We’re in the midst of tough economic times and a lot of people are finding themselves in situations where they need to come up with money quickly in order to pay for one debt or another.  Whether it’s IRS tax debt or needing to replace a broken water heater, there are times when people find themselves with a large bill with no emergency fund to pay it.  So what do you do in a situation like that?  For many people the answer is to take out a 401(k) loan.  Up to 3/4 of company 401(k) plans have a provision available to do a 401(k) loan, and up to 30% of people with one of those plans have taken advantage of that and taken out a 401(k) loan.

Taking out a 401(k) loan can be a legitimate road to take if you’re dealing with a serious financial situation like IRS debt or a foreclosure. You should also be aware, however,  that there are risks to taking out a 401(k) loan.

How 401(k) Loans Work

Before we get too far into talking about the pros and cons of the 401(k) loan, let’s look at how they typically work.  Different plans may have different rules and regulations surrounding 401(k) loans, but typically they’re pretty similar.

• Minimum withdrawals: Most plans will have a minimum amount that you can take out when doing a 401(k) loan, typically anywhere from $500-1000.  They do that in part to try and discourage people from taking out small amounts from time to time to pay for smaller bills, to discourage people from short-circuiting their investment gains.
• Maximum loan amounts: Typically you’re allowed to borrow up to 50% of your vested balance in your 401(k) account, but no more than $50,000.   Also keep in mind that quite often you won’t be able to borrow from your vested company matching funds, but only personally deposited and vested funds.
• Payment terms:  Usually 401(k) loans have a 5 year payment term, and the interest rates are usually set at prime rate plus 1%.    If you’re taking out the loan to buy a home, longer terms may be available.
• Fees to process your loan:  Many plans will charge a fee just to process your loan – a fee anywhere from $50-100.

When taking out a 401(k) loan be sure to know what the provisions and stipulations of doing one are with your company’s 401(k).  Depending on what the fees are, maximum or minimums may be, you may not want to go down that road.

Pros Of Doing A 401(k) Loan

I’m not a huge proponent of doing a 401(k) loan just because I think it short-circuits the gains you could see in your retirement account, and it carries some significant risks.  That being said, there are some situations where I might consider doing one.

For example, if you’re in a situation where you’ve got a large IRS debt that you need to pay, I think a 401(k) loan might be preferable to getting in trouble with the IRS.  You don’t want to go to prison. Or if you’re in danger of going into foreclosure, or losing a vehicle to repossession, you may want to consider it.   Just know the risks.

Here are some reasons why a 401(k) loan can be a good thing.

• Very little paperwork needed:  Typically a 401(k) loan requires very little paperwork and can be done regardless of if you have an actual need.  In many cases it’s as easy as making a phone call or clicking a few links in your online account.  The only time you may need additional paperwork is if you’re using it for a home loan.
• Paying yourself interest:  When you get a loan from your bank or a credit card you’re going to be paying interest to them on the loan proceeds.  With a 401(k) loan you’re paying yourself interest.  Sounds like a good deal right?
• Easy repayment:  Quite often a 401k loan repayment comes directly out of your paycheck.  That makes paying your loan back easy – it comes directly out of your paycheck so you never see the money and feel the pinch of losing it.

While I don’t typically suggest a 401(k) loan, it can be an option if you’re in a pinch and you have to pay off a pressing debt right away.  There are some positives of doing one, but you also have to be aware of the significant risks – which we’ll look at next.

Cons Of Doing A 401(k) Loan

There are some considerable risks to be aware of when doing a 401(k) loan.  If you’re not careful they could come back to haunt you.

