Family member needs debt advice

[TheAnonOne]

I've got a family member with a hair-on-fire amount of debt they are dealing with. I'm no expert when it comes to this, as a mustachian, I never find myself in this situation.

Deets:
Income - $4800 (take home)
Spending - $3400~ - $1261 mortgage + $2200
Left over - $1300-1400

Debts:
CC#1 - 9k
CC#2 - 7k
CC#3 - 19.5k

So essentially, they are paying $6-700 every month in interest, out of the $1300 they have left over.

I don't see any great avenues here.

My ideas
1. Just pay it off, cut the cards up and work on it. This will take years.

2. Consolidation loan, not much different from option 1, rates they are seeing are 16%+

3. Cash out 401k, they do have 65k in a 401k, cashing out the 36k will cost them taxes + 10%, the taxes and fees here will be around $12,000! OUCH! The alternative is a 401k loan here, which, generally sucks too.

4. Bankruptcy, not 100% on the law here, but they make something like 90k, I don't think the courts are going to just discharge debt for someone like that???

5.??????????????????????


My personal opinion is 100% non optimal, but maybe the lower stress over time option. Cash the 401k, it will cost you $47,000. Then turn around and put the CC payments into the 401k going forward. Never back the contribution down and use this to start your FI journey (obviously a tall ask for a non-mustachian sometimes). This person is "only" 30.


Any ideas are appreciated!

[chasingthegoodlife]

How is their credit? Can they get a low-rate balance transfer onto a new card for at least some of the debt?

Could they do a little side work to speed up repayments?

How did the debt come to be in the first place, and how confident are they that they can live within their salary/without charging more to the cards going forward?

My concern about taking the money from 401k is that if the underlying reasons for the debt haven’t been addressed they will just run up the debt again and find themselves in the same position but without their retirement savings.

[GilesMM]

Have they addressed the issue that allowed them to get into debt in the first place? If not, the payoff may just be short term solution.

[ixtap]

What is the interest rate on each card?

[bacchi]

Taking money from the 401k is a Bad Idea. You don't want them to see it as an emergency fund.

I second the question brought up by others: Have they addressed the underlying problem of over-spending? If not, you're wasting your time.

[dandarc]

Agreed "HARD NO" on 401K withdrawals - that's a huge price to pay, and without more information my big question would be "why will you not rack this debt up again?" Rather go bankrupt and have 401k money still in hand than the reverse if it came down to that.

Where did the debt come from? Is it systemically spending more than coming in over a long period of time? Some one-off purchases? Income changed substantially and recently?

If there really is $1300 per month to throw at it, and there's good reason to believe that this situation won't pop up again, then seems like a good candidate for a debt snowball to me. Knock out that $7K loan - minimum payments should total around $300-400 per month. That should mean roughly an additional $1,000 to throw at it.

But if this is a problem that is likely to recur, then they gotta start at step 0 if they want to make real progress - learn how to budget and otherwise handle money. No point in worrying about someone else's debt until that someone else has a reasonable grasp on the basics.

[TheAnonOne]

How is their credit? Can they get a low-rate balance transfer onto a new card for at least some of the debt?

Could they do a little side work to speed up repayments?

How did the debt come to be in the first place, and how confident are they that they can live within their salary/without charging more to the cards going forward?

My concern about taking the money from 401k is that if the underlying reasons for the debt haven’t been addressed they will just run up the debt again and find themselves in the same position but without their retirement savings.

They got denied for a balance transfer, unsurprisingly.

Agreed on the fear they will just regain the debt. They seem pretty "rock bottom" right now and ready for a serious change, I have no reason to not believe them at this time.

[TheAnonOne]

Have they addressed the issue that allowed them to get into debt in the first place? If not, the payoff may just be short term solution.

Somewhat, they accumulated this debt over the last X years and have since started making more money, and become a bit more responsible overall, simply growing up. They seem ready for change, but, proof is in the pudding.....

