struggling to pay off credit card debt only to charge an emergency back unto the very card you are trying to pay off. Emergencies will come whether we are prepared for them or not.
2. Controlling their spending. According to their cash flow information from above, they have a positive cash flow of around $600 per month. However, he told me in the email that they are actually spending more each month than they earn. They could have even more if they dumped the preschool. He told me in an another email that his wife has trouble controlling spending. If this is the case, I would sit down with her, show her the budget and emphasize the importance of staying within the budget. If that doesn’t work, I would then give her the cash she needs to meet those needs.
3. Once the emergency fund has a balance of at least $2,000, I would then concentrate on paying off the credit card balance. Additionally, they will have another $300 per month once their car is paid off.
4. I would get back into the 401(k) as soon as possible. Although forgoing a long term goal sounds legitimate when times are tough, you have to realize just how much you are giving up. That $6,500 he cashed in could have easily been worth $65,000 – $113,000 in 30 years.
Finally, I would like to tell this guy to not lose heart. Although his situation isn’t good, it could be a lot worse. He could owe a lot more on his car loan and he could also have a lot bigger mortgage. So, it’s not all bad unless they don’t get things under control now.
Now, I would like to open this up for input from everyone else. Do you have any suggestions for a fellow reader?