• Fees, fees, fees:  If you’re not careful you could be losing quite a bit of money to fees. There can be loan origination fees, and in some cases annual maintenance fee.  So for example, if you take out a $1000 loan, and then have a $75 origination fee and $25 maintenance fee on a 5 year loan, you would end up paying $200in fees – or 20%.  That’s a steep price to pay.  Be careful to know what fees your plan charges.
• Defaults, penalties and taxes:  If you go into default on your loan for one reason or another it will mean that the money will be taxed at your normal rate, and you’ll be charged a 10% early withdrawal penalty.  That could mean a huge tax payment when it comes to tax time, something most folks may not be prepared for, especially if the money is already spent.
• Money taxed twice:    When you repay your 401(k) loan, you’re using post-tax money to repay it.  But since the money is then going back into a pre-tax account, it will then be taxed again when a distribution is taken in retirement.  Double taxation!
• Moving jobs or being fired means loan comes due: If you end up deciding to move to a new job, or if you get let go from your current job, the 401(k) loan will automatically come due in full – although usually there is a grace period of 60-90 days.  If you can’t pay in that time you’ll be subject to a 10% penalty and your normal tax rate just like a normal default. That can mean upwards of 35-40% in taxes and penalties.  So when tax time comes, you may have a big tax bill at a time when you can least afford it!
• Lost retirement gains:  When you take money out of your 401(k) you’re taking away from any gains that your retirement funds may have made during the interim.  The cost can be especially great if you take the money out at the bottom of the market and it isn’t returned to the account until later when the market is higher.  You lose out on any gains your money may have made.

So as you can see there are a ton of cons associated with taking out a 401(k) loan.  There are risks associated with the fees charged, penalties if you default or lose your job and can’t pay in full, and the lost opportunity cost of not realizing investment gains.  Those are some pretty serious things to consider.

Try Considering Other Options First

My suggestion when it comes to taking out a 401(k) loan is to avoid it if you can and try other options first.  What are some other options?

Try saving up an emergency fund in advance so that when you have a need for a large chunk of cash you’ve already got it saved and ready to go.  That’s what I’ve done with our 12 month emergency fund – so that when big bills come due, like my recent $5000 tax bill, it wasn’t a problem because we’d planned ahead.

Another option is to open and use a Roth IRA account for your retirement savings instead.  When you use a Roth, you can withdraw your Roth IRA contributions at any time without any tax penalties, so you can avoid those risks of the 401(k) loan.   You’ll still be having the risk of losing out on investment gains, but at least you won’t be paying taxes or penalties.

If and when you decide to go down the road of a 401(k) loan, however, make sure that you’re doing your homework.  Go run the numbers using a 401(k) loan calculator and see just what interest rates you’re actually paying.   That may help you to decide if it’s actually a good deal.

Have you ever taken out a 401(k) loan?  If so, how did it turn out, did you pay it all back, or did you face paying taxes and penalties? Tell us your 401k loan experience in the comments.

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One thing we’ve heard a lot about the last couple of years is the rash of foreclosures and short sales, and how the real estate market is experiencing a huge downturn. A lot of people are finding themselves underwater in their homes, owing more on the homes than they’re currently worth. People have seen their home values drop by tens of thousands of dollars, if not hundreds of thousands.

In the area that we live in the story hasn’t been much different. There have been a lot of foreclosures and home values have dropped significantly. We bought our house near the height of the housing bubble, and over the past 5-6 years we’ve watched as our home value has dropped by more than $70-80,000 dollars. I don’t have to tell you that it hurts to watch your equity disappear into thin air like that.

Over the past year or so we’ve been thinking about upgrading our house a bit, in part because we’re hoping to have more children some day, and want to have more space, and a backyard for them to play in. We also figured now would be a pretty decent time to buy with the home values being so low. We’ve been able to find some properties that we’d like, and we’ve strongly been considering building our own home since my in-laws are builders.

Owing More Than Your Home Is Worth

Our only problem? Despite the fact that we’ve paid off almost $80,000 of our mortgage, we’re not sure we can sell our house for more than what we owe on the property. The values have just dropped too much.  We’ve also looked at sales of similar homes, and they’re selling for an additional $30-40,000 less than we though our home was worth.

My wife’s mom, while discussing the topic, suggested that the solution was to do a short sale, and then start over and buy a new house. I don’t think my mother-in-law or wife are aware of just how a short sale works, or that there are significant downsides to doing one.

How Does A Short Sale Work?

Just saying  you’re going to do a short sale isn’t enough as not all lenders will accept a short sale or discounted payoff.  In many cases for the lender it makes more financial sense to foreclose – and they’re under no obligation to agree to a short sale.   Also, not all properties or sellers are eligible for a short sale.

To get the process started you would need to first call your lender and talk to the person responsible for handling short sales, and capable of making a decision.  Next you’ll need to submit a variety of paperwork.  The things often asked for include a preliminary look at the numbers (how much you’ll sell for, and how much the shortfall will be), a hardship letter explaining why you need to do a short sale, proof of income and assets, copies of bank statements, a comparative market analysis showing prices of similar homes in the market and when you finally find a buyer – a purchase agreement.