All I can do is focus on solutions and plans for now.

[TheAnonOne]

What is the interest rate on each card?

Mid 20%, the 19k card is technically 7% today but will bump back to 20+ in Feb.

[Freedomin5]

Use the debt snowball method.

1. Put all three cards on ice. Literally, freeze the three cards in a block of ice. Better yet, cut up the cards, as they have proven that they cannot use cards responsibly.
2. Make minimum payments on all three cards. Throw any and all extra money into the one with the smallest balance (CC2).
3. Once CC2 is paid off, make minimum payments on the remaining two cards. Throw all extra money into CC1 until paid off.
4. Throw all extra money into CC3.

Bonus: Get a part-time job and throw all money from the part time job into paying off the credit cards.


Mathematically, you should pay off the CC with the highest interest rate first, but it’s psychologically more rewarding for many people to see earlier success by knocking out the smaller balances first.

[okits]

I've got a family member with a hair-on-fire amount of debt they are dealing with. I'm no expert when it comes to this, as a mustachian, I never find myself in this situation.

It's implied but I wanted to be sure, this family member has asked you for advice?

Or you have offered and they've agreed to advice?

If neither, the idea I offer is you don't get involved until they want you to.

[TheAnonOne]

I've got a family member with a hair-on-fire amount of debt they are dealing with. I'm no expert when it comes to this, as a mustachian, I never find myself in this situation.

It's implied but I wanted to be sure, this family member has asked you for advice?

Or you have offered and they've agreed to advice?

If neither, the idea I offer is you don't get involved until they want you to.

Yeah, this isn't me just injecting myself into a situation. They are actively looking for options.

[okits]

I've got a family member with a hair-on-fire amount of debt they are dealing with. I'm no expert when it comes to this, as a mustachian, I never find myself in this situation.

It's implied but I wanted to be sure, this family member has asked you for advice?

Or you have offered and they've agreed to advice?

If neither, the idea I offer is you don't get involved until they want you to.

Yeah, this isn't me just injecting myself into a situation. They are actively looking for options.

👍 Great!

People have already outlined some approaches.  One additional suggestion is if they can access other, lower-interest-rate credit (home equity line of credit, 0% introductory rate on a new credit card) to reduce the ongoing interest expense while they aggressively pay off their debt.

I'm with those who caution that a longer-term adjustment is needed to ensure they don't end up here again.  Whether that's much better tracking, better adherence to a budget, restructuring some big ongoing expenses, or just a new embracing of frugality, the immediate solution needs to be accompanied by a behavioural change.  I am sympathetic that if they have $45.5k in credit card debt that this will be a hard change for them.  But it's the only way they will ever truly be free of debt shackles.

I hope they find a way and use the information and support you're offering.  Best wishes.

[JAYSLOL]

Have they addressed the issue that allowed them to get into debt in the first place? If not, the payoff may just be short term solution.

This. It is a really bad idea to consolidate if they haven’t addressed the issues that lead to the debt, AND cut up their cards and closed all access to them, and I would go as far as to lock their credit as soon as the consolidation loan goes through.  Short of that level of commitment, there’s a very high likelihood they will dig themselves into even more debt to the point of bankruptcy.  They need behaviour change above all else, and consolidation doesn’t do that for them, it’s only a good tool afterwards. 

[sonofsven]

Pay the minimums on the higher balance cards and deploy all $$ to pay off the $7k card.
Repeat with the $9k card.
The only way out is through, and it's supposed to hurt.

[Smokystache]

It's worth looking at selling something. Do they have a couple jet skis in the garage? Do they have a vehicle worth $75k that they could sell and get a $5k used car and use the difference? May also be helpful to go through their subscriptions and show them how much they are paying over the year/ 5 years on each subscription -- is the NFL+, Barkbox, or high-end makeup subscription really worth it?

