Best use of $20k life insurance

[Rick1]

Hi all. I haven't made the smartest money moves in the past but I would like to start. My mother passed a few months ago so I received about $20k in life insurance. That's no where near what I need to cover just credit card debt, but I would like to get some ideas on the best way to use it.

Here's the layout.

Gross household income is about $75k per year. House payment of $1050 and 401k loan come out pre-deposit so I usually net about $1K every two weeks. I keep about $1200 in savings for emergencies but not much else seems to stay there. Currently about $60k in my TSP/401k with 7% income contribution. Only 39 so lots of years until retirement. I'm married with 3 kids. Wife is a stay at home mom. I travel a lot for work so I do get some supplemental income from time to time and that it really what has kept us afloat.

$16,000 balance @ $400 p/mo - 401k loan (very low interest)
$4800 balance @ $300 p/mo - Same as cash (0% interest)
$9500 balance @ $300 p/mo - Credit union card (8% interest)
$7200 balance @ $145 p/mo - My Discover - 17% interest
$6700 balance @ $150 p/mo - My Citi card - %18 interest
$5400 balance @ $145 p/mo - Wife Discover - 17% interest
$5200 balance @ $120 p/mo - Juniper - 16% interest
$2100 balance @ $50 p/mo - Wife Citi card - %16 interest
$1700 balance @ $60 p/mo - Paypal - %18 interest

All told that's about $43k total for a monthly payment of about $1600. Needless to say I've spent myself into a corner and I need to figure out the best way to get out of it. As the price of everything continues to go up, it's getting hard to make it work.

My main questions are these:

1. Do I try a snowball and try to get out of it from the lowest balance up? I know that's a great idea, but it doesn't really help me survive check to check.

2. Do I drop it all on the 401k to net $400 more per month to survive on?

3. Do I drop it all on the credit union and same as cash loans to net back $600 per month.

The 401k, credit union and same as cash are the lowest rates, but they are also the biggest bang for upping the net per check....

I know there are several ways to approach it; I just don't know the best way to net more per month to survive on vs doing a debt snowball and trying to get out of it. Your thoughts and ideas are welcome. I don't think $20K is quite enough to consider investing in anything given my debt to income ratio at the moment. I know I'm paying stupid-tax...

Rick

[kork13]

Short answer: focus on eliminating the high-interest debts first. At 16-18% interest, you're hemorrhaging money.

I suggest that you pay off both Discover cards & your Citi card now, and throw the rest at the PayPal card. That will reduce your monthly payments by about $450/mo. Use that and every dollar you can spare to pay off the PayPal card, then wife's Citi & the Juniper card. Only then do you work on the credit union card & 401k loan, finishing up with the 0% loan.

How long is that "same as cash" loan staying at 0% interest? Are you certain that you're not getting a bunch of outrageous fees tacked on by stretching out that repayment?

Last thought, I hope your family is strapping down and eliminating every unnecessary expense possible. You're in a deep hole here, and it will take quite a while to recover. Stop using your cards, stop taking out loans, and learn to live on what you can actually afford.

The little quote at the top of my S-A page right now is from Thomas Jefferson: "Never spend your money before you have it." Take note.

[phantom]

I would start by knocking out that 401k loan. If you were to lose your job or want to move on to something else, you would have to pay that back immediately or it would suddenly become as though you withdrew the money early, resulting in high taxes and penalties. In my mind, that's a huge risk, so I would want to clean that up right away. The fact it would give you an extra $400/month to put towards other debt is a nice added bonus.

Next I'd look at that 0% same as cash card. Often that type of offer has some date by which you need to pay it off or get hit by a really high interest rate. If that is the case, I'd either attack that one next or at least make sure you're on track to have it paid off by the deadline. You could have it gone in 2 months if you used the remaining $4000 on it and then applied the extra $400/month you'll have from not having to pay the 401k loan any more.

The rest of the debt, I would just snowball, paying them off smallest to largest. The interest rates are all close enough that the order you pay things off will not have a huge impact on how much interest you end up paying before things are completely cleaned up, and I get the impression that freeing yourself from monthly payments would really motivate you.

The other thing you need to do is make sure that you're not digging yourself deeper into debt. You don't say exactly where all this debt came from. Have you corrected the habits that lead to all the debt yet? The danger of using a big windfall to pay off your debt is that it doesn't force you to make the lifestyle changes you need to make to avoid getting right back into debt. If you haven't already, cut up the credit cards so you aren't tempted to keep using them, and make yourself a budget that you can stick to such that you won't spend more than you take in.

[Rick1]

Thank you kork13 and phantom. You both make very good points.

I'm a federal employee and even with the possibility of sequestration, I'm farily secure in my employment. With that said- phantom, your point is still very valid.

I can see the logic of killing both the high interest and the 401k.

