Lightening the Debt Load

SPECIAL TO THE TIMES

Juliet Arroyo tried to downshift but instead got herself caught in the economic gears.

After reading Juliet Schor's influential "The Overworked American"--the recent study positing that modern-day folk are devoting too much time to their jobs to the detriment of personal and family life--Arroyo, an urban planner, decided to forgo upward mobility. In 1995, she arranged to work a 32-hour week in a new job at a slightly lesser salary.

The thirtysomething single mother wanted to be more available for her two boys, now 16 and 14, as well as have more time to pursue her favorite hobby: belly dancing.

"It was very stressful, working 40-plus hours a week and raising two kids alone," she explained.

Yet Arroyo, already facing financial difficulties, didn't cut back enough to make up for the lost income. After she pays the minimum due on her various obligations each month, she has barely $1,000 left over for everything from food to medical expenses. She is, however, saving $192 a month in her 401(k), of which her company matches 25%.

Arroyo grosses $46,500 annually and collects $5,400 a year in Social Security survivor's benefits for her younger son, but she is currently $33,000 in debt. And that's on top of the mortgage on her Glendale home and a housing-rehabilitation loan (for a new roof) with a balloon payment of $39,500 due in 2008.

"You have to get a budget that balances. Nothing will improve until you do that," Kathleen Stepp, a fee-only certified financial planner in Overland Park, Kan., told Arroyo. "Right now, you need to get your fiscal ship turned around."

There are months in which Arroyo barely makes it from the 1st to the 30th, even as she pays only the minimum due on her five credit cards and her student and personal loans. What's more, she receives no child support for her elder son.

Unfortunately, her expenses are increasing. She strongly believes her younger son will benefit from a private education, and the boy has received a scholarship for his school, but Arroyo will still have to pay around $6,000 a year. And her car, with 170,000 miles on it, isn't getting any younger.

"I don't feel my money goes far enough," Arroyo said. "I can't even save money, never mind invest it. I barely get by day to day. I'm trying to live a middle-class lifestyle when I'm a single parent with one income.

"There's car repair, house repair, school photos," she said, expressing her frustration. "I try to anticipate these expenses, but I never realize what things will come up and what they will really cost." So when Arroyo comes up short, she taps her credit cards to pay for necessities such as groceries.

And let's face it, denying yourself and your children the occasional treat isn't easy. Then again, neither is paying for a treat you can ill afford.

Arroyo took her boys on a summer trip to Seattle. "My older son is moving out next year, and we'd never gone on a family vacation before," she explained. But to pay for the trip, she took out a $1,000 loan from a finance company at 24% interest.

Arroyo's plight is stark evidence of the troubles many middle-income single parents face.

Stepp's first recommendation: Arroyo should not continue to battle her red ink alone--and Arroyo readily agreed. Nonprofit consumer credit agencies such as the Consumer Credit Counseling Service or Debt Counselors of America can often negotiate with creditors to get reduced interest rates and lower monthly payments on obligations, and they can be more persuasive than debtors usually can be on their own. Moreover, either service would offer Arroyo classes in budgeting basics, something Stepp believes Arroyo needs.

Stepp dismissed any notion that Arroyo might want to tap the approximately $40,000 equity in her home to pay off her bills, either by selling or borrowing against it. It would be too easy for Arroyo to get herself into an even worse financial mess down the road. That's because she'd be either liquidating or risking the loss of her one significant financial asset without, presumably, making a serious commitment to changing her lackadaisical approach to money.

Besides, Arroyo's monthly mortgage payment, before tax deductions, is $1,117. If she sold the home, it's unlikely she'd be able to rent a two-bedroom apartment for less than that.

What should Arroyo do, then?

Stepp and DCA debt counselors urge that Arroyo boost her income, either by returning to work five days a week or accepting the paid nighttime belly-dancing gigs she's been offered.

She also should reduce or stop her 401(k) contributions, currently set at 4% of her salary, to increase the money available for debt payment and living expenses, Stepp and DCA representatives said.

It should be noted, though, that giving up her 401(k) for, say, five years would be a big sacrifice. It would save Arroyo about $6,000, after taxes, but it would cost her about $86,000, if one factors in what those contributions would have earned by age 67 at an annualized return of 8%.

Clearly, it would behoove Arroyo to resume contributing to her 401(k) as soon as she can.

DCA officials who studied Arroyo's case believe that the agency can indeed negotiate with many of Arroyo's creditors and persuade them to either lower or forgive the interest compounding on Arroyo's debt. Assuming that what the counselors propose is agreed to, Arroyo's consumer debt payments would go from $535 to $450 per month, and she'd be able to pay off the majority of her bills in five years instead of the 12 it would otherwise take.

