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Should Julianna let her homes go into foreclosure?

DFA Reader Julianna asked:

We are guilt-ridden and full of shame that we have allowed ourselves to get caught up in this lethal debt trap. Unwise use of credit cards when income diminished due to income drop. This month we had $1900 income with $7K in debt payments:

$300K unsecured debt, 2 mortgages (one rented) while waiting to sell, 2 auto loans $5K remaining on one and $20K on the other; $24K student loans. Income drastically reduced due to medical crisis for me; husband employed in real estate, 100% commission based. RE market is dreadful here.

Against our better judgment, met with bankruptcy attorney and were advised we make too much money to file. He said only way is to let both homes get foreclosed, give up one vehicle, and find a rental house $700/mo (IRS allowable guideline) As strong Christians, we do not believe bankruptcy is the way. We want to pay our debts, and have now contacted Consumer Credit. The repayment plan would reduce interest rates and lock fees, but we aren’t certain if we can meet the minimum payments. I’m scared of being homeless! I’ve been reading everything I can — and realize we need an emergency fund right away — but with what? We are in survival mode. Please pray for us and give any advice God lays on your heart. Thank you in advance. God bless.

Debt and shame

This is an extraordinarily difficult situation, but there is hope. Release your feelings of guilt and shame. They will not help you; a firm commitment to paying back what you borrowed will. That being said, the task ahead of you is neither small nor easy. You will need to live far below your means in payment for living above. The process will be all the harder if well intentioned people foolishly say you “deserve to live a little.” Ignore them, and continue to do what you know is right… and you can do this.

Although this situation is difficult, the way out is no secret. The principles of sound financial management are the same no matter what amount you are working with:

Spend less than you earn and save the surplus.

Here is my recommendation for how to deal with your situation.

Create a Written Budget

This MUST be your first step, your budget is your map. Without a written budget, it is impossible to know what you have or where you are going. This is especially crucial because of the variable nature of your husband’s income. To calculate your monthly income, use his net income from last year (be conservative) and divide by 12. Never spend more than that in a month, even when you have more. When creating your budget, follow this simple rule:

Give 10% – Save 10% – Live on 80%

Realize that somewhere out there a family is living off 80% of your income. It is important, as a Christian, that you not neglect your giving when in financial difficulty. The 10% you save will be used to start building a $1,000 emergency fund (a larger cash reserve only makes your creditors more likely to sue for payment.) With every check that comes in, before you do anything else, write a check for 10% for giving, and place 10% into a savings account. When setting up the rest of your budget, eliminate every monthly bill you can: cable, magazines, cell plans etc. Small bills add up. Assess the difference between wants and needs and get down to the basics of food, transportation for employment, and shelter. The excess will go towards freedom from debt.

Debt Reduction

Once your budget is in place, you need to eliminate all the debt you can. First step is to cut up all the cards. This prevents you from going deeper into debt slavery. Next, eliminate as many debts as possible. Return anything you still can that was bought with credit. Those that you cannot return try to sell for enough to pay it off. Try Craig’sList, a garage sale, and friends/church/family. Finally, do not limit yourself to things you still owe on. Anything of value you can do without should be sold. Your goal is to reduce the amount of debt you will have to pay off with earned income.

Downsize Your Vehicles

The car you still owe $20,000 on needs to go. Try to sell it for enough to eliminate the debt, and adjust your lifestyle to having one vehicle. The one you owe $5,000 on is another matter. If you can sell it for enough to cover the debt, you should, but you may already owe twice as much as it is still worth. If this is the case, make paying off the vehicle your priority. If your husband’s job allows, consider going car-less for some time and using bicycles or public transportation.

Evaluate Your Housing Situation

You say you have one house rented pending sale. I hope that it will sell soon. Add up the total ownership cost of your current home (mortgage, PMI, insurance, utilities, maintenance, etc.). If the total is more than 35% of your husband’s net income, or more than 40% of gross, the house is more than can be afforded. Place the home on the market, and begin the search for an apartment that meets the above guidelines. It may be smaller, but you will feel better knowing that all the bills can be paid.