In other words you have to contact them and show them that there is a good reason for doing  a short sale.  You also have to show them that you are truly having a  financial hardship.  Then they will make a decision as to whether they’ll allow a short sale.

Should You Do A Short Sale?

So the question is, do you really want to do a short sale?  Will your situation even qualify for a short sale?

Some reasons that may NOT qualify for a short sale:

• Wanting to buy another home:  The lender won’t care if you want to move to a different location or bigger home.
• Pregnancy: Having the size of your family increase or expenses increase are not qualifying hardships.
• Spending all  your money on electronics: Having irresponsible spending habits will not qualify you.
• Bad neighbors:  You may have found that all your neighbors are drug dealers, but this won’t qualify you to do a short sale.

Some reasons that might qualify for a short sale:

• Unemployment: If you lose a job and your source of income, that may be a qualifying hardship.
• Bankruptcy: Having a bankruptcy could be a qualifying hardship since you probably don’t have the money to pay your mortgage.
• Death:  Having one of the spouses die could qualify you.
• Divorce: Having a divorce and a resulting loss of dual incomes or other expenses could qualify you.
• Health problems:  Having health problems that lead to financial hardship, that could qualify.

The point here is that you have to be able to show some legitimate source of financial hardship that precludes you from making full payment on your loan.  So if you just want to get a bigger house with a nice fenced in yard, that is not a good reason to be doing a short sale.

Consequences Of Doing A Short Sale

So even if you qualify for a short sale, what are some of the consequences of going through with one?   Will it put a blemish on your credit report?  Is it better than  walking away and going through foreclosure?

Here are some of the things to consider:

• Your credit will be dinged: If you decide to do a short sale your credit will be hurt.  It will usually show on your report as a pre-foreclosure that has been redeemed, and reported as paid in full for less than agreed.  While you might think that a short sale would be better than a foreclosure on your credit, many lenders will not make distinction and just see the fact that in both cases the bank probably suffered a loss.  Both a foreclosure and short sale are reported and will affect your credit score about the same.  From what I’ve read the ding to your credit score could be anywhere from 2-300 points.  It could be slightly less on a short sale if you weren’t behind on payments.
• Tax or debt consequences:  You may be liable for taxes on the forgiven mortgage debt.  In some situations the bank will issue you a 1099 for the forgiven amount and you’ll be liable for taxes on that amount (which could be a huge tax bill).  Also, in some states the bank may come after you for the amount you are short.  Some states are no recourse states and you won’t have this issue, but others do not.  Check the laws in your state.
• You may not be able to get another home loan: If you’ve had a foreclosure or short sale you may not be able to get another Fannie Mae or Freddie Mac backed loan.  You’ll have to wait at least 2 years to get another loan with a short sale, and  5 years with a foreclosure.

So if you thought that there were advantages to a short sale over a foreclosure when it comes to preserving your credit, most sources that I’ve read say that really isn’t the case. They both affect your credit about equally. About the only advantage would be if you wanted to get a new home loan sooner, you may be able to get one within 2 years after doing a short sale.  Beyond that, you may be liable for taxes on the forgiven debt, or in some cases liable for the difference itself.  Make sure to do your homework before going down that road.

For us, we’re definitely not going to be going down the road of a short sale as we can afford to make the payments, we don’t have any hardship and I don’t want the ding to our credit. That plus we’d need to get another home loan right away if we sold.   So I guess we’ll just have to wait until we can sell it for what we need, or save up the difference.

Have you considered doing a short sale, or going into foreclosure?  After knowing the consequences, would you still attempt to do one?

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Within the last four years, it has become more difficult to borrow money, and more and more people may find themselves in a tight financial position through unemployment, loss of equity in their homes and debt load.  This type of environment may foster the desire for family members to help one another out with personal loans.

If you are the family member with money to lend, you may want to read some of the alternative solutions to lending money as outlined in the post, Should You Lend to Family Members?  If you are the family member in need of the personal loan, consider the implications before accepting.

