Get With The Plan: July 10, 2011

71011If you can’t rein in spending, it doesn’t matter how much money you earn.

Mark, 63, and Melissa, 59, have learned that the hard way. They owe more than they own, and despite an annual income of about $200,000, they can’t seem to stay current with their bills.

They’re behind on their mortgage and they owe back taxes to the IRS. And that’s just the beginning.

“It’s a ceaseless struggle of paying off our debts,” says Mark.

Mark says they’d like to get current and stay current with their two mortgages, pay off more than $335,000 in student loans they took for their three grown children and pay off their credit card obligations.

Despite the debt burden, the couple is still planning to spend more.

“Repairs and improvements need to be made to our house over the next few years and, hopefully, the housing market will come back somewhat over that period,” Mark says. “We plan to sell, downsize and pay off as much debt as we can at that time. Retirement cannot come until we get to an affordable living situation.”

Mark and Melissa, whose names have been changed, have $29,000 in a cash balance pension plan, $3,000 in a brokerage account and $3,000 in checking.

Years ago, they cashed out Mark’s 401(k) plan when he had a salary reduction at work, and they never restarted the saving.

The Star-Ledger asked Jerry Lynch, a certified financial planner with JFL Consulting in Fairfield, to help this couple take a look at their options.

“Their combined income is about $200,000 and they are living paycheck to paycheck — if that,” Lynch says. “They have to make some hard choices if they want to get through this.”

Lynch says Mark and Melissa need to aggressively cut their expenses and start saving.

“We need to break this down to basics,” he says. “We really only need three things: food, shelter and water.”

Mark and Melissa estimate their home is worth $575,000, and they have $478,000 of loans against it. But according to real estate price tracking website Zillow.com, the home is currently worth $465,000. That puts their home underwater — worth less than they owe on the home.

Lynch says the couple may want to consider a short sale, which is when the bank agrees to accept a selling price that’s less than the mortgages are worth, and the bank takes a loss on the loan(s).

Next, they need to address their credit card usage, and theirs have interest rates as high as 27 percent. Mark and Melissa simply have to stop adding to their debt.

Lynch doesn’t recommend they cancel their credit cards, but instead take the cards, place them in a plastic bag, fill the bag with water and stick it in the freezer.

“If they really need something, they can defrost the cards, take them out to pay and then stick them in the freezer again,” he says. “Generally the process of defrosting the credit cards gets the person to think, ‘Is this really necessary?’  ”

Next, they should drastically cut back on their discretionary expenses, which include annual costs of $9,000 for vacations, $5,400 for snacks and meals out and $3,420 for house cleaning and lawn maintenance.

“I am not saying that all these costs can be eliminated, but the reality is that radical steps are needed if they ever want to have the ability to retire,” Lynch says.

If they want to pay off the student debt in 12 years when Mark is 75, they need to pay about $40,000 a year on the loans. Lynch says this means to pay the college debt alone, they need to earn about $60,000 before taxes.

But even with cutbacks, that level of college loan payback may not be realistic, he says. The couple has expenses of about $15,000 a month. Even if they pare back spending by a third, or $5,000 a month — to cover the college loan payback — they still need funds to address the credit card bills and any notion of retirement saving.

Lynch says when parents and college-bound children look at college, they need to see it as an investment and not a birthright. If you are making an investment, the first question should be if the investment is reasonable based on the expected return.

For example, Lynch says, if your child is accepted to both Rutgers and a private school that costs $50,000 a year, you have to ask yourself if the private school is worth the extra $37,500 annually in costs for a commuter student, or the extra $26,500 for those who live on campus.

“If your child thinks it is worth the additional cost, then their name should be on the student loans, not the parent,” he says. “The additional cost on a four-year college is over $140,000 per child. Unless your child makes it into an Ivy League school, generally it is not worth the additional cost.”

The couple have other risks, too. If either of them gets hurt or sick and can’t work, or needs nursing home care (at a cost of $70,000 or more per year in New Jersey), Lynch says the entire plan falls apart.

“I suggest that they speak to a bankruptcy attorney just to understand what their options are,” Lynch says. “They have a tremendous amount of debt at a period of time when they should not. Generally student loan debt is not canceled in bankruptcy, however, sometimes it is.”

One thing that they have going for them is the longer they work, the larger their Social Security benefit will be.

Lynch says if they retire at age 66, their combined monthly benefit is $3,600. If they wait until age 70, their benefit will be $4,900.

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