She’s Got to Pay the Piper
Dianne Franks, like many other people, took out a federally guaranteed student loan to see her through college. For her, it was Lesson 1 in the dangers of easy credit. Now, at age 41, Franks still finds herself at battle with the demon debt.
From her early 20s, when Franks wanted something, she borrowed money. She began to accumulate bank credit cards and revolving charge accounts from stores such as Nordstrom and Sears.
“You name them, I had them,” Franks admitted of a credit card habit that persists to this day. “I used them frequently, bought clothes and never set up a budget.”
Five years ago, when the opportunity came to purchase a $148,500 home with a 5% down payment and a subsidized mortgage from the Community Development Commission of Los Angeles County, Franks didn’t hesitate. She borrowed $10,000 from a friend and became the proud possessor of a Spanish-style residence in Pasadena.
During and after a six-month bout of
unemployment a few years later, Franks fell behind on her mortgage and her credit card debt surged. Now, more than a year after obtaining a $44,000-a-year position as a contract administrator and proposal writer for an environmental firm, Franks still finds herself barely able to tread water.
Not counting her mortgage, she is more than $45,000 in debt. She owes $18,000 on bank credit card accounts (average interest rate: 12%); $4,480 on revolving store charge accounts (average interest rate: 21%); $15,000 on her student loan (interest rate: 9%); and $8,000 on a personal loan from the funds in a 401(k) retirement plan (interest rate: 8.625%).
Her assets are limited. She has $8,300 remaining in her retirement accounts and a little more than $100 in a bank savings account. She doesn’t know whether her home is worth more than its purchase price.
“I’ve done everything wrong. I need to be turned around,” Franks admitted. “I want to get out of debt more than anything. I feel like I’m working for nothing.”
But there’s one step she refuses to take: She will not declare bankruptcy.
“My sister tried to convince me to do bankruptcy, but it’s against everything I was raised to believe in,” she says. “My grandparents were immigrants from Europe, and they taught me you work and you pay your bills and you don’t give up.”
In the last few weeks, Franks met with Richard Pittman, director of counseling for the Consumer Credit Counseling Service of Los Angeles, and Ginita Wall, a San Diego-based fee-only certified financial planner and author of several books on personal finance.
Pittman and Wall maintain that Franks does have the wherewithal to pay off her debts and that, with some discipline, she can avoid bankruptcy. Besides the moral and social discomfort it would create, a bankruptcy filing would remain on her credit record for a decade--longer than the seven years for most credit problems. Besides, a bankruptcy would not erase her student-loan obligation.
Both advisors also would like to see Franks hang on to her house. Even though her housing expenses seem high--she pays $1,088 a month on her mortgage, plus property taxes and insurance--she’s receiving significant tax benefits from homeownership. She’s saving several thousand dollars a year on her federal and state taxes because the subsidized-mortgage program she participates in means she gets a 20% tax credit as well as the usual mortgage-interest tax deduction.
More important, Franks’ home represents her best chance for security in her later years. She stands to own the house free and clear by retirement age, thus freeing her from a need to worry about monthly housing costs when she’s no longer working. Homeownership can help Franks in another way, too: She can take in a roommate to reduce some of her expenses. And, in fact, Franks has done just that. Beginning in November, her roommate will contribute $375 a month plus a share of the utility bills.
The fact remains, nevertheless, that Franks must deal with the consequences of years of reckless spending, of borrowing from one place to pay a loan from another. For example, Franks caught up on her mortgage and repaid the friend who lent her the down payment on her house in part by borrowing against a 401(k).
She’s now so overextended that she’s paying the bare minimum on her credit card bills. In some cases, because she’s negotiated reduced monthly payments with the lenders, her payments hardly cover the interest charges.
Pittman and Wall both expressed concern that because Franks has no emergency savings to speak of, any headway she manages to make on her debts is quickly wiped out by an unexpected expense, however small.
In short, too much of Franks’ take-home pay is being eaten up by debt service. No wonder she feels as if she’s caught in a financial riptide.
“The problem you’ve been running into is that every time you start to see the light at the end of the tunnel, something comes along that really ends up being a freight train coming your way and knocks you out again,” Wall told her.
It’s a situation all too familiar to those who have fallen deeply into debt. How do you know whether you’re headed for trouble? As a general rule, if your consumer debt payments equal more than 20% of your take-home pay, you’d better be mighty worried.
Wall drew up a repayment schedule that would extricate Franks from the most onerous of her debts within five years. The key to the plan: Franks must find an additional $100 a month to put toward paying off her credit cards and 401(k) loan. If she refrains from adding her tenant’s contributions to her general spending income, it’s likely the money to erase her debt could derive from that source alone, Wall said.
The financial planner recommends putting the money from her tenant toward the credit card with the highest interest rate. That would probably be her Nordstrom or Sears card, both of which charge about 21% annually. In fact, because Franks owes a little less than $300 to Sears, she could pay off that card by the end of the year and pay off all her other store charge accounts in less than two years.
She can then turn her attention to making more than the minimum payments on her five bank credit cards and 401(K) loan, again beginning with those carrying the highest interest. If Franks maintains this regimen and refrains from running up new bills, Wall said, she “can be debt-free by the age of 45.”
But those are big ifs. Not only are there emergencies to be handled, there’s also temptation to be resisted. For example, Franks recently paid down most of her Nordstrom account only to decide she needed a new work wardrobe. The bill: $1,300. And there are the little luxuries that many of us take for granted--buying books instead of going to the library, buying coffee and a muffin each morning. Franks can’t afford those indulgences, the advisors said.