[lhamo]

Are they contributing significant amounts to the 401k currently?  While it is not ideal, might make sense for them to pull back on that while focusing on getting the high interest debt more under control.

90k/year in salary is 7500/month.  3800 month in take home is a lot less than that.  Are they really paying nearly 50% in taxes?

[mistymoney]

How disciplined will they be?

If they start paying everything they can on the debt that will be 700/month and the amount to principal will increase every month.

If they were really disciplined, they could pick a card to pay off and then they could put as much of the 2200 month "other" expenses on one of the cards as they can and then put all the money they can to that card each payday.

So for example, if they buy 250 dollars of food every two weeks, each paycheck just immediately take that 250 and pay the on the card balance. Then carefully buy food as needed on the card over the 2 weeks. If they can do this with about 1500 of monthly spending over the month it will really bring down the average daily balance that interest is calculated on.

Towards the end of paying off a particular card, there could be about 3 months were they still can't pay it off yet, but are able to avoid interest entirely on that card. Then once that card is paid off for real without the churn, move on to the next.

Takes discipline, but it helps send more money to principal each month

[plog]

Prime candidates for Dave Ramsey.

Technically this isn't hair on fire situation, it's a hair smoking very heavily situation.  If they wanted they could limp along for a few more years in the lifestyle they have now and accumulate a few more 10ks of debt. I say that to make 2 points:

1.  Not a bankruptcy/kill the 401k situation.  Take a breath, do the math and this can be tackled with a plan. 

2.  They need to recognize this is going to involve pain.  They can face some pain now or a lot more pain later.  How serious are they about this change that will be made?

Dave Ramsey is going to say, kill the credit cards, get on a bare bones budget,  get  second and third jobs and knock this out in 18 months. 


 

[Laura33]

My advice is psychologically-based more than anything:  the vast majority of people who get out of debt via consolidation, home equity loans, or bankruptcy end up right back in just as much debt a few years later.  Why?  Because those things are a quick fix, so they don't address the habits and spending patterns that led to accumulating the debt in the first place.  Indeed, quick fixes suggest that the debt isn't that big of a deal, and that there is always an easy way out that doesn't actually involve sacrifice or pain.

You know who does get out of debt successfully?  People who pinch their pennies and pay it down over time.  The thing that "fixes" bad habits is feeling the pain of their consequences.  The fact that it takes a long time and is uncomfortable and requires sacrifices is the point -- it's a feature, not a bug.  And the discipline and delayed gratification that people need to develop to succeed in a paydown plan are the kinds of habits and characteristics that lead to long-term financial success. 

I will quibble with one thing above:  if we're talking 20% interest rates on any of this, that is a hair-on-fire situation -- hell, that's dumpster-fire territory.  You just cannot get ahead on anything paying that kind of interest rate.  The good news is that with the extra $$ they have every month, they can knock out most of the two smaller debts this year.  The approach above -- paying minimum to two cards and focusing all extra cash on the third until that's paid off -- is absolutely right.  Which order you choose is less important than figuring out something they will stick with.  Mathematically, the best approach is always to start with the card with the highest interest rate, then do the next-highest, until everything is done.  However, if the biggest debt is also the highest-interest one, sometimes people get discouraged if they can't get it paid off in a reasonable amount of time.  If that is their personality, then they should pay them off smallest-to-largest so they get the immediate satisfaction of getting some of it gone very quickly.

Do stop retirement contributions during this payback -- at least until they are down to CCs with very low interest rates.  Do not take money out of retirement to pay off the debt.  The numbers you give say they will lose 1/3 of what they withdraw due to taxes and penalties for early withdrawal, which is a huge, huge hit off the top.  But more important long-term is that they have this tax-deferred savings space that they can never "get back" if they cash it in now.  Uncle Sam gives us all tax benefits for retirement savings, but only up to a certain amount every year.  And once that year is over, you can't make up for it later.  If they cash out now, they lose not just the money they take out, but all of the decades of tax-free growth they have ahead of them.  So if they take out $50K now, they're not losing $50K -- they're losing around half a million bucks by the time they're ready to retire in 30-35 years.

