“I took out a HELOC to fund a business I had,” she says. “Property was purchased, a house I built didn’t sell, another project got delayed with the local planning board. I used credit cards to live on.”
Now she’s struggling to pay an interest-only $419,000 loan on her home and more than $116,000 in credit card debt.
“My biggest financial concern is to decide if I should sell my house to pay off my credit card debt and rent, or struggle through the real estate market downturn, assuming my house will be worth significantly more in a few years,” she says.
Sunshine, whose name has been changed, has $14,294 in a brokerage account, $1,000 in an IRA, $1,100 in a savings account and $100 in checking. In addition to the HELOC and credit cards, she also owes $19,440 on a car loan, $10,000 in college loans and $400 in medical bills. She also borrowed $30,000 from her kids’ college funds, which she’d like to return.
The Star-Ledger asked Michael Pirrello, a certified financial planner with Mill Ridge Wealth Management in Chester, to help Sunshine create a plan to get out of debt and on better financial footing.
“Sunshine is an extreme case of what can happen when one assumes significant risk and then has to pay a financial price for that risk,” Pirrello says.
When real estate was approaching its highs several years back and reality shows like “House Hunters” and “Flip This House” were all the rage, Sunshine took a big real estate gamble. When things went wrong, she had to borrow and borrow and borrow to make ends meet.
She was forced to sell the investment properties at a loss, and now all she has is a big tax loss and a mountain of debt, some of which is at very high interest rates.
Pirrello says her first move should be to sell the house, which still has lots of equity, and pay off the debts.
“With credit card interest rates as high as 14, 15 and 23 percent on a few balances, Sunshine is wasting money in monthly minimum payments, and interest charges are mounting,” Pirrello says. “Interest rates, though low for the time being, will eventually begin to rise and at that point, Sunshine will lose the debt game and not be able to keep up.”
By selling the home now for $750,000, Sunshine should be left with proceeds of $715,000 after expenses. She can then sell her stock portfolio, and start paying off the debt, including the money she borrowed from her children’s college accounts. When all is done, Sunshine will be able to start over with a debt-free savings of approximately $143,000.
Once Sunshine’s debts are paid, she needs to turn her attention to budgeting. Based on her expected income and significantly reduced expenses, Pirrello says she should be able to operate on a positive cash flow basis.
One area that could affect her budget is her variable life insurance policy, for which she pays $200 a month, or $2,400 a year, for $500,000 of coverage. Pirrello says at that cost, and without impressive investments within the policy, she could do much better with her money. A 20-year term policy for the same coverage would cost approximately $875 per year, which Pirrello says would be a much more efficient approach.
By taking the uncomfortable, but necessary, step of selling her home and paying off all her debt, Sunshine will be putting out one big fire, Pirrello says, but there are other sparks in the future: Retirement.
Pirrello says she should start with baby steps. First, she should participate in her employer’s retirement plan and commit to saving 15 percent of her salary to start. Then, she should open a Roth IRA and begin to make maximum annual contributions each year. Pirrello says moderate growth-based mutual funds with a 70/30 stock/bond ratio will serve her well in the short run, with her investment allocation becoming more conservative as she approaches full retirement.
Of most importance, Pirrello says, is the preservation of the $143,000 remaining proceeds from her debt payoff.
“These assets can be contributed in part annually to her Roth IRA, but should also be invested in a conservative manner until Sunshine has more clarity regarding her future,” Pirrello says.
When she becomes financially stable, those assets can be diverted into higher-yielding investments in accordance with a proper retirement investment strategy, he says, but they should not be committed yet.
“Options are a nice thing to have now that Sunshine is not being held captive by the burden of debt,” Pirrello says. “She understands how she got here and is dedicated to working her way back to financial security. By taking that first big step and selling her home to pay off her debt, Sunshine will again be financially free and ready to build her financial future with a less risky and more predictable approach.”