Advice – Paying off Credit Cards

[admin]

I normally wouldn’t ask for specific financial advice on this board, but I have been sufficiently impressed with some of the postings I have seen here to try it this time!

I have a relative who has $25,000 in credit card debt on 5 credit cards with an average APR of 13%. They are a middle class family, 61 and 64 years old, and the husband still works, making 40-45k a year (living in the Midwest). House will be paid off next year, they have no additional savings other than a $40,000 401k. They are counting on social security payments, countinued work income, and two pensions for retirement. Pensions will pay approx $1,500/month.

I care deeply about this couple and am concerned about their credit card balances. They should be able to live a comfortable, if limited, retirement given the details I provided above, but the credit cards are hanging over them and causing stress. They are paying the minimums, and cannot pay more.

Am I wrong to advise them to consider paying off the credit cards with the 401k? No penalties since they are 59 1/2 +, and since they will only pay income taxes, I am thinking they will pay 15% tax on the withdrawal. Compare this with continuing to rack up 13%+ compounded interest on the credit card balances that will grow and cause continued stress. I also have convinced them to rip up 3 cards and keep the 2 cards with the lowest rates.

I realize that the usual advice is to stay away from your retirement funds at all costs. But in this situation, is it right to pay the cards off? Financially it seems to make some sense, and psychologically even more sense.

Thank you all in advance…

[lindismith]

Good question. Do you know what the mortgage payment is each month? Do you know what the credit card payments combined is each month?

To reduce costs right away, they should look into a very low interest rate credit card, and put the other two balances on it. BE SURE TO TELL THEM THAT IF THEY ARE EVEN A DAY LATE ON THE NEW CREDIT CARD, THE INTEREST RATE COULD SKYROCKET. I cannot impress this upon you enough.

[Steve Beebo]

It might be a good idea, but only if they don’t run their credit cards right back to $25,000 again.

[Anonymous]

Lindi – I am not quite sure what the minimum is. I know there is a generic formula to estimate it, but can’t remember what that is. Good advice on the transfer.

Steve – Great point! I actually told them that as well, in a tactful manner.

I suppose paying it off with the 401k is no different than paying it off with extra income. Both are taxed as earned income.

[lindismith]

hmmmm. I personally would not dip into my 401K to pay off the credit cards. If the house is almost paid for, then allocating what they would have spent monthly on the mortgage is what should be paid towards the credit cards until they are paid off.

The thing is, they need to be really committed to paying them off, else, they will just keep that revolving debt. They have to really want to be debt free, you know?

A very clever man once told me, ‘paying an extra 13% (in their case) for the privilege of using credit, it just stupid.’ What item is so important that we should be willing to tack on an extra 13% just to pay for it?

I am personally a huge fan of American Express. Using it is good because it keeps you honest about what you really can afford. And, they have amazing customer service. I am consistently impressed with their organization.

Your relatives have quite a bit of debt that will only grow if they do not get a handle on it. Whatever you can do to help them would be good. You may have to have the conversation with them a few times.

I believe that anyone with a little debt going into this next recession is really going to pay for it. Credit card companies are increasingly becoming more sophisticated and aggressive, and they have figured out how to grow the balances of card holders very easily. You can imagine if consumer spending slows, the card companies will still be looking for income, and increasing fees, interest, and service charges will only grow in the next few years.

Does anyone else have any ideas?

[sdduuuude]

Seems to me a HELOC would serve them well in this case, if they can keep out of credit card debt after paying the cards off.

The interest rate with a HELOC would be lower and they may be able to write off the interest on their taxes, which they can’t do with a credit card.

[Anonymous]

I’m thinking that by paying the cards off with the 401k they will get a fresh start and I can also get them started on paying their cards off monthly. I agree with you guys that the key thing here is that they don’t continue to rack up balances. What sense does it make to pay the cards off only to charge them back up again, right? They are my parents, so I have alot of leeway with regard to following up with them on this and making sure they are indeed paying these cards off monthly, in a respectful way of course:) The HELOCs and paying via the former mortgage payment next year are great ideas I will look into. For some reason, though, I really want them to see that zero balance, feel good about it, and then focus on keeping it that way at the end of every month. Do American Express cards have to be paid back every month? How do they differ from Visa cards?

[tugg49]

Here’s what has worked for me. I ws able to payoff the credit cards and kept a minimal balance on them afterwards.
The problem with paying off CC is that you feel like you can run the balance back up. It’s like an addiction…maybe two or three years and you are back at it.
What I do is go to a credit union and get a consolidation/signature loan. Use a sum of my cash on hand and the CU loan to pay off the balance. The CU loan is a fixed term loan with a fixed interest. Those CC’s are time bombs. They can inch up the interest on you and you won’t even notice it. Miss a payment or whatever and 25% there you are.
CC’s are tough.