Be Willing To Answer To The Family Member, Frequently Perhaps

When I was 19, my beater car died, and I tried to apply for a car loan but was denied because I had no credit history.  At the time, car loan rates were 6 to 8%.  My grandfather generously offered to pay cash for a new car for me, and then we signed a contract with monthly payments spread over five years.  I paid him about 5% interest, which gave me a discount off the bank interest rates, and he earned more on his investment than he could with the money sitting in the savings account.  On paper, it looked like a win-win situation, and it was for the most part.

However, every time my grandfather got in the car with me, he looked over my shoulder to check the mileage and to lecture me if he thought I was putting too many miles on my car.  I know he must have bit his tongue more than a few times not to say more, but I felt uncomfortable, and his looks were often enough to tell me what he was thinking.  I felt like I was using his car, and not in a manner he approved of.

If you borrow from a family member, be prepared to be questioned about how you are spending your money and what financial decisions you are making now that that family member has a vested interest in your financial life.

Know That Get Togethers Will Be Different.

Proverbs  22:7 says in part that “the borrower is slave to the lender.”  Borrowing money from family members changes the dynamic of the relationship.  When you borrow from a bank or a credit card, you don’t have a personal relationship with the lending party.  That is not the case when you borrow from family members.  There is a power shift when you borrow from a relative; suddenly that person has power over you, even if she is lending to you with the best intentions.  Even if your relative doesn’t make mention of the loan, you will feel the weight of your debt more so when it is a burden your family member now carries for you.

What To Do If You Must Borrow

If you must borrow from a family member, take the following steps to make sure the transaction goes smoothly:

1. Write up an agreement and have it notarized.  It may seem odd to write up a repayment plan, but it is essential for both parties.  It shows a good faith effort, and by notarizing it, you give the lending party more protection legally.  As the borrower, you demonstrate that you take this seriously and will pay back the loan.
2. Do NOT be late with payment.  Even if you have to scramble and get another job or a side job, do not be late on payment.  It is essential that your relative trust you to repay the loan as agreed upon.
3. Pay off the loan as quickly as possible.  Family relationships are much too precious to ruin over borrowed money.  Make it your mission to pay off the debt as soon as possible.  Free yourself of this financial burden and restore your relationship.  As Dave Ramsey says, no one wants to eat Thanksgiving dinner with their master.

If you have other options, it is in your best interest to avoid borrowing from a family member.  However, if you must, know realistically that it will change the dynamic of your relationship.  Also, make plans to pay the debt in a timely matter and to try to pay it off as quickly as possible to restore the natural dynamic of the relationship.

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It is no secret that many Americans graduate from college mired in debt.  Nearly 66% of college students graduate with student loan debt averaging $25,250 per student according to the Project on Student Loan Debt.  However, student loan debt is only one of the many economic problems confronting young college graduates.  The Project on Student Loan Debt further states:

“In the current economic climate, recent college graduates who borrowed for their education face particular challenges in paying back their student loans. The unemployment rate for young college graduates rose from 8.7 percent in 2009 to 9.1 percent in 2010, the highest annual rate on record.”

At $25,250 average debt, the recent graduate is looking at a $290 payment monthly, which seems manageable, but unfortunately, $25,250 is just an average.  Many students owe much more than that.  My cousin attended law school for 1.5 years before deciding a law degree was not for him; he walked away with $65,000 in student loan debt and a monthly payment of $780.  He is currently living at home and has a serious girlfriend, but any plans for an engagement are on hold while he chips away at his debt.  He is one of many student loan holders who have put off marriage and home ownership because of the amount of their debt.

The student loan problem has permeated the news, and Obama recently announced a student loan relief plan.  What does this plan mean for college students?  There are two main features to his plan:

Changes to the Income Contingent Repayment Plan

When choosing a repayment plan, students are typically allowed to choose between four repayment options—standard, extended, graduated and income contingent.  Currently, under the Income Contingent Repayment plan, students are responsible for paying 15% of their monthly discretionary income to student loan repayment.  If, after 25 years the loans are still not paid off, the loans are forgiven.

Beginning in 2014, the income contingent repayment plan would change to a payment of 10% of a loan holder’s monthly discretionary income and loan forgiveness after 20 years.  Congress has already approved this, but under Obama’s new plan, this would be pushed forward and take effect in 2012.  In addition, if a loan holder is unemployed and has no income, they would not be required to pay during that time.  This will hopefully reduce the default rate, which currently hovers at 8.8% (based on 2010 data).

