Couple Have a High Interest in Reducing Their Debts

Michele Ramirez feels guilty every time she buys something. And Fred Ramirez worries he’s not being a good husband and father.

“As a young man, I was always told that I should provide for my family,” said Fred, 34, an assistant professor of education at Cal State Fullerton. “I have this conscious belief that we should have a home, all our debts should be paid and that we should start to make a way for our kids. But debt creates a high hurdle.”

Indeed, debt does cast a long shadow over the Ramirezes’ future. The Cypress couple owe $25,000 on credit cards, $30,000 in student loans and $2,200 in hospital bills, not to mention $7,500 on their car.

The debt “is always in the back of my mind,” said Michele, 28, an assistant regional manager at a hearing-aid company.

Even with a combined income of about $80,000, the couple can’t seem to pay more than the minimum required on several high-interest credit cards, so their obligations remain ominously heavy.

But as parents of a baby and a toddler, Fred and Michele know they have to take action. But how does a couple with significant debt and little savings achieve such goals as buying a home, saving for retirement and building a college fund for their children?

The key is whittling down costly debt, said Georgene M. Grattan, a fee-only certified financial planner in San Gabriel. She believes the Ramirezes’ top priority should be paying off their four credit cards, with interest rates ranging between 13% and 19%. Their remaining debt carries much lower rates.

“The interest on the credit card debt you’re paying is very high,” the planner said. “You want to eliminate this debt as fast as possible because it’s very expensive.” And Grattan noted that paying off such debt is equivalent to making a guaranteed, tax-free investment earning 15%--about the best possible deal around, except possibly for savings matched by an employer in a 401(k) or a similar retirement plan.

Specifically, 15% interest on $25,000 adds up to almost $4,000 a year. Because the Ramirezes now pay only $400 a month, or $4,800 a year, they’re barely tackling the principal. And that’s assuming they won’t make new charges on their credit cards.

If they eliminate that $4,000 annual debt payment, however, everything else they need to do will be much easier.

The Ramirezes don’t feel they can boost their monthly payments because there’s nothing left from their paychecks after they pay their bills, but they recognize it’s worth reviewing their budget.

“If they pay just the minimum, it’ll take a staggering amount of time for them to pay off their debt,” said Glenn Woody, a certified financial planner in Costa Mesa. “But a lot of people in debt don’t know how to deal with it, so they just let it sit there. When that happens, I try to shock people by showing them some numbers, then explaining how it will drag down their lives.”

The Ramirezes accumulated most of their debt while Fred was in graduate school in Indiana, studying for his PhD. During their time there, from 1995 to 1998, the Ramirezes had two children and lived on Michele’s salary.

“We took out school loans and used our credit cards to pay for living expenses,” Fred said. “But now that we’ve moved back here and we both have jobs, we’re hoping for a fresh start.” A former high school teacher, Fred doesn’t regret pursuing his career goal. But if he could do it over again, he would think harder about the financial obligations.

“I wish I had planned things and thought about the big picture before I went to school,” he said. “Maybe during my last year of teaching, I could’ve saved more and put that money in mutual funds. That way, we might have more flexibility now.”

Grattan said sometimes life choices make finances tough. But she encouraged the couple to take immediate steps to ease their future rather than dwell on the past.

First, she said the Ramirezes should take advantage of a recent credit card deal that arrived in their mail. A bank will allow them to transfer up to $11,000 from an existing card at a 4% interest rate for up to nine months. The rate then would rise to 14%.

The planner encouraged them to transfer the maximum amount from their most expensive cards, because even if the rate rises to 14%, they’ll save considerable interest. Over nine months with a 4% rate, they’ll pay roughly $330 in interest on $11,000. By comparison, they’d pay about $1,237 in interest with a 15% rate in the same period. That alone should cut their total debt load by $900.

To pare away at the $14,000 remaining on other credit cards, Grattan said the Ramirezes should try to find a similar deal or consider cashing out the $11,000 they have in Colonial Strategic Income, a global bond fund that has returned an average 8.4% over the last five years. Michele’s father bought the fund for her many years ago, but she admits she knows little about it.