[hs]

Here is another idea. If it does not fit you, please ignore it. If you
have that amount of money, you can help them to pay the balance off and
ask them to pay you the 25k plus 7% or 8% interest monthly.(Of course
your parents need to keep their promise.) It is like they owe you the
debt, not the credit card company.In this case, you can help them to
avoid paying 13% (high) interest, but get 7 or 8% interest yourself. At
least they are paying the 8% interest to their son or daughter, not the
credit card company.

[(former)FormerSanDiegan]

I had this very same problem. However, I got it out of the way in my 20’s and 30’s after running up ~20+ K in credit cards and ~20K in student loan debt during college/graduate school.
I quickly learned the time-value of money and how to dig myself out by paying the highest rate cards first, then working my way out. It took me until my early-thirties to clear out both the habits and the debt.

Breaking the habit of adding additional debt is the key

I would advise against a “bail-out” loan. They need to work on eliminating additional charges to the cards. Once they do this, it will be easier to pay them down. If they can maintain the payments until the house is paid off, they can apply the amounts they have been paying towards mortgage to the credit cards. This only works if they stop the habit of using the cards.

A bail-out loan will not solve the underlying problem.

[(former)FormerSanDiegan]

Book recommendation :

Downsize Your Debt: How to Take Control of Your Personal Finances – by Andrew Feinberg

I bought this when I was finishing college with 40K in debt and it helped immensely. Looking at the book now the strategies seem obvious, but they didn’t at the time.

[Anonymous]

Thanks for all the great recommendations! The theme that is emerging is that they need to change the habits that got them into this mess to begin with. I have begun addressing this issue the past week and I have my mother on board with ripping up all but the 2 lowest interest cards and also paying the balance off monthly. My father is the real problem, so she and I are going to get him on board with only using two cards, paying it off monthly and I am going to make sure my mother has more oversight on the charges.

I’m more hesitant now to recommend taking the 401k money to pay off the balances, but it is still my preferred course of action. For starters, we can immediately work on developing the habit of paying off the cards monthly. In my own life, I developed this habit around age 25 after coming to San Diego with 40k in debt. I went from 6 cards to two, and started to view them as evil necessities that had to be paid in full monthly. Secondly, since the 401k withdrawal is taxed as regular income, and they are only at the 15% bracket, I am viewing this as no different than if my parents used regular income to pay down the balances.

I look at the options outlined above and I can see that many of them make more sense financially over the course of time, but I’m not sure that the difference is large enough to sway me. Instead of having the debt saga drag out over the next 5 years, this is an opportunity to get rid of it and develop some good habits immediately. The results will be easy to measure, “So mom, did you pay them off last month?” Psychologically they will feel like they’re getting ahead and not swimming up river. Once the mortgage is paid off next year, I’ll recommend that they make that payment into a retirement account instead. In fact, after 6 months of paying the cards off monthly, I think I will get them to set up an automatic paycheck withdrawal to a retirement account for at least half the amount they used to send in minimum payments. The best part is that the one action item for them is to pay the card off each month. If they can’t, they need to cut spending. The one measure of success I can look at is whether the card is being paid off or not.

[lindismith]

That’s why American Express is so great, you have to pay it off each month. (Although now they do offer a rotating balance card, but you don’t want that kind for them.)

The key is to pay down the debt each month, and then cut them up.

Use the Amex for plane tickets or other purchases that REQUIRE credit cards, but nothing.

You might consider talking to Rich (Prof. Piggington) about the 401K issue… He can best advise on those sort of things.

[sdcellar]

What’s the rationale behind keeping 2 cards active? I think you’d want to let the credit limit be your friend, i.e. if you’re maxed out then you’re forced to stop using the card until you pay it down some.

[ibjames]

I used to keep around 3-5k on my credit cards (embarassing to admit on this forum) but after I paid them off the feeling of accomplishment and the stress of having that weight of my shoulders changed me forever.

A few years later, I’m on a site like this because I’ve become very conscious of my money. You might be surprised on the way they react to being credit card debt free also.

I did it by finding no interest cards. Put the cash there and pay on it as much as possible. I would keep track of when they expire. If I couldn’t pay it off in time, apply for another card and move it there. If they see money can be transferred, those no interest deals will usually say yes.

See if their bank accounts have auto payment ability over the web or something like that. Set it up for them to pay automatically so it’s always on time. If they aren’t computer savvy, you can put in your calendar reminders of when the 0%is going to expire.

I don’t think dipping into the 401k is a good thing. If the house is almost paid off, they can put all that cash that used to go to that payment onto their cards. If you transfer their balances to cards that have no interest, it makes a big difference.

Sorry for the long post. I’m a big advocate of not touching 401ks, especially if you can transfer the balances to 0% credit and still get interest from the 401k

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