Money Makeover By Dorothy Rosen, "The Dollar Diva" • Bankrate.com

Digging out of a financial hole

The money problem
Tamara tells the Diva: "I was out of work on maternity leave nine months ago and our finances got behind. It seems that no matter how hard we try, we can't get out of this financial hole."

Tamara and Gregory bought a spanking new four-bedroom house three years ago, and turning their house into a home has saddled them with heavy debt.

Their $1,900 mortgage payment, $300 child support payment, $470 car loan and $400 minimum credit card payments are eating up a whopping 68 percent of their take-home pay, and there's not enough left over to live on. Worst of all, they can't sell the house because they wouldn't net enough to pay off the mortgage.

Tamara admits it was a stretch when they bought their home. They didn't have a 20 percent down payment, but felt they could make the $1,600 monthly payments. "It looked good on paper," says Tamara. Never mind that they had no savings to cover contingencies, such as Tamara taking time off from work to have a baby, and having to cough up an extra $300 a month because someone

Because they have less than 80 percent equity in their home, they're paying private mortgage insurance (PMI), that ugly expense that hurts the borrower and benefits the mortgage company enormously. Here's how it works: The Torrences pay $126 a month for PMI. That's more than $1,500 a year to provide their lender with a risk-free loan. It also creates a disincentive for the lender to work with them if they should fall on hard times. Once the other debts are paid off, Tamara and Gregory should concentrate on paying extra on their mortgage each month. They need to build up their equity enough to get rid of the PMI.

Tamara and Gregory have a lot of hard work ahead of them, but they love their home and are going to do everything in their power to hold on to it. Tamara has asked the Diva to help them figure out how to do it.

Tracking the expenses
The first priority: The Torrences have to cut their monthly expenses so they can pay off their high interest debt as quickly as possible. Here are the Diva's recommendations and the anticipated savings:

• Get a cheaper cell phone plan ($70).
• Practice energy conservation; don't heat or air-condition the rooms that are not being used, set the thermostat a little lower in the winter and a little higher in the summer, and treat water like it's gold ($30).
• Reduce cable to bare bones ($30).
• Buy fewer convenience foods and avoid impulse purchases ($30).
• Buy less clothing ($10).
• Cut dry cleaning expense: use K2R for spot cleaning, and hand press clothes that are wrinkled, but not dirty ($40).

The gift expense of $160 a month is totally out of line for a couple with enormous debts and no emergency savings. This needs to be cut by $140 a month. People with big hearts and small budgets can say "I love you" to friends and family by attaching large love notes to small gifts.

There is no provision in their expense budget for out-of-pocket expenses, or saving for emergencies. For example: Gregory's 1991 Ford Aerostar is dead and there is no money to replace it; he's borrowing a car from a relative to get around in.

Bringing in more income
Tamara and Gregory are hanging by their fingernails. If they hope to stay in this home, and maintain their moderate lifestyle, they have to bring in more income.

Tamara is expecting a raise this month. She needs to ensure her success by writing up a list of reasons detailing why she deserves a big, fat one. What is she doing now that she wasn't doing since the last raise? Is she bringing in clients? If not, how much would she get if she did? Has she sharpened her computer skills? Does she deliver on time? Do the clients love her? When her boss sits her down to talk about the raise she's been granted, she should be prepared to negotiate it up. The Diva says: If you don't ask, you don't get!

Whatever the raise is, $100 a month should go into savings, and what's left over should go into paying down the debt. And Tamara should ask what she can do to increase her value to the company, and make more money in the future.

Gregory is an outgoing, social person who loves interacting with people. He's looking into moonlighting as a property manager. Until that gets off the ground, he can bring in an additional $300 a month by working a couple of extra shifts each week. He needs to do this for bare-bones out-of-pocket expenses and to save up for the down payment on an inexpensive used car.

No one said this was going to be easy, and to get themselves motivated, Tamara and Gregory should read Bankrate.com's "Five steps to financial freedom."

Paying off the debt
If the Torrence's continue to make minimum payments on their high interest debt, they'll be shackled to it forever, and will pay out a small fortune in interest. Plugging their numbers into Bankrate.com's calculators "The true cost of paying the minimum" and "What will it take to pay off my credit card?" will motivate them to get the debts paid off fast.

Even if they make more than the minimum payments, unless they allocate more than their current $400 a month to debt repayment, they'll be tied to the debt for almost eight years, and lay out over $8,000 in interest. That's still too long and too much.

By following the Diva's earlier cost cutting suggestions, Tamara and Gregory can free up an extra $260 a month to pay down debt. They also expect to get a $2,000 tax refund this year and next because of their large mortgage payments. By adding the extra $260 a month and the two tax refunds to their debt payment effort, they could be debt-free by November 2002. Or even sooner if some of Tamara's raise can be used to push the payments even harder.

Being debt-free, the Torrences will be able to line their own pockets with an extra $660 a month, plus their $2,000 annual tax refund. They'll be able to loosen their belts a bit, save some money and make extra payments on their mortgage to get rid of that PMI. Here is a sample "Debt Repayment Schedule" the Diva structured for Tamara and Gregory.

The Diva Concludes
Making a commitment to pay off their debts as quickly as possible is the Torrences' first step toward financial freedom. Here are some other good habits that will move them in the right direction:

• Emulate those who have already achieved financial freedom. The paperback book, "The Millionaire Next Door" by Thomas Stanley and William D. Danko, shares the secrets of the wealthy, and they're pretty basic. For example, the rich tend to live below their means and believe that financial independence is more important than displaying high social status.
• Keep track of their spending. Manual ledger sheets will do, but a computer program such as Microsoft Money or Intuit's Quicken is faster.
• Schedule a time together each month to review what came in, what went out, and what they're worth.
• Understand that they are both money-making machines. Keep improving their skills and searching for opportunities that will pay the highest price for their talents.

Success is a journey, not a destination. The Diva wishes Tamara and Gregory the best of luck as they travel along the road to financial freedom. The Money Makeover is a weekly feature of Bankrate.com. The Money Makeover is a weekly feature of Bankrate.com in which money experts help readers untangle their finances. Do you need to get your financial house in order? Could you benefit from the guidance of a customized financial plan? If so, click here to enter the Money Makeover contest! To read more makeovers about people like you, click here.

-- Posted: March 16, 2001