Michele said she’s a reluctant to sell the fund, because it has sentimental value and she is considering using the money toward a home.

“I don’t want my dad to think that the money he invested for me long-term has gone out the window,” Michele said.

But Grattan said financially it makes sense to cash out, because the investment isn’t earning as much as the interest they’re paying on credit cards. And the income from the fund is taxable, while there is no deduction for credit card interest payments.

And if the Ramirezes do keep the money earmarked for a home, the planner suggested that they switch to a higher-yielding bond fund, such as Federated High-Yield Trust (five-year average annual return: 10%.)

On a similar note, Grattan said the Ramirezes should try to use any other income or savings toward high-interest debt. Possible grants and a summer job would earn Fred an additional $7,000 or $8,000 a year, money he and Michele intended to use toward a down payment. But the planner said they might be better off using the money for debt reduction.

Overall, Grattan urged the couple to gain a better handle on their spending. She suggested that they develop a cash-flow chart, listing their expenses. Every month, the Ramirezes pay $1,050 in rent, about $1,000 for child care, $247 for their Ford Explorer, $63 toward student loans, $180 for life insurance and the $400 for credit cards.

That doesn’t leave a lot for everything else, but writing it all down may give them ideas for cutting their daily expenses. One area they might reconsider is life insurance. They currently have small life policies on their children, which most planners consider a waste of money. And they might investigate cheaper life insurance policies, possibly through their employers, for each other.

“See if there are any funds that could be spent differently,” the planner said. “Prioritize what’s important. You might identify ways you can save money that you didn’t think about before.”

If the Ramirezes are able to pay off a good portion of their debt and curb their spending, home ownership could be the next focus. Eventually, the couple hope to buy a home in West Orange County, the South Bay or another area known for strong public schools.

The Ramirezes have pre-qualified for a $190,000 mortgage. And Michele’s father may help with the down payment. If they purchased a $220,000 home at a 7% interest rate over 30 years, they’d pay close to $1,300 each month, the planner said.

If a good deal of their debt is paid off, Grattan believes the Ramirezes could afford such payments, taking into account the tax advantages of a owning a home.

Along with buying a home, the couple also want to start saving for retirement. Grattan encouraged them to start investing in their work retirement plans.

Michele’s company will match 10% of contributions up to 5% of her annual pay. Grattan suggested that Michele begin contributing at least 5% to her plan.

Fred, meanwhile, has a 403(b) plan, but there is no employer match. Grattan suggested it would be wise to get in the habit of saving in that as well, although it may be more important to pay off debt than contribute to this plan.

When Fred can start retirement saving, Grattan said a better option might be to contribute the maximum $2,000 a year to a Roth IRA, which offers some flexibility after five years if money is needed. Part of the Roth IRA could, for example, be tapped to help buy a house.

Fred hopes having a financial plan will ease his mind. “I just want to be in a situation where we’re prepared for things like emergencies and our kids’ education,” he said.

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This Week’s Make-Over

Investors: Fred Ramirez, 34, an assistant professor; and Michele Ramirez, 28, an assistant regional, manager for a hearing-aid company

Combined annual income: About $80,000, with possibility of $7,000 or $8,000 from grants and a summer job

Financial goals: Pay off debt, buy a home, save for retirement, establish a college fund for children

Current Portfolio

Cash: $5,000

Mutual funds: $11,000 in Colonial Strategic Income

Debt: About $65,000 including $25,000 on credit cards, $2,200 in hospital bills, $7,500 in a car loan and $30,000 in student loans for Fred

Recommendations

Pay off as much high-interest debt as fast as possible, by any means possible.

Track expenditures to find ways to save money.

Start contributing to Michele’s work retirement plan up to matching amount.

Establish wills.

When possible, contribute to education IRA for children and Roth IRA.

Mutual fund suggestion: Federated High-Yield Trust, (800) 341-7400.

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Meet the Planner

Georgene M. Grattan is a fee-only certified financial planner at Grattan Financial Strategies in San Gabriel. She specializes in investments for individuals as well as strategic business planning for small-to-medium-sized companies.

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Diane Seo is a regular contributor to The Times.