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Peter Is Trying to Find Shelter In These Uncertain Economic Times

“Dear Steve,

I’m wondering if it time for a a mid-recovery, mid-recession course correction?

My situation is grad school era babies, two layoffs and completely unnecessarily missed/late CC payments have buried us in CC debt (65K@30%APR), auto (6K@0%, 15K@7%) and student loans (35K at 8%) with little hope of lower interest rates or new financing options.

Thankfully we got out of our mortgage before the housing crisis, but are now renting. We’re at >70% utilization of credit limits and have no emergency fund, but are doing everything “right” now and working on avalanching highest credit card debts first.

My grad degree helps some, and salary is good, but industry is labile, layoff possible next six months. We’re putting every extra penny onto credit card debt each month, still saving up to the company match on dividend-yielding, 3.5% return-yielding 401(k).

I have about 20K cash coming to me for various reasons in the next 2 months. The tight credit market has changed the landscape, and I fear my credit card limits being lowered, leaving no way to take on new debt in an emergency to cover ourselves. In other words, the credit card limits aren’t even a safety net anymore.

Since it’s essential for survival, is paying off a secured debt (the car) a good move to stave off repossession, or should I retain a cash reserve against possible further crisis?

Peter”

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The Answer

 

Dear Peter,

Thank you so much for all the detailed information. It really helps in answering your question. Your question really gave me pause because there are so many options you could select from and they range from the most calculating to the most emotionally responsive.

Your senses are right on track for the coming credit card limit reductions and your statement that you can no long view your credit cards as a financial safety net, is so true. Something that I’ve been preaching about here.

If I take two large steps back and look at your overall situation the issue that concerns me the most is the $65,000 credit card debt at 30% interest. That is an enormous chunk of change to payback at high penalty rates. Interest alone on that credit card debt is going to be about $19,500 over the course of the next twelve months. That’s quite a spanking to take. And paying back that $19,500 does not even lower the amount you owe on the credit card debt.

It is so ironic that knowing you have a guaranteed $20,000 coming to you in the next couple of months is probably the worst thing that could happen. Here’s why. If you pay off the cars and then you are not able to sustain credit card payments and decide that bankruptcy is the only way out, then the cars may be at risk of being liquidated by the court since they would be a valuable asset to go after.

Well maybe you could do a debt settlement to get rid of the credit card debt? But the $20,000 isn’t enough to do a debt settlement on all of the credit card debt to eliminate it. Eliminating some of the credit card debt might be possible but then it does not leave you with a much needed safety net, which is prudent and needed. Besides, if you settle the credit card debt then you can be left with a huge income tax bill on the forgiven debt and you’d have to use money from the $20,000 to pay that.

So from the $20,000 you’ll have to pay income tax on the $20,000, use some to settle debts and then pay income tax on the forgiven debt. Before long the whole $20,000 will be gone and you’ll have little to show for it and nothing left over to protect you.

Peter Is Trying to Find Shelter In These Uncertain Economic Times

Your Financial Tornado is Coming

Doing what is right to protect your family and doing what is right to repay your debt is often two different things. It’s a lot like living on the open plains in tornado alley right before an upcoming really bad tornado season. Do you spend your time digging a storm cellar to protect your family for the coming tornados or spend your time harvesting wheat so you can repay a loan to the bank? I’m not sure there is a completely right or wrong answer to that question. It is a choice between contractual obligations and making sure your family is safe.

Maybe this will help. To best prepare to survive a layoff you would need to shed all the debt you can and lower your living expenses to the lowest level possible to make any income stretch further. We know that the student loans are not going to go anywhere and are going to survive through any financial winter, so your only chance of preparing to best protect your family would be to seriously consider bankruptcy before you get any “potential” cash.

I think you should talk to a bankruptcy attorney today for a free bankruptcy review and discuss your situation and take action immediately to get yourself best prepared for the coming economic tsunami that is forecasted to hit.

And if I go back to my tornado analogy, in the case of a severe storm, you don’t need to store credit to pay for food to survive in your shelter, you need food in your shelter. Cash is going to be your food.

You really need to discuss this situation with a licensed bankruptcy attorney in your state. You can click on one of the bankruptcy links to find one or to get a free bankruptcy review.

If you were able to discharge your credit card debt you could reaffirm your car payments to keep them.

Then, if you did get any lump of cash in the future you could use that as your twice welded steel storm shelter.

I asked a friend, who is a bankruptcy lawyer, for some feedback on your situation as well. Here is what they said.

As a bankruptcy lawyer, I see this as a matter of putting one’s priorities in order. The absence of a significant emergency fund is dangerous, especially in today’s economic landscape and when you have two children and significant student loan debt. It’s like going without health insurance, I don’t think you can afford to do it!

The amount of credit card debt, even if the interest rates were to be reduced, is too high given the other factors. Student loans must be paid, they have no statute of limitations and go with you to your grave. Presumably, the two vehicles are needed to facilitate family life and work. You are currently renting and will want to fix your credit and begin saving for the downpayment that good mortgage terms are likely to require.

I advise a chapter 7 bankruptcy if this is possible. The issue is the $20k that is coming. I strongly suggest that you consult NOW with a lawyer in your area who is a specialist in consumer bankruptcy law. This lawyer can help you with bankruptcy planning so that you can use the $20k in ways that will render it exempt from the bankruptcy case (this is a matter of state law). Such a lawyer will also advise you on how long you will need to wait after receiving and spending the money, to file your case.

A vastly improved debt-to-income ratio and the fact that you will maintain your payments on the two vehicles and the student loans should help you to rebuild your credit quickly following the bankruptcy.

So it seems that at least two people, myself and the bankruptcy lawyer, independently see the same issues of concern.

I hope that helps.

Big Hug!

Peter Is Trying to Find Shelter In These Uncertain Economic Times
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The Answer

 

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Steve Rhode
Steve Rhode is the Get Out of Debt Guy and has been helping good people with bad debt problems since 1994. You can learn more about Steve, here.

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