I also did a little more math and it appears that if I knocked out:
Juniper
Discover (wife)
Same as cash loan
Paypal
Citi (wife)

I would save almost $600 a month. The same as cash is actually three separate loans for furniture and stuff that I had to replace as it died or as the kids needed to get out of a toddler bed and into a twin etc. I calculated the payments to come out to where they would be paid off before the interest kicked in.

Or I could pay off several of the cards in my name Citi, Discover, paypal and 90% of credit union) which would inevitably raise my credit score back up (was 745 before debt to income killed it but still no late payments) which may save me money in the long run.

To address the other questions, most of the debt came from expenses above and beyond what I could cover with cash. About $12-14k came from my mothers final expenses and helping her out over the last year or so as she fought lung cancer.

Thanks,
Rick

[rxtrom]

Rick,

I was going to just reply with that suggestion. If you AND your wife are really serious about attacking this debt then I would look at more than just the debt. Look at where your money goes via a budget. Sit down with your wife and come up with a basic budget on an excel spreadsheet and try to stick with it. Then you will know how much money you will have every month to attack these debts.

As far as the 20k goes. I would pay off the the smallest to largest amounts until the 20k is gone. Interest rates are not important as the minimum payments you are saving every month to apply to the next debt. Essentially you are snowballing your payments. This leaves you with the top 3 or 4 largest debts but frees some substantial money to attack them with and they will be paid off in no time. The interest you accrue will be insignificant compared to the benefit of paying them off sooner. The 401k interest is interest you are paying to yourself so do not get focused on that % rate.

Good luck.

[snafu]

Rick, I'm sorry for your loss. The months of helping your mom with her battle in cancer was surely very difficult.

Facing down debt is also difficult. Does your wife understand that your finances are hemorrhaging with 16-18% interest rates? The whole family will need to be aboard and make significant changes to get out from under the weight of $ 42,000. mostly credit card debt + the 401K loan of $ 16,000. For the short term, it's helpful to evaluate spending and spending categories. I suggest working with your wife to create a 'cut it back' budget until your credit rating allows much lower interest rates. Are you both willing to stop using credit cards? Just drop them in the freezer until you can afford to pay the entire sum owed by it's due date. {I realize you likely use a card for travel;it's imperative to pay it off as due by sums reimbursed since it's not smart to pay interest on travel].

What paradigms will you change? Does your wife use shopping as entertainment? It's important to make small cuts that add up over time. Eating out is twice as expensive as the same meal at home. Would you be open to setting a specific sum for food based on averages in your area? Step II is creating a menu plan of meals everyone likes. Step III requires sticking to a shopping list and using what's already in the pantry. Once food sum has been spent, the spending stops in that category for example. Can you reduce driving since gas is so much more costly? Have you re-evaluated insurance policies? What services can you drop for the short term?

My suggestion is to tackle the debt outlined by paying off 18%, 17%, 16% debts from insurance payout. Work out the sum needed monthly to pay off 0% loan before it reverts to fees and give it priority. Snowball remaining debt until the 401K loan is cleared. Just imagine how great it feels when the money you earn is yours

[kv968]

$16,000 balance @ $400 p/mo - 401k loan (very low interest)
$4800 balance @ $300 p/mo - Same as cash (0% interest)
$9500 balance @ $300 p/mo - Credit union card (8% interest)
$7200 balance @ $145 p/mo - My Discover - 17% interest
$6700 balance @ $150 p/mo - My Citi card - %18 interest
$5400 balance @ $145 p/mo - Wife Discover - 17% interest
$5200 balance @ $120 p/mo - Juniper - 16% interest
$2100 balance @ $50 p/mo - Wife Citi card - %16 interest
$1700 balance @ $60 p/mo - Paypal - %18 interest

All told that's about $43k total for a monthly payment of about $1600. Needless to say I've spent myself into a corner and I need to figure out the best way to get out of it. As the price of everything continues to go up, it's getting hard to make it work.

My main questions are these:

1. Do I try a snowball and try to get out of it from the lowest balance up? I know that's a great idea, but it doesn't really help me survive check to check.

2. Do I drop it all on the 401k to net $400 more per month to survive on?

3. Do I drop it all on the credit union and same as cash loans to net back $600 per month.

The 401k, credit union and same as cash are the lowest rates, but they are also the biggest bang for upping the net per check....

I know there are several ways to approach it; I just don't know the best way to net more per month to survive on vs doing a debt snowball and trying to get out of it. Your thoughts and ideas are welcome. I don't think $20K is quite enough to consider investing in anything given my debt to income ratio at the moment. I know I'm paying stupid-tax...

Rick

Sorry about your loss Rick.

Actually snowballing would be pretty ideal in your case since the lowest balances have the highest rates.

