Progress on Debts Is Something to Cheer

Eric and Debra Stillwell liked to live for the moment.

Before they were married, the Burbank couple--individually and together--traveled whenever and wherever they wanted, bought what they liked and thought nothing about saving for a home or retirement.

They were living high on a middle-class income. Their indulgences, along with a failed business venture by Eric, left them owing a combined total of more than $60,000 on credit cards and loans by the end of 1995.

They’ve managed to climb most of the way out of the hole since then, and now the couple want to make plans for a secure future.

Eric discharged about $25,000 of debts in a bankruptcy forced on him by a creditor. After the couple, who are in their 30s, were married in July 1996, they took steps to aggressively pay down more debt. Now, they owe less than $8,000 in loans and credit card debt, and about $1,800 on a car.

Inspired by Debra’s feelings about approaching the age of 40, the couple started thinking even more seriously about the future, including buying a home and saving for retirement.

“We started off the marriage in a financial mess,” said Eric, 35. “We decided that in 1997 we were going to get our act together.”

*

Indeed, the Burbank couple were well along the right track by the time they spoke to Linda Gadkowski, a fee-only certified financial planner on Cape Cod in Massachusetts who reviewed the Stillwells’ finances for Money Make-Over.

“I applaud you in taking the first steps in pulling yourselves together financially,” the planner told the couple. “You’re not in great shape, but you’ve set goals and you’re saving.”

Despite their financial setbacks, the couple do have time on their side. But they will face two obstacles in meeting their goals: namely, the repercussions of Eric’s bankruptcy, which could make a housing loan harder to get and more expensive, and Debra’s preference for part-time work.

Debra, who normally earns about $29,000 a year as a part-time nurse at St. Joseph’s Hospital in Burbank, acknowledges that working full time would help their finances, but she feels the advantages in flexibility and reduced stress are worth the financial sacrifice. “I don’t want to burn out,” she said.

Nonetheless, Debra sometimes works more shifts and brings in more money some months.

In September, Debra took an important step toward financial security when she began contributing 4% of her pretax pay to the hospital’s 403(b) retirement program, which began matching half of her contribution this year.

The biggest single chunk--about $700 most months--of Debra’s paycheck goes to paying off her credit card debt. If she keeps up that pace and doesn’t add new charges, she’ll have the balance paid off--and that $700 a month available for saving--before the end of this year.

Eric, who has worked for Paramount off and on since 1987 in a variety of administrative support jobs, earns about $43,000 annually now. He became eligible to participate in the company 401(k) tax-deferred retirement-saving plan this month and contributes 6% of his pretax salary, and the company matches 50% of that.

About $200 a week is automatically deducted from Eric’s pay to repay an $8,000 credit union loan he took out in 1996 to pay off a chunk of his and Debra’s debts. That loan, which has an interest rate of 7.5%, will be paid off by May.

An additional $150 is automatically withdrawn from his checking account every month to go toward an individual retirement account he opened in September with Putnam Investments, which he is considering rolling over into a Roth IRA.

“I guess neither of us really wanted to grow up,” Debra admitted of the way she and Eric used to spend money. “I know I didn’t.”

Debra had leaned heavily on credit cards from the time she arrived in the United States from her native Canada in 1991 to attend nursing school. During one period--from July to November 1994--when Debra was not working, she lived almost entirely off her credit cards, using them to pay for groceries and rent, and also to buy furniture and airline tickets for trips to visit family and friends in Canada and Florida. Until last year, Debra generally was paying only the minimum payment required on each.

Gadkowski called that practice fiscal suicide. “By paying only the minimum, every time you buy something new on your credit card, you may as well tack on another 10% or 15%, depending on the interest rate,” Gadkowski said. “Plus you’re still paying interest on the previous purchases. It’s ridiculous.”

Eric, for his part, has had some weighty financial problems of his own. From 1987 to ‘92, Eric did various administrative jobs for the TV series “Star Trek: The Next Generation” for Paramount, earning a salary but no benefits. In 1992 he left Paramount to take a job helping to organize Star Trek conventions.

