The Palmers have to consider some of the following strategies to get a handle on their cash flow and to get out from under the debt they've accumulated, which could not be until the year 2014. Debt Pay Down Plan — We put the Palmers on a debt payment plan, the essence of which does the following.
We have them on a 63-month plan to pay down their credit cards beginning with the balance on the highest interest rate card first. At the rate they were paying previously, it would have taken decades to eliminate this debt. The plan is strict and long — this is the burden of consumer debt. The couple is motivated however because they are tired of the pressure from the debt. They understand it is limiting their present and future options.
We have also recommended they choose one credit card to continue using and stop using every other card. As the accounts are paid off, we are asking them to close them except the one card they will continue to use.
- Debt Restructuring — The Palmers should not consider paying off all their outstanding credit cards by consolidating debt into a personal line of credit. They had consolidated in the past and then put more debt on the cards. This is a common problem when folks consolidate their debt. Consolidating will also extend the time period they take to pay the debt off.
- Asset Reallocation — In this time period when rates on cash have collapsed, they cannot benefit from investing cash for income to help pay these debts. They have no assets at this time except for a small amount of equity in their home which is unavailable to them because using it would simply increase their debt again. Should rates on savings go up, the Palmers might consider investing in a higher yielding investment that could produce income to pay down their debt.
- Expense Control — The Palmers have done a great job of controlling their discretionary expenses, but they will need to continue this habit as they consider starting a family either through adoption or through fertility clinics.
- Income Tax Planning — They should be able to deduct her medical expenses on Schedule A. That will provide some tax savings.
- Retirement Plan Savings — They may be able to begin saving for retirement in less than five years but the priority in this plan is to reduce their debt load and ease the pressure on their paychecks.
- Cash-out Refinancing – They'd simply be attaching their home to this high debt and should they fail in their payback plan, they may lose their home as well. Cash-out refinancing is not recommended.
- Home Equity Loan or Home Equity Line of Credit — Under current guidelines, they wouldn't qualify. Loans on cash value of life insurance policy or from company savings plan – More loans are not recommended.
Debt Management Ratios
Knowing how much the Palmers spend on discretionary and nondiscretionary expenses is important. But financial planners also like to analyze the percent of money spent on various expenditures and liabilities. For instance, consumer debt (credit cards, auto loans, etc.) should not exceed 20 percent of net income (gross income minus taxes). In the Palmers' case, at the time of this analysis, it was 24 percent. In addition, their monthly payments on a home (including principal, interest, taxes, and insurance) should be no more than 28 percent of their gross income. In the Palmers' case it was 24 percent.
And the total monthly payment on all debt would be no more than 38 percent of gross monthly income. In the Palmers' case it was 25 percent. The Palmers payments are below the maximum. However, the problem is that if they continue to pay at the minimum rate they will not be out of debt for decades. The balance of their cash flow is being depleted by medical bills and regular monthly bills.