Incentive to Consolidate Loans

Typically, a graduate leaves college with a myriad of loans from different sources and with different interest rates.  If the student attempts to pay the minimum payment on each of the loans, the required payments may quickly become overwhelming.  To make the repayment more manageable, students may want to consolidate so they will just be paying one payment monthly.  To offer loan holders an incentive to do this, Obama is offering a .5% reduction in interest rates when loans are consolidated.

What It Means To Loan Holders

While these changes do offer incentives to make loan repayment more manageable, it is important to note they will most likely help new student loan holders as the Income Contingent changes will only apply to those who take out student loans beginning in 2012.  In addition, many older loan holders have already consolidated their loans, which can only be done once, so they will not benefit from the .5% interest rate reduction.

Student loans are not currently discharge-able in bankruptcy, so if a borrower defaults, they can face having their wages garnished as well as their tax returns.  In addition, their credit score will be ruined.  While Obama’s changes offer some student loan relief for new borrowers and will hopefully help them avoid default, older borrowers must continue to carry the burden of their debt with little relief in sight.

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Americans are notorious for wanting to keep up with their peers.  A popular holiday commercial for a home improvement store features one neighbor putting up his holiday decorations in his yard.  Not to be outdone, his neighbor rushes to the home improvement store and buys triple the number of lights and decorations for his own yard just to look better than his neighbor.

Nowadays, we see homes with three and four car garages, seven year olds with cell phones, a couple dropping $100 or more for a nice dinner out. . .We see excess everywhere.  Even if we aren’t being excessive, we may run into unexpected obstacles in our lives.  Many Americans carry debt from obtaining a college education, paying medical bills or other expenses.  Things happen in life, and it is, unfortunately, not unusual to find yourself in debt.  In a country where the average credit card debt per household is $7,134, Americans have plenty of company when it comes to being in debt.  Yet, we hide debt and do our best to pretend it doesn’t exist.

By not being honest about our debt load, we can pretend that it is not as bad as it is.  Many people even hide the debt from themselves by never taking the time to add up the amount they owe, computing the interest rate, computing how many years it will take them to pay off the debt, and how much debt they will pay over the life of the debt.  If they don’t figure this out, they can keep spending freely.  If they take the time to figure it out, the free spending is typically over, and if it isn’t, spending is now attached with a sense of guilt.  It is easy to see why people want to avoid the reality of their financial situation.

Facing Financial Reality

If you are looking to free yourself from the chains of debt, the first step is to compute exactly how much you owe.  After you have done that, you need to create a plan to pay back the debt aggressively.  My husband and I recently did just that.

My husband completed his Ph.D. a month ago. He was enrolled in a dual Master’s/Ph.D. program, and it took him 10 long years to complete.  He took two years off during the course of the program to care for our two young children while I worked full-time, and one of his professors was quite slow with giving him feedback and guidance on his dissertation.  These two factors probably prolonged his graduation by three years.  Because I was working full-time, we managed to avoid any student loans until we had our last two children 17.5 months apart and I quit my job because the cost of daycare would have taken almost my entire salary.  He is graduating with $30,988 dollars in student loan debt, and I also have some residual student loan debt.  We have created a plan to aggressively pay down our debt, and we plan to be debt free within 3 to 4 years, hopefully faster if we can continue to make extra money.

Confessing For Accountability

I am a fan of Gail Vaz-Oxlade, host of the popular TV show, ‘Til Debt Do Us Part.  I like her no nonsense approach.  When she is counseling couples to get out of debt, she often requires that they confess their debts to at least one close friend or family member, but sometimes she makes them reveal it to all of their close friends and family members.  I always cringe when I watch those scenes because it feels akin to standing naked in a room, and indeed they are standing financially naked in front of those they care most about.  The key here is not just to reveal your debt, but to reveal your plan to get out of debt.

Why Reveal the Debt Repayment Plan?

By revealing your debt, you are taking ownership of your debt.  You did this, and you are willing to take responsibility.  When you explain your debt repayment plan, you are holding others to help keep you accountable.  No longer can you enjoy a carefree $100 dinner out for two.  You will have others cheering you on as you repay your debt.  In addition, they will understand when you have to say no to outings or when, instead of going to a movie and out to eat with friends, you invite the friends over to your house to watch a DVD and have a home cooked meal.