And don't take a 401(k) loan, either.  You pay the money back with post-tax earnings (i.e., you don't get a deduction for those contributions), then you pay taxes again on your future withdrawals.  So you're paying taxes twice on anything you borrow -- not to mention missing any market gains from that money during the time the loan is outstanding. 

Yes, it is boring and frustratingly slow to just cut back and tackle the debt over time.  But that's the best way to keep them from falling back into their old habits.  They got into this debt by making a series of poor decisions over a number of years, so they need to expect that getting out of it will require making a series of good-but-difficult decisions over a number of years.

[Malum Prohibitum]

I've got a family member with a hair-on-fire amount of debt they are dealing with. I'm no expert when it comes to this, as a mustachian, I never find myself in this situation.

It's implied but I wanted to be sure, this family member has asked you for advice?

Or you have offered and they've agreed to advice?

If neither, the idea I offer is you don't get involved until they want you to.

Yeah, this isn't me just injecting myself into a situation. They are actively looking for options.

Well, then, the solution is more income.  Even a low paying second job to bring in $1000 to $1500 a month will much more quickly get them out of this situation.  If she is contributing to the 401(k), then stop, temporarily.

Folks here will be nerding out about the math and interest rates, when what is really needed is more work, more money, and aggressively paying down debt.  What can she sell?  Where can she pick up extra income?  Does she have any savings she can throw at it?   Get rid of the smallest balance first for the psychological boost and the feeling of making progress.  Her credit rating and access to better, lower interest options (like 0% balance transfer offers) will come about as the balances decline, although that may get rid of the urgency in her mind for paying it off. 

Dave Ramsey's program is sort of tailor made for a person in just this situation.  Consider guiding her in that direction.

[Malum Prohibitum]

90k/year in salary is 7500/month.  3800 month in take home is a lot less than that.  Are they really paying nearly 50% in taxes?

Hey - good catch.

$90k should not be anywhere near as low as $3800 per month, unless she or he is being garnished for a huge child support payment or something.

Does she get a huge tax refund each year?  If so, then (1) file early and apply the refund to the $7,000 credit card balance, and (2) adjust withholding to have $0 refund and more in the paycheck and then apply that larger paycheck to the $7000 credit card balance each paycheck until it is $0 balance.

Sell everything.  Apply $ to balance.

Work a second job.  Apply $ to balance.

But, $90k ought to be enough income to tackle that debt without even needing a second job.

Please share some details about what is happening to half of the income before it makes it into "take home" pay.  Even if she is single, her standard deduction is $14,600, leaving 90-14.6 = $75,400 to be taxed,
11,600 at 10% = $1160
35,550 at 12% = $4266
28,250 at 22% = $6215
$11,641 in fed tax, but it will be less than that once she completes the form and much less if she is married or has children.

$90,000 - $11,641 = $78,359

Then payroll tax, 7.65%

$90,000 x .765 = $6885

$78,359 - 6885 = $71,474

$71,474 / 12 = $5956, almost $6k, not $3.8k.

Income - $6000 (take home)
Spending - $3400~ - $1261 mortgage + $2200
Left over - $2600

The smallest credit card can be paid off before Christmas if she figures out what is happening to her paycheck.



Does she live in a state with a state income tax?

I do not see how she gets from $7500 gross down to $3800 take home even if she lives in a high income tax state.

Have her change whatever is being withheld if she can.

[TheAnonOne]

Just got clarification, there was a mistake.

Monthly take home is 4758. The have a 8% 401k setting as well.

EDIT: Something is up, im going to ask for the literal paycheck photo.

[LifeHappens]

Just got clarification, there was a mistake.

Monthly take home is 4758. The have a 8% 401k setting as well.