Then, sensing a business opportunity, he launched his own company, Horizons Conventions in 1994, to put together Star Trek conventions. The first three conventions were highly successful, he says. But, according to Eric, when “Star Trek: The Next Generation” went off the air in 1995, interest in the conventions plummeted and so did Eric’s business. By mid-1995, after having lost money with three conventions, he dissolved the company--but not before racking up thousands of dollars in personal credit card debt he couldn’t pay right away.

“I didn’t want to file bankruptcy if I could avoid it,” Eric said. “I was really concerned that it would screw up my credit history for a long time.” A creditor, however, did not want to wait, preferring to write off the loan right away for tax reasons. The bankruptcy discharged about $25,000 in debt.

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Eric’s worries about credit history problems were valid. But such problems, although difficult to overcome, aren’t insurmountable. “For people filing bankruptcy, the key is to get positive information back into their credit file,” said lawyer Robin Leonard of Nolo Press in Berkeley the author of “How to File for Bankruptcy” and other legal self-help books. “Creditors look for a recent history of making debt and making payments.”

In fact, Leonard said, people who have filed for bankruptcy are more often than not considered low credit risks because most of their other debt has been wiped out and because they are likely to repay loans or credit cards to reestablish good credit.

And a bankruptcy does not preclude anyone from buying a home--it just makes it more difficult and expensive to finance it. Lenders may, for example, insist on high down payments--20% to 25%, say--or on interest rates significantly higher than borrowers with good credit would get.

In considering a purchase, the Stillwells need to look at the trade-offs between renting and buying. Buying a house would mean spending even less on entertainment than they do now in the short run, although odds are they will be better off financially in the long run.

And, of course, they need to decide what kind of home they would want. The Stillwells have shopped for homes in and around Burbank, with prices ranging from $189,000 to $279,000.

“That’s a pretty wide price range for a house. You may have to narrow that down,” Gadkowski told the couple. “Let’s consider $190,000 given your financial situation right now.”

Even at $190,000, if the couple could find a lender that would let them put down 10% and take out a 30-year mortgage at 7.5% interest, they would be paying $1,328 a month toward their mortgage, far more than their current housing costs of $840 a month. The tax benefit of deducting mortgage interest and real estate taxes would reduce the real cost, but the taxes, maintenance and insurance costs would offset much of that.

A house whose purchase was 90% financed would require private mortgage insurance. PMI is usually not required with down payments of 20% or more.

“The first-time homeowner options are great for the bank and they may sound great for you, but if you can put more money down, that will be the best for you overall,” the planner advised the Stillwells.

The Stillwells, like many others who’ve looked into buying a home, know that all other things being equal, making a larger down payment would reduce the long-term cost of owning. However, real estate prices and interest rates are the other factors in this equation, and both are unpredictable variables. If prices or interest rates--or both--rise quickly over the next couple of years, then the Stillwells won’t find buying a home any easier then than now. If, however, prices and rates remain flat or fall, the couple will be better off having waited to buy.

*

In the meantime, Gadkowski urged the Stillwells to make some changes to their finances.

She suggested that they cash in a certificate of deposit when it matures, which it did at the end of last year, and use all or part of it to pay off their credit card bills--advice they took soon afterward.

Whatever money they are saving for the house should be invested in a money-market account or shorter-term savings accounts, so it will be easily available. There are many places to invest such money; Gadkowski suggested a Strong Money Market fund, which can be opened with $1,000 and has an annual yield of 5.5%.

Eric asked the planner about what to do with $3,300 in a whole-life insurance policy his father took out for him in 1980. “It’s just been sitting there, and I don’t think it’s the best kind of life insurance policy for us,” Eric told the planner.

“You’re right, it’s not,” Gadkowski said.

Such policies may be convenient, but higher investment returns and cheaper life insurance can be had elsewhere.

Gadkowski advised cashing in the policy and putting the money in the money market fund or using it to pay off more debt.

Instead, the couple should buy term life insurance policies while they need it.

Gadkowski also suggested that Eric roll over his IRA out of the Putnam fund. Although it has a decent average annual return, it is a load fund, which means there is a sales charge. In this case, it’s an upfront charge of 5.75%. That means that for every dollar invested, 5.75 cents goes to pay the sales charge, in effect reducing the returns Eric will earn on his investment.