I choose to reveal the extent of our debt on my blog along with our action plan to pay it off.  I am not going to lie, it was difficult to write down the numbers.  It was even more difficult to get the frantic call from my mom after a friend had her read the debt confession blog post.  She immediately offered us money she really doesn’t have to help us pay down our debt, which we declined.  For a few weeks, she tip toed around our finances and continually expressed her concern.  Yet, now, as she watches us attack the debt and implement our debt repayment plan, she is more confident and comfortable with the situation.

I know at least a handful of my relatives read my blog, and I am guessing that they have shared our situation with other family members.  Does it make things a bit awkward?  Yes, it does.  However, even among the handful of relatives that know about our debt, at least half of them also have a serious level of debt.  I am hoping by sharing our story that I can also motivate those who are in a similar situation.

There are some countries where very few people hold debt.  The United States used to be one of those countries, but thanks to the economy and the ease of which we can use credit, many Americans have debt.  You are not alone.  If you want to take concrete steps to get out of debt, take the time to determine how much debt you have, make an action plan to pay it off, and tell at least one person you love and trust how much you owe and how you plan to pay it off.  Revealing your debt is difficult, but it can also be empowering.  As one who has done it, I highly recommend a debt reveal to help you accelerate your debt repayment plan.

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Like a lot of people these days at one point in my life I struggled with credit card debt, and with spending more than my income could justify.  Over about 4-5 few years my wife and I were able to get rid of our debt, but it ended up taking far longer than it should have.  Why?  We weren’t able to completely rein in our emotional spending or change the behaviors that got us to being so far in debt.

While we did finally get out of debt, in the end what finally gave us the boost to get over the edge was getting involved in a financial program that gave us accountability and structure while we reduced our debt.

If you’re still struggling with debt I think it’s a great idea to get into a group or community that will help you to make the changes you need in order to better your life.

A Debt Reduction Program Built On Experience

This week my friend Adam Baker over at ManVsDebt.com has launched a new 6 week daily video course and accountability community called You Vs. Debt that aims to help empower people to take back control of their financial lives.   Adam knows from experience what it takes to get out of debt as his wife Courtnay and he eliminated thousands in debt themselves, and struggled through a process of debt reduction trial and error. Here he discusses their turnaround.

Through their process of trial and error Adam realized a lot of what it takes to make a change, and decided to put together a program of his own that addresses a lot of the hurdles that people face.

You Vs. Debt: A Debt Reduction Program That Works

So what is involved in the You Vs Debt program?  It’s a 6 week video course with daily videos with short lessons, and followed up by specific challenges to completely.  Each day should take around 15 minutes or so to complete, and includes the video, an MP3 and  a full transcript – so you can learn via whatever method works best for you.  Daily custom worksheets are also provided to help you track your progress.

Topics covered in the 6 weeks.

During the class there are weekly surveys, and public awards to help keep you accountable, as well as a community of other registered users who can help you along the way.

Limited Enrollment And Double Your Money Back Guarantee

I normally don’t recommend these types of programs unless I’m familiar with the program having been through it myself, or if I know and completely trust the program leader.   While I haven’t been through the program I do know Adam and I know he has a passion and a fire for helping others get rid of their debt, and I know he can help.

If you’re considering the program, but still aren’t sure, you can also rest assured that there is a double your money back guarantee, that you can read about on his program page.   So you’ve got nothing to lose (except debt), and everything to gain!

Head on over to the You Vs. Debt program page, and register for the class today!  Enrollment for this class ends Thursday, September 22nd. That’s coming up quick!

You Vs. Debt Class Details And Registration

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I‘m convinced that there is only one surefire way to undo your debts. No, it’s not with a debt consolidation company. We’ve paid off our debt without negotiating for lower payments, lower amounts owed, or fighting with collectors.

Some may say we had it easy. Sure, it wasn’t the most difficult situation. But that doesn’t mean undoing our debts was an easy task. Here are some things that worked for us as we fought our way to freedom from non-mortgage debt.

Step 1: Cut Expenses Wherever You Can

This isn’t going to be pretty. If you want to get rid of your debt in a hurry, think of things you are paying for that you really don’t need in your life anymore. For example, do you have cable TV? It’s time to get rid of it. Visiting Starbucks every day