EDIT: Something is up, im going to ask for the literal paycheck photo.

That is a good start. The numbers aren't adding up.

[TheAnonOne]

Just got clarification, there was a mistake.

Monthly take home is 4758. The have a 8% 401k setting as well.

EDIT: Something is up, im going to ask for the literal paycheck photo.

That is a good start. The numbers aren't adding up.

They are maxing their HSA, thats a pretty huge chunk.

[dandarc]

That does close the gap more or less on the gross to taxable question - 8% to 401K is about $600 per month, HSA another almost $700. Would still be good to check if they're withholding such that they get a large refund.

Could stop those if they want to supercharge payoff, or could just suck it up in other ways like taking on a part time job or finding some fat in the budget to trim. Or could live with a slower payoff. So long as they stop putting more onto the cards, it is a solvable problem any number of ways.

[RetireOrDieTrying]

Skipping over the whole "these numbers don't add up" part - I have to add my voice to the chorus of those pointing out that lack of pain won't typically change habits.

With that said, a couple of thoughts:

• Contributing to a 401(k) is chronologically limited - you can ONLY contribute during a plan year, and anything not contributed can NEVER be "caught up." I wouldn't stop contribs.
• Someone said that a 401(k) loan is taxed twice. This is incorrect. There is only one tax - upon distribution. The "tax" on the money to pay back the loan is no different than the tax on the normal income which goes to CC payments. You're simply making payments somewhere else. There is zero net-tax difference.
• 401(k) loans mean that you're not going to get any market gains while the money is out.
• A 401(k) loan means that you don't lose the chronological limitations of contributing, as you would with a withdrawal. You can pay back the loan, which restores money contributed during previous years. In a withdrawal situation, you can NEVER back-fill.

My first recommendation would be massive belt-tightening, sell anything that isn't nailed down, and snowball it. I offer the 401(k) loan thoughts above simply as a possibility, not as my primary preferred path.

[Morning Glory]

That does close the gap more or less on the gross to taxable question - 8% to 401K is about $600 per month, HSA another almost $700. Would still be good to check if they're withholding such that they get a large refund.

Could stop those if they want to supercharge payoff, or could just suck it up in other ways like taking on a part time job or finding some fat in the budget to trim. Or could live with a slower payoff. So long as they stop putting more onto the cards, it is a solvable problem any number of ways.

They probably get 26 paychecks per year and aren't averaging the 3 paycheck months into "monthly income".

Those "extra" checks can go straight to the debt with the highest interest.

[TheAnonOne]

That does close the gap more or less on the gross to taxable question - 8% to 401K is about $600 per month, HSA another almost $700. Would still be good to check if they're withholding such that they get a large refund.

Could stop those if they want to supercharge payoff, or could just suck it up in other ways like taking on a part time job or finding some fat in the budget to trim. Or could live with a slower payoff. So long as they stop putting more onto the cards, it is a solvable problem any number of ways.

They probably get 26 paychecks per year and aren't averaging the 3 paycheck months into "monthly income".

Those "extra" checks can go straight to the debt with the highest interest.

Nope 24 annual.

I am going to have her pause her HSA for a year. Chronological losses or not, 20-30% interest rates are insane enough to make almost any choice a good one.

[Moonwaves]

I've got a family member with a hair-on-fire amount of debt they are dealing with. I'm no expert when it comes to this, as a mustachian, I never find myself in this situation.

Deets:
Income - $4800 (take home)
Spending - $3400~ - $1261 mortgage + $2200
Left over - $1300-1400

Debts:
CC#1 - 9k
CC#2 - 7k
CC#3 - 19.5k

So essentially, they are paying $6-700 every month in interest, out of the $1300 they have left over.

Is the rest of the $1,300 also going to the cards or are they only paying minimum amounts or interest or something like that?