Final Details

Remember when paying your bills to take care of the important stuff first. Give, save, pay for your housing, buy food, and spend the money needed to keep your husband working. Do not spend the money for these things on unsecured debts. If you are late paying an unsecured debt, the worst-case scenario is a line on your credit report. That is ok as long as you have a place to live. Meet your needs, and as you are able, begin paying on the highest interest debt first. If a consumer credit agency can work out a payment plan, that is a good option. Stay focused, stay the course, and one day sooner than you think, you can be debt-free without having to go through bankruptcy.

Do you have any advice for Julianna?

Have something to add? Please share your wisdom and experience and help point Julianna in the right direction. Thanks!

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*Disclaimer*
We accept no liability whatsoever for any loss or damage of any kind arising out of the use of all or any part of this material. Our comments are an expression of opinion. While we believe our statements to be true, they always depend on the reliability of our own credible sources. Any advice taken from this site does not in any way establish a client/adviser relationship. We always recommend that you consult with a licensed, qualified professional before making any financial or investment decisions.

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How much should Marlon spend for a vehicle?

DFA reader Marlon asked:

“On super bowl Sunday of last year my sister in law totaled my car. 15 days later we bought a 99 Mercury Cougar. We went to a buy here pay here car lot. As of March 1st we will have made one year of payments. Just this past December I got my bankruptcy discharged. I would like to get out of the 99 Cougar and into something safer.
How long and how much should I come up with for a used vehicle?”

The 1/10th Rule for purchasing a vehicle

I first saw this concept used by the Financial Samurai, and I like it. The 1/10th Rule states that the car you buy should cost no more than 1/10th your gross annual salary. Example: If you earn a $50,000 yearly salary [50,000/10 = 5,000] you should spend no more than $5,000 toward your next vehicle.

Marlon, divide your annual salary by 10. That is the limit on how much you should spend toward a vehicle.

Financing after bankruptcy

You also mention the fact that you just had your bankruptcy discharged in December, 2009 and are wondering how long you should wait. I am assuming you mean how long you have to wait before you can be considered for additional financing for yet another vehicle. I have a couple of things to say about that.

Can you finance? Financing purchases may be what caused your bankruptcy in the first place. You said you were making payments on the 99 Cougar and that March 1st will mark 1 year worth of payments, but you also stated your debts were discharged in December. Did that discharge not include the auto loan for Cougar? Do you still owe on the Cougar? If so then the last thing you should be thinking about is financing another vehicle. If the Cougar is unsafe AND unpaid then you need to focus on getting that debt settled ASAP… THEN you can begin saving money toward another used vehicle.
How long until you can finance? Although a bankruptcy can remain on your record for up to 10 years, its effect on your credit can begin to lessen the day after the case closes. As long as you handle your finances responsibly from here forward, your credit will improve sooner than you might expect. How soon you will be available for financing depends on how responsibly you handle your credit from here on out.
Rebuild your credit. Your credit has taken a hit and needs to be nursed back to life. If your debt to income ratio (the measure of your monthly debt payments to your monthly gross income) is raised too high too fast your credit will never improve and you’ll find yourself back in financial trouble but without another bankruptcy net to fall into. If you must borrow, do so a little at a time.

Here’s what I would do Marlon:

I would not finance another vehicle. You mention the Cougar is not safe. If the Cougar is not beyond repair then do whatever necessary to get it operating safely. Will new brakes make it safe? Then get new brakes.

If it is beyond repair then do the following:

Find alternate transportation (friends, bicycle, bus, etc.)
Cut out all unnecessary spending.
Save extra money toward your next used vehicle.

Do this as long as your situation will allow, or until you have enough money saved to buy a vehicle in sound operating condition. You can find such vehicles for as little as $1,000 if you know how to look. Also, remember not to spend any more than 1/10th your yearly salary on the vehicle. So if 1/10th your salary is $5,000 – then shoot for somewhere between $1,000 and $5,000 for the vehicle.

What do you think?

What would you do if you were in Marlon’s shoes?

If you need debt help or personal finance advice – Ask Matt Jabs.

*Disclaimer*
We accept no liability whatsoever for any loss or damage of any kind arising out of the use of all or any part of this material. Our comments are an expression of opinion. While we believe our statements to be true, they always depend on the reliability of our own credible sources. Any advice taken from this site does not in any way establish a client/advisor relationship. We always recommend that you consult with a licensed, qualified professional before making any financial or investment decisions.

Debt Plan – Facing Bankruptcy & Foreclosure