Both advisors agree that Franks needs to change her attitude about money, but they disagree about the approach. Wall believes Franks should funnel any additional savings into paying down her credit card debt. If she makes that a first priority and keeps a close eye on her expenditures, Wall contends, it probably isn’t necessary for Franks to undertake a more formal budgeting plan, which wouldn’t suit Franks’ personality anyway. Instead of accumulating an emergency savings fund at a bank, then, Wall maintains that Franks should continue to use her credit cards to meet unexpected expenses.
“Credit cards get to be an expensive emergency fund, but it’s better to get those credit cards paid down rather than setting aside cash you can draw on for emergencies,” Wall said. “If you’ve got money sitting in the bank, it just beckons to you and says: ‘Spend me! Spend me!’ ”
Pittman disagreed. He believes Franks must learn to budget--he even recommended that she take the counseling service’s money management classes--contending that she’ll never get a grip on her debt if she doesn’t master the art of parsing one’s finances.
“Your first task is to get something into the bank,” Pittman told her. The credit counselor was particularly concerned about Franks’ habit of gathering up money for her property taxes in the two months before they are due rather than saving systematically over the course of the year.
Pittman urged Franks to begin keeping close track of her spending, noting areas in which she may be able to cut back.
He also suggested that she close the majority of her Visa and MasterCard accounts, keeping active only the one or two with the lowest interest, and those only for emergencies that can’t be handled any other way. He added that she might write to those cards’ issuers to ask that they lower her credit line.
All store cards should be jettisoned, Pittman said. These not only charge high interest, but also present a constant source of temptation.
Franks preferred Wall’s approach. She’s just not the type, Franks said, to have “$160 a month going into the bank to pay for my property taxes--I’ve not lived my life like that.” And Franks disagreed with Pittman’s gentle admonition that many of what Franks would characterize as one-time expenses, such as clothing, are actually repeat offenses.
Wall and Pittman concur, though, that Franks should not stop contributing to her company’s 401(k) plan--building up retirement savings is an important priority. They suggested that Franks continue her policy of putting any raise she gets into the tax-favored account.
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Wall reviewed the mutual fund selections available to Franks in her two 401(k) plans (one is with a former employer) and suggested some adjustments. Currently, the $8,000 in the plan with her former employer is in Neuberger & Berman Partners Fund (five-year average annual return: 24.1%), a mid-cap value fund subject to moderate volatility but that has offered investors higher than average returns.
To diversify here, Wall recommended that Franks keep 40% of the savings in the Neuberger & Berman fund and transfer 40% into Vanguard Index Trust 500 Portfolio (five-year average annual return: 22%) and 20% into T. Rowe Price International Stock Fund (five-year average annual return: 15.1%).
If Franks would like to take on a little more risk to pursue more aggressive growth, Wall said, she could instead leave 20% in the Neuberger & Berman fund and have 20% go into Acorn Fund (five-year average annual return: 22.6%), a highly regarded small-cap fund.
As for the plan her current employer offers, and in which Franks has only about $300, the planner recommended that 40% of future savings go into the Vanguard Index 500 fund; 40% into Fidelity Contrafund (five-year average annual return: 23.3%), a large- and mid-cap value-oriented fund; and 20% into Templeton Foreign I (five-year average annual return: 16.4).
With the holiday season coming up, Wall said, Franks could consider taking a temporary part-time job in a store to bring in a few extra dollars.
Pittman suggested Franks obtain an appraisal of current estimated worth on her home. It’s possible, he said, that appreciation alone has given Franks a 20% stake in her property, which would give her enough equity to allow her to drop her private mortgage insurance, an expense of $400 a year.
For Franks, the process of reviewing her finances proved not only instructive but also energizing.
“I needed to see that [getting out of debt] is doable,” she said.
(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)
The Situation
Investor: Dianne Franks
* Annual income: $44,000
* Immediate goal: Pay off debts.
* Problem: More than $45,000 in credit card, personal and student loan debt.
(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)
Meet the Planner
Ginita Wall is a certified public accountant and a fee-only certified financial planner based in San Diego. She has written several books on personal finance, including “The Way to Save” and “Your Next Fifty Years.”
(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)
This Week’s Make-Over
Investor: Dianne Franks, 41
Occupation: Contract administrator and proposal writer
Gross annual income: $44,000
Financial goals: Pay off debts; save for retirement
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Current Portfolio
Real estate: House in Pasadena purchased for $148,500 in 1992 on which Franks owes $129,500
Retirement accounts: About $8,300 in two 401(k) plans; nearly all money is invested in Neuberger & Berman Partners Fund ([800] 877-9700)
Cash: $100 in savings account
Debts: More than $45,000 in consumer loans, student loans and money borrowed against a 401(k) account
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Recommendations
* Make concerted effort to pay down debts. Track expenses in an effort to find at least $100 a month that can go toward debt repayment, then start accelerating payments on credit cards, beginning with those carrying the highest interest rates. Close all store charge accounts. Close all but one or two Visa and MasterCard accounts; the active accounts are to be reserved only for emergencies.
* Investigate whether home’s value has appreciated enough to allow cancellation of private mortgage insurance.
* Diversify 401(k) account holdings to include mutual funds investing in large-company stocks, foreign stocks and perhaps one investing in small-company stocks.
Recommended Mutual Fund Purchases
Vanguard Index Trust 500 Portfolio (800) 662-7447
T. Rowe Price International Stock (800) 638-5660
Templeton Foreign I (800) 292-9293
Acorn (800) 922-6769
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Helaine Olen is a Los Angeles-based freelance writer and can be reached on the Internet at holen@aol.com. To participate in Money Make-Over, send your name, age, phone number, income, assets and financial goals to Money Make-Over, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053.