If you were to put the entire $20k towards the cards with the lower balances you'd pay everything off except $1100 on your Citi card. If you took the payments from the cards you paid off and still paid the $150 you're currently paying on it, that would be $525/month and that card would be paid off in about 2 months.

Then you could apply all of that to your current payment of the Discover card and that'll be $670/month and that card will be paid off in about 10-11 months.

Granted it wouldn't free up any money for you and not knock out all of your bills but would get you out from underneath those high interest rates.

I'd also say that you don't have enough in your emergency fund so maybe put at least a couple of grand in there which would slow down the debt payment process but at least you'll have a little more of a cushion.

[jpg7n16]

I also did a little more math and it appears that if I knocked out:
Juniper
Discover (wife)
Same as cash loan
Paypal
Citi (wife)

I would save almost $600 a month.

Please do not make the mistake of focusing only on monthly cashflow.

The best way to think about debt is that the interest rate is how much your debt is charging you. So for each dollar of debt at 18%, you're getting charged 18 cents per year. At 15%, it's 15 cents per dollar per year. That's best way to think of it. So let's review your interest rates:

Each dollar costs you--

401k loan (very low interest) = next to nothing
Same as cash (0% interest) = nothing, this is free money
Credit union card (8% interest) = 8 cents/year
My Discover - 17% interest = 17 cents/year
My Citi card - %18 interest = 18 cents/year
Wife Discover - 17% interest = 17 cents/year
Juniper - 16% interest = 16 cents/year
Wife Citi card - %16 interest = 16 cents/year
Paypal - %18 interest = 18 cents/year


Now because you're looking at cashflow only, you'd pay off the ones that aren't charging you anything, and keep the ones that are charging you the most.

It's like you have multiple apartments, one that charges you $1800/month, one at $1600/month, and one with free rent -- so you're trying to move out of the one with free rent first?? Why?



Here's some math for you to consider:

If you took the $20k, and paid off highest interest rate to lowest, based on interest rates listed, you would save roughly $3,484/year of interest

If you go with your current plan that you posted here (and use the remaining $800 for the highest rate left), you would save roughly $2,536/year of interest charges.


Kork's advice to have you pay off the highest interest rate would save you nearly $1,000/year more in interest charges.



After hearing some of these figures, which method would you prefer?


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A couple other thoughts:

1) You guys really need a budget.

2) Is your employer matching the full 7%? If not, you need to reduce to the match, and use the extra cash to pay down your high rate debts. Why build up investments that are expected to earn 7-11% (taxable), when you can save 16-18% tax free??

3) For your situation, I'd strongly recommend: The Total Money Makeover: A Proven Plan for Financial Fitness: Dave Ramsey: 9781595550781: Amazon.com: Books

4) Any sort of refi options available for the home?

[Rick1]

jpg7n16,

You make very good points. The only reason I would focus on monthly cash flow now is that now, is when cash flow is tight... The difference is somewhat negligible so it does make sense to stop hemorrhaging money as kork and snafu put it.

My job matches up to 5%. I'm just putting the extra 2% in to try and save a little more.

Just refinanced the house from 4.8 to 3.2 @ 30 which brought the payment down from 1,400 to 1,010. Hopefully the next refi will be for a 15 year. I'm not totally upside down anymore but I'm barely above break even on it.

I'll look at starting with the highest rates first.

Rick

[Bob B.]

Kork and JPG have already said it all, so there isn't much for me to add, other than - I've been exactly where you are. In fact, I've still got $1,700 of CC debt to clean up, down from a high of 30K.

When I started getting serious about it, I too was tempted to free up cash flow. I turned to this forum, and was persuaded to clean it up from high int. rate to low. I followed the advice, and I'm sure I'm better off for it.

If you look at it from a high to low int. rate strategy, you'll clean up total debt faster.

Oh, and I agree with others. Cut back your 401K cont. to 5% match until all you high interest debt is cleaned up.

[Rick1]

Kork and JPG have already said it all, so there isn't much for me to add, other than - I've been exactly where you are. In fact, I've still got $1,700 of CC debt to clean up, down from a high of 30K.

When I started getting serious about it, I too was tempted to free up cash flow. I turned to this forum, and was persuaded to clean it up from high int. rate to low. I followed the advice, and I'm sure I'm better off for it.

If you look at it from a high to low int. rate strategy, you'll clean up total debt faster.

Oh, and I agree with others. Cut back your 401K cont. to 5% match until all you high interest debt is cleaned up.

It looks like that is going to be the plan...

Thanks all,
Rick

[jpg7n16]

It looks like that is going to be the plan...

Thanks all,
Rick

Ok good. So then, what is your plan to fix your budget going forward?


My big concern for you is that you take the inheritance, pay off a big chunk of debt, don't fix your budget, and find yourself right back where you started in a few years...