A Tale of Two Families

Young Ned and his wife Sally really want a home of their own. Ned has been at the same job for a couple of years and Sally stays home with their 1 year old. They have been reasonably careful with their money. They have an old, but reliable, Honda Ned’s parents gave him when he graduated from college and no credit card debt. Ned makes $50K a year and Sally’s parents have given them $10K to use as the down payment. Ned and Sally go to an online lender to get pre-qualified for a mortgage. Using the lender’s  “Home Affordability Calculator” Ned and Sally are told they can afford a monthly payment of $1,499.76 including taxes and insurance.  Estimating taxes and insurance at $5,500, Ned and Sally start shopping for a $200,000 home.

Not too far away another young couple is dreaming of a home of their own as well. Paul and Janet have a new baby and are finding their tiny apartment rather cramped. Paul makes $50k a year but has 15% of his pay going to his 401K. Paul and Janet never see that money, so they budget as if it doesn’t exist.

Paul and Janet have recently struggled and sacrificed to pay off the credit card debt they ran up when they were in school.

Janet has been reading money management books and knows that they should put at least 10% down on a house and that their mortgage should be no more then 25% of their take-home pay. Using Paul’s take-home pay after taxes and the 401K deductions, Janet calculates a maximum mortgage payment of $764.  She knows they can afford a $100,000 home with a 15 year mortgage.

Before they can go home shopping, they know they must save the down payment and build their emergency fund to equal at least three months of expenses.

Paul takes on as many overtime hours as he can get at work and Janet takes the baby to the neighbors three times a week to watch their 3 year old. With this additional income and cutting their expenses as low as they can go, Paul and Janet are able to save $2000 a month for 8 months.

Ned & Sally end up with a $200,000 home. Their mortgage payment is $1,019 a month and taxes & insurance add another $450 per month. Paul & Janet have found a nice little starter home for $100,000. Financing their home over 15 years gets them a lower interest rate and shortens the term by half. Their mortgage payment is $671 and taxes and insurance add $200 a month.

Ned & Sally                        Paul & Janet

Take Home Pay $3550 $3056
Housing Cost $1469/41% $871/29%
401K After 5 years $0 $43,436
Interest paid on Mortgage after 5 years $45,614 $16,185
Principal Paid after 5 years $15,526 $24,083
Net Worth Increase $25,526 $77,519

Ned & Sally’s budget allows them to live on $2031 after housing costs.  Paul & Janet get just a hundred dollars more but their utilities and maintenance costs are about half of Ned & Sally’s. They have their retirement saving working for them and enough room in their budget to save and pay for a better car.

Paul & Janet were careful, after learning their lesson with credit cards, not to be lead astray by lenders who make more by lending you more. By the time they managed to pay off the old debt, they could not even remember what they had bought. They swore it would not happen again. They vowed to live on less then they make, to save aggressively and to give. We hope Ned & Sally get a wake up call soon.

I Can’t Pay

If you are currently in the very uncomfortable position of not being able to pay all your bills on time, here’s how  to get through this valley with the least amount of pain and scarring,

Do not allow the current situation to redefine who you are.

You are a person of integrity. Your word means something; you take care of your family; you honor your commitments. This doesn’t mean that you never stumble or lose your way. It does mean that when you do fall short of your own expectations you change course and re-commit.

Protect your relationships and rely on your faith during this rough spot.

Take Responsibility

If they hadn’t cut your bonus, eliminated your job, if housing prices hadn’t crashed, if you mother hadn’t gotten ill…. you would not be here. But it happened and you are – so start right here today with where you are. You made a promise you cannot keep and now you need to get to control over the situation.

Make a Realistic Plan

 

Winning the lotto, scoring a new job that pays twice what the old one does, or selling your car for twice what it’s worth, are examples of events that are not likely to happen.

You need to create a Crisis Spending Plan based on your actual income.

Develop your plan starting with basic food – no restaurants, no fast food, no steaks, no beer, just beans & rice, mac & cheese, PB&J; cut the budget to the bone.

Next you need to pay your utilities, water, electric, gas, not cable not internet. If the utilities are behind, catch them up before doing anything else.

Shelter is our next priority. Pay your rent or your mortgage.

Finally, secure your transportation. Make your car payment; get your bus pass; set your gas money aside.

Now that you have your four walls (food, utilities, shelter, and transportation) in place, you can start your battle against your debt.

Who Gets Paid?

 

Make a list of all of those you owe; how much you owe them and how far behind you are.

If you can’t make the minimum payments on all your debts, you may choose to pay them each their pro-rated share of the money you do have available.

List each debt. Divide each debt by the total debt to get the debts percentage of the total. Multiply each percent by amount of money you have available to pay debt. This will give you your new payment. Send a copy of your worksheet with each payment.

Like this:

Contact your Creditors

 

Some creditors will be much more willing to work with you if you can state your hardship case and your plan for overcoming it. Some won’t. Typically credit card companies, big banks and Sallie Mae don’t care about your problems and will treat you in whatever way they think is most likely to get them a payment. They may appear to be warm and understanding today and then become belligerent and abusive tomorrow.

If you owe money to local businesses or individuals, you may be able to negotiate a payment plan.

As much for yourself as for the creditor, always communicate honestly with the creditor. Calmly tell them why you haven’t paid, when you expect to send them some money and how much it will be. Send them a copy of your pro rata worksheet with any payment that is less than the minimum.

When Sears calls about the past due payment on your credit card, your side of the conversation could sound like this:

Yes, I’m aware that the payment is late. My hours have been cut at work and we are unable to pay all our bills. When I am paid next Friday, we will be sending you $21.06.

No matter what they say, you stay calm and repeat that’s all your able to do. Keep your four walls in place and do not put your family in jeopardy because of some collectors ranting. Never give them electronic access to your accounts.

Once you have a written plan in place – follow it.