Get With The Plan: January 23, 2011

12311Jeff and Joy say they made a big miscalculation. When Joy was on maternity leave after the birth of their now 18-month-old baby, they grossly underestimated how much money they’d need.

“Although we can get by day to day financially, we are carrying a large credit card debt and live paycheck to paycheck,” Jeff says. “Although Joy has gone back to work, and thus is getting paid again, our child is in day care, and that is another financial burden.”

The couple, in their early 30s, would love for Joy to be a stay-at-home mom, but with $50,000 in credit card debt, $35,000 on a home equity loan and other debts, they know they can’t afford it.

Jeff and Joy, whose names have been changed, have saved $15,000 in 401(k) plans, $6,500 in IRAs and $500 in checking. There’s also a $3,000 cash value from a life insurance policy.

The Star-Ledger asked Reed Fraasa, a certified financial planner with Highland Financial Advisors in Riverdale, to help the couple come up with a debt-reduction plan.

“You can liken the effects of high debt to a cancer in your financial life,” Fraasa says. “The result can be stress, lack of funds, a sense of being held captive and a general lack of control. This can rob you of any vigor you have to pursue your goals.”

Like a cancer, Fraasa says, sometimes debt has to be dealt with radically.

The $50,000 in credit card debt is at 18 percent interest, or higher. Fraasa says that’s more than $9,000 in interest payments annually, and it would take more than four years to pay it off at the current payment rate of $1,450 per month.

The first move Jeff and Joy need to make is to cut up all but one credit card. They shouldn’t cancel the other accounts, just cut up the cards. The one card they keep should be for emergencies only.

Fraasa says they should never charge anything that they can’t pay off in one month. For example, if they’re paying $1,450 per month and they charge $100, they need to be able to make a payment of $1,550 next month.

Next, they need to get copies of their credit reports from the three major credit bureaus ( to see where they stand. Then they should look for better interest rates through balance transfers. Even if the rate is only good for six months, Fraasa says they should take it.

Next, the couple needs to consider a new way of living.

“Like the person who diets once a year to lose weight only to gain it back when they return to their bad eating habits, you need to avoid a short-term change to get a quick fix,” he says. “You need to start living within your means, and that means you need to reassess your lifestyle needs and wants.”

That starts with annual cash flow. After examining their budget, Fraasa says there’s a positive cash flow of about $700 a month — yet the couple say they live paycheck to paycheck.

They should monitor their spending more carefully.

Fraasa recommends they start paying cash for everything that is not a billed fixed expense (such as the mortgage or utilities). Or, if they feel they can control impulsive buying, they can use their one credit card, which offers a simpler way to review the expenses at the end of the month.

The couple can also make moves to increase their available cash flow.

Jeff and Joy received a substantial tax refund last year, equal to 4.5 percent of their income. Fraasa recommends they change their federal withholdings, which would increase take-home pay by about $300 to $400 per month. Those funds should be used to pay down the credit cards.

Next, they should put a hold on retirement savings.

“I know this is contrary to what you may read in the media and that means that Jeff will give up a 100 percent match from his employer, but this is only temporary,” Fraasa says. “They can start it up again after the debt is paid off.”

That will free up another $450 per month for debt payback.

Finally, they should consider canceling Jeff’s $250,000 variable universal life insurance policy (VUL), which has a $3,000 cash value and costs $100 per month. There could be a surrender charge, but Fraasa says even a 10 percent penalty would give them $2,700 to pay down debt. Then, the couple should look for $500,000 term insurance policies, which should cost about what they’re paying now for the VUL if they are in good health.

“The three ideas will create another $12,300 in funds to pay down debt this year,” Fraasa says. “If they can reduce their budgeted expenses by about 10 percent, that is another $9,600, for a total of $21,900 in additional cash flow to pay down debt.”

Add those funds to what they’re already paying each month and Fraasa says the credit cards and the home equity loan will be paid off in about two years and three months.

If Jeff and Joy really want Joy to be a stay-at-home mom, they will need to make substantial changes to their standard of living. They may need to consider downsizing their home, which would also downsize utility costs, property taxes and other expenses.