Get With The Plan: July 22, 2012

Elton, 47, and Kate, 36, have an enviable income level, but their debt is pulling away at their chances for future financial success.

With two mortgages, two second mortgages, more than $50,000 in credit card bills, family loans, college loans, a 401(k) loan and business loans, they don’t have much of a net worth despite the higher salary Elton earns.

“When the market tanked, Elton’s company froze salaries and reduced bonuses. Likewise, my work hours were reduced and we went into pre-foreclosure,” says Kate. “With family loans, we were able to stave off a judgment but that added to our debt load.”

And there’s more potential debt in their future. They will pay half the college expenses for Elton’s two kids, 17 and 14, from a previous marriage, and the couple has a 7-year-old and a 4-year-old together.

“Our biggest concern right now is our burdensome mortgage payment,” Kate says. “Five years ago, we bet against the house thinking home values would go up and that Elton’s position would reward him handsomely, so we envisioned a future refinance and construction loan to fix up the fixer-upper.”

Things haven’t gone as planned.

The couple, whose names have been changed, have saved $54,700 in 401(k) plans, $3,500 in IRAs, $433,900 in a brokerage account that holds stock in Elton’s company, $10,000 in money markets and $2,000 in savings. They also have $1,800 in college savings.

Their total debt is $837,225.

The Star-Ledger asked Kim Viscuso, a certified financial planner with Stonegate Wealth Management in Fair Lawn, to help the family dig out.

“I recommend that the family begins to decrease miscellaneous spending, which currently runs approximately $30,000 a year,” she says. “I would also urge them to pay off all loans and credit card debt within the next five years.”

If spending is carefully monitored, the family can still successfully attain all of their goals, Viscuso says.

Clearing up the debt is the most important part of the plan, she says.

“Their best investment is to pay off the credit card liability since it guarantees a rate of return on money equivalent to the interest rate on the credit cards,” she says. “They should look into consolidating their debt if they have not done so already.”

There are many advantages to consolidating, she says, including paying off credit card bills at lower rates of interest, consolidating multiple bills into a single manageable payment, and creditors may reduce or eliminate late fees and over-the-limit charges through a negotiation process.

This would also help their credit ratings, she says, perhaps making it easier to refinance their mortgages at a more desirable rate once the pre-foreclosure issue has been cleared from their credit reports.

The couple need to sit down and examine how they built up so much debt.

“They should try to get a handle on where they are spending in order to lower their monthly nut,” she says.

Viscuso says debt can be a result of “investment” that is enduring, such as a car or house. Or, it can be the result of negative cash flow.

“In other words, their spending is in excess of their recurring income,” she says. “If that happens, they are in effect spending future dollars for things like vacations and food.”

She says when the couple examines how all the debt happened, they’ll discover much of it came from spending on items that should have been considered recurring expenses, not the types of longer-term investments that endure.

“Budgeting your dollars and identifying where your money is going is critical to avoiding the accumulation of debt,” she says, recommending Elton and Kate use a software program to help identify and consolidate their cash flow. If they don’t, she says, they may find that retiring could be a goal that they don’t achieve until very late in life.

After they rein in spending, Viscuso says they need to build an emergency fund of at least six months of expenses. After that, they can turn to retirement funding.

“Elton should be contributing the maximum amount to his 401(k) which is $17,000 for 2012 for participants under the age of 50,” she says. “The current investment allocations in his plan should be revisited and possibly reviewed by an expert. It does not reflect enough diversification by asset class.”

Viscuso says it is also extremely important to make future spending decisions in relation to the value of Elton’s company in his brokerage account. This asset is the largest part of their net worth, and if it were to decline in value, it could have a significant impact on their future.

Viscuso says she performed retirement projections using a very detailed cash flow and the results showed a success rate of about 85 percent, meaning that in over 1,000 random trials, the family’s funds did not run out before reaching age 100 in 85 percent of the cases.

“This hinges largely on Elton’s company stock, which is their main investment asset,” Viscuso says. “This is risky due to the fact that so much of their assets are in one place causing a lack of diversification.”

Then, college funding. Their rental property should help significantly.

“There is no equity and it is costing more than it is bringing in,” Viscuso says. “Because an additional expense — college costs begin — the output of funds toward the condo can be used to help pay for college expenses.”