Although some specialized funds might be worth such a large sales charge, or “load,” Eric shouldn’t be investing in those now.

“I don’t think you can afford that right now. It’s like you bought a Cadillac when what you really need is a Chevy,” Gadkowski told Eric.

The planner instead suggested that his IRA be invested in a no-load mutual fund, Vanguard PrimeCap, a growth fund that invests heavily in high-technology stocks and that has a five-year average annual return of 23.64%. Although some might think investing in tech stocks now is risky, Gadkowski said it is best seen as an investment that has a good chance of beating the market over the long term. She also suggested that Eric may indeed be better off rolling his current IRA over into a Roth IRA.

A Roth IRA has several advantages over a traditional IRA, the most important of which is that withdrawals at retirement will not be taxed. Eric and Debra meet the income eligibility requirements for Roth IRAs.

Moving the money into a Roth IRA would require Eric to pay taxes on his tax-deferred IRA earnings accumulated so far, but since he opened the account just a few months ago and paid a load, the tax bite will be minimal and even then could be spread over four years if he does the rollover in 1998.

“You want to make every single dollar work for you,” Gadkowski told Eric.

Another wise retirement-saving strategy, Gadkowski said, would be for Debra to invest 10% rather than 4% of her pretax pay in her 403(b). “You want to save 10% if you can. That’s the formula if you want to be on target for retirement given your age,” she told the Debra.

“I have to work up to it slowly,” Debra said of that suggestion. “Probably by next year, when I’ve dug out from under this debt, I’ll increase it to 6% or look into putting in more.”

The couple can make the greatest difference with their saving by being more strict with their day-to-day expenses, Gadkowski said.

“Everything that you have some control over--gas, cable, phone--you want to cut back by 10%. Then everything you have total control over--eating out, vacation, personal care--you cut by 20%,” Gadkowski told the Stillwells.

“This is for starters; if you can save more than that, you should.” Gadkowski said.

Debra and Eric eat out as often as five days a week. They make a weekly pilgrimage every Friday night to a North Hollywood Mexican restaurant where they treat themselves to $30 worth of margaritas and food to wind down the week.

“If you know you’re this close to saving for the house, you may want to have peanut butter and jelly one night with candles,” Gadkowski suggested. “Try to make a game out of it so you don’t feel deprived.”

After talking with Gadkowski, the couple felt confident. “We still live paycheck to paycheck, but we’re trying to make small changes where we can to try and save as much as we can,” Eric said.

But they’re still enjoying their weekly trips to the Mexican restaurant.

To participate in Money Make-Over, send your name, age, phone number, income, assets and financial goals to Money Make-Over, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053.

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MEET THE PLANNER

Linda Gadkowski is president of Linda Gadkowski Inc., a Centerville, Mass.-based fee-only financial planning firm that specializes in money management, retirement planning and financial ethics issues for businesses and individuals.

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This Week’s Make-Over

* Investors: The Stillwells, Debra, 39, and Eric, 35

* Occupations: Registered nurse, TV production associate

* Combined gross annual income: About $72,000

* Financial goals: Save to buy a house and for retirement; pay off remaining debts.

Current Portfolio

* Retirement accounts:

Eric: $700 in an individual retirement account invested in a load mutual fund; just started to contribute to company 401(k)

Debra: $225 in workplace 403(b) plan

* Cash: About $3,550 in a certificate of deposit; about $1,000 in checking accounts

* Insurance: Eric: $3,300 cash value in life insurance policy

* Debts: About $3,000 on credit union loan, about $4,750 on credit cards, about $1,800 on car loan

Recommendations

* Continue aggressive efforts to pay down debts.

* Cash in life insurance policy and use proceeds to pay down debt or to add to savings. Buy term insurance instead.

* Eric’s IRA is invested in a mutual fund carrying a 5.75% load. He should roll that over into a Roth IRA invested in a no-load mutual fund that invests in technology stocks, such as Vanguard PrimeCap ([800] 523-8398).

* Money being saved for a home down payment should go into short-term certificates of deposit or into a money market account.

* Aim to reduce expenses 10% to 20%.