In addition, Arroyo would be eligible to participate in an income- sensitive Sallie Mae program that would allow her to cut the monthly payment on her student-loan debts, the bulk of which were incurred as she earned her master's in urban planning at UCLA. If Arroyo is willing to stretch these payments out over the next 12 years instead of eight, she could pay $157 a month on her student loans instead of the current $203. Doing so would free up that much more money toward paying off her high-interest consumer debt.

Why would creditors be willing to forgo all that interest? Simple: When debtors work through an agency such as DCA or CCCS, the creditors know they'll be getting the vast majority of their money back. That might not happen if a debtor declares bankruptcy.

Debtors should be aware, however, that there may be significant drawbacks for them in working with a credit agency. Critics point out that DCA, CCCS and others like them get some of their funding from the credit card industry. Therefore, they argue, these agencies may not recommend bankruptcy even when that course would be in a client's best interest.

In any case, for Arroyo to sign on with either service would mean that her credit cards would be frozen. Furthermore, the fact that the agency had renegotiated her debts would be noted on her credit report, making it much more difficult for her to obtain any kind of credit for the next several years

Some would argue, however, that bankruptcy is the only realistic alternative for Arroyo.

But DCA President Steve Rhode maintains that bankruptcy is not the answer, that with her income, Arroyo should be able to not only repay her (renegotiated) debts but to use the money she would otherwise pay as interest to gradually build a $12,000 emergency fund.

Stepp, however, isn't as sanguine. "If you look at your situation nine months from now and, even with budgeting, see it's not getting any better, you should talk to a bankruptcy attorney," the planner said. "I don't want to see you pay and pay and not save anything for the future."

Desperate debtors take note: Bankruptcy is no panacea. Although it wipes out consumer debt, and Californians may retain $50,000 in home equity, it won't erase student-loan obligations. Moreover, it will remain on one's credit record for at least a decade.

All in all, Arroyo has a lot of options to weigh. Notwithstanding her objection to filing bankruptcy, none of the proposed solutions would ease her problems simply or quickly. But she realizes that if she allows the situation to continue, things are likely to just get worse.

"I want to begin to save money," Arroyo said. "This burden of debt is unmanageable. I always think it will get better every year that I keep paying, but it doesn't."

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Helaine Olen is a regular contributor to The Times. She can be reached by e-mail at holen@aol.com. To be considered for a published 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.

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This Week's Make-Over

* Investor: Juliet Arroyo, 34

* Occupation: Urban planner

* Gross annual income: $46,500 from job, $5,400 in Social Security survivor's benefits for younger of two children

* Financial goals: Pay down debt, finance private school for younger child, begin saving for retirement.

Current Portfolio

* Real estate: About $40,000 equity in Glendale home with $157,000 outstanding on mortgage; home is also encumbered by $39,400 redevelopment loan to be repaid by 2008.

* Retirement account: $5,600 in 401(k) plan, invested in two growth stock funds

* Other debts: $14,000 in student loans, $8,000 on a credit union debt-consolidation loan and $12,000 on bank credit cards.

Recommendations

* Contact a consumer credit agency to assist in renegotiating debt payments; consider bankruptcy filing as last resort.

* Cease or reduce contributions to 401(k) but resume contributions as soon as possible.

* Begin building an emergency fund to consist of three months' salary.

Meet the Experts

Kathleen Stepp, a fee-only certified financial planner, is the president and founder of Stepp & Rothwell Inc. based in Overland Park, Kan. She advises individuals in all phases of personal finance planning and serves as vice president of education for the board of the National Assn. of Personal Financial Advisors.

Debt Counselors of America is an Internet-based national nonprofit organization based in Rockville, Md. It works with creditors and consumers to create debt-repayment programs. The group can be reached at (800) 680-3328 or at http://www.dca.org.

New Money Make-Over Features

Beginning this fall, The Times will publish two new kinds of Money Make-Over columns, which will rotate with the general financial make-overs such as the one that appears today.

One type will focus on specific matters having to do with investing and personal finance, such as making 401(k) choices, creating or changing an estate plan and choosing life insurance.

Another type will explore readers' first-person experiences with investing and personal finance issues that teach an important lesson. Readers are invited to submit summaries of their experiences, such as choosing stocks and mutual funds and forming strategies for changing their spending habits.

To be considered for inclusion in any Money Make-Over feature, send your name, age, phone number, income, assets and financial goals to Money Make-Over, Business Section, LosAngeles Times, Times Mirror Square, Los Angeles, CA 90053. We regret that we cannot respond to all inquiries.

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