No money, too much debt

3 min read

Cathy Failor, 41, of Iowa is a single mom raising a 10-year-old daughter. She’s a homeowner and has lived in her home for four years. She works for a law firm.

Cathy Failor

The challenge: Upside down in home with an ARM and home equity loan; income shortfall every month
The plan: Boost income and slice spending to cut debt load and free up equity.

As a single mom, she is struggling with quite a debt load and money is tight. In addition to a mortgage, she has: a home equity loan, a car loan, an unsecured loan and credit card debt. Her adjustable-rate mortgage is scheduled to adjust in March 2008. She is unable to refinance her way out of that adjustment because she is upside down on her home, meaning the market value of the home is less than the debt against the home. The main culprit is a $33,000 home equity loan at 12.9 percent interest with a backbreaking $448 per month payment.

The problem

Despite big debts, in lots of little ways Cathy’s instincts are good and she does some things right.

She began contributing to her employer’s 401(k) plan as soon as she became eligible, even though an employer match won’t kick in until her two-year anniversary is reached in January 2009. She has regular monthly deductions from her checking account into a 529 college savings plan for her daughter and to an IRA. She pays for expenses such as her parking and daughter’s summer care through flexible spending. She refinanced her car loan to cut the rate from 11 percent to 4 percent. And she rolled over her previous employer’s retirement plan balance into an IRA, converting it into a Roth IRA that will permit tax-free withdrawals in retirement.

Unfortunately, Cathy’s efforts at utilizing tax advantages to boost savings and investments have been dwarfed by her growing debt load. While she admits to having tried budgeting and tracks her expenses with MSN Money, Cathy’s income isn’t enough to cover her monthly expenses. In examining her monthly expenses and comparing it to her salary and the monthly child support payments she receives, Cathy is in the red by more than $500 per month.

Debt overload
Home equity plan $33,000
Credit cards $11,000
Personal loan $13,000
Auto loan $6,000
Total $63,000
*plus a mortgage

Because she has but $300 in savings, this is a difference that is being absorbed by credit cards. The credit cards appear to have been around for awhile, as both her home equity loan and personal loan contain remnants of previous consolidations of credit card debt. With such a stressed monthly budget, it comes as no surprise that Cathy makes little more than the minimum payments on her three credit cards each month.

Aside from the usual mortgage, car loan and routine household expenses, Cathy is also making monthly loan and maintenance payments on a time share. The time share loan payments are scheduled to continue through 2008.

Cathy received a large tax refund last year, nearly half of which she used for a will and other legal expenses, cutting into the amount that was applied to debt. Since she gets to claim her daughter as a dependent every other year, 2007 being one of those years, she is looking at an even larger refund for this year. Despite this, Cathy recently changed her W-4 at work to increase her tax withholding.

Through her employer she has health, disability and dental insurance as well as life insurance that would provide twice her annual salary.

Key issues
  • Mortgage and home equity debt exceed the current market value of home.
  • Adjustable mortgage rate to reset in March 2008, resulting in a higher payment.
  • Debt is escalating as it serves to cover the $500-plus monthly shortfall.
  • Making only minimum payments does not make headway on high interest debts.
  • No emergency savings = no wiggle room.

This report was prepared by Bankrate Senior Financial Analyst, Greg McBride, CFA.

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