Unlike most people here, this sounds a lot like I was. And, much as it pains me to admit it where I have found myself again (mostly thanks to a very serious period of depression over the last couple of years where nothing mattered so fuck it what's debt to me). So, as many people have mentioned here, it is really important that they understand why and how the debt arose in the first place.* Do they have a proper budget in place for right now?  It does sound like a younger person who is now getting their act together but a big component is finding and maintaining the right mindset and this is a good time to do it. Reading Your Money or your Life and even the MMM blog might help with this.






* It's many years old at this stage but I did write about this on my then blog and a different finance-based website - here in case you or they are interested.

[midweststache]

This seems relevant to the ongoing HSA / retirement discussion: https://forum.mrmoneymustache.com/investor-alley/investment-order/

[Malum Prohibitum]

That does close the gap more or less on the gross to taxable question - 8% to 401K is about $600 per month, HSA another almost $700. Would still be good to check if they're withholding such that they get a large refund.

Could stop those if they want to supercharge payoff, or could just suck it up in other ways like taking on a part time job or finding some fat in the budget to trim. Or could live with a slower payoff. So long as they stop putting more onto the cards, it is a solvable problem any number of ways.

They probably get 26 paychecks per year and aren't averaging the 3 paycheck months into "monthly income".

Those "extra" checks can go straight to the debt with the highest interest.

Nope 24 annual.

I am going to have her pause her HSA for a year. Chronological losses or not, 20-30% interest rates are insane enough to make almost any choice a good one.

It sounds like there is more margin than what was originally presented.  I would temporarily pause the 401(k), too. 

Does this person budget ahead of time for the month?

From there is it just math.  It sounds like your relative is in a perfect position to follow the Dave Ramsey plan, and this debt does not look like it will be around very long now that we have a little more information. 

The 401(k) and HSA investing can take off again just as soon as the debt is gone, but the percentage allocated to investments can be even higher because there are no longer any debt payments to make each month.

[Dictionary Time]

To help them get a better interest rate, you could offer them a spot as authorized user on your oldest credit card. Obv you wouldn’t give  access to use the card, but putting them on it might help their overall score and free up some 0% offers, etc.

Nothing will stick until they make the painful underlying changes though unfortunately.

[dandarc]

That does close the gap more or less on the gross to taxable question - 8% to 401K is about $600 per month, HSA another almost $700. Would still be good to check if they're withholding such that they get a large refund.

Could stop those if they want to supercharge payoff, or could just suck it up in other ways like taking on a part time job or finding some fat in the budget to trim. Or could live with a slower payoff. So long as they stop putting more onto the cards, it is a solvable problem any number of ways.

They probably get 26 paychecks per year and aren't averaging the 3 paycheck months into "monthly income".

Those "extra" checks can go straight to the debt with the highest interest.

Nope 24 annual.

I am going to have her pause her HSA for a year. Chronological losses or not, 20-30% interest rates are insane enough to make almost any choice a good one.

It sounds like there is more margin than what was originally presented.  I would temporarily pause the 401(k), too. 

Does this person budget ahead of time for the month?

From there is it just math.  It sounds like your relative is in a perfect position to follow the Dave Ramsey plan, and this debt does not look like it will be around very long now that we have a little more information. 

The 401(k) and HSA investing can take off again just as soon as the debt is gone, but the percentage allocated to investments can be even higher because there are no longer any debt payments to make each month.

How large is 401K match? Absent a match, you should pause 401k before HSA if you're going to do one or the other. HSA (if through employer) saves FICA as well, so you get more bang-for-buck in terms of freeing up income to prioritize the 401K.

[sonofsven]

I would halt all retirement savings until the debt is payed. Sell everything that isn't nailed down.
The reason it's supposed to hurt is so they never do it again.
Show them how much it's costing them monthly in interest, and show them the projected losses of not funding retirement and HSA accounts fully now because they can't afford it.
If that doesn't light a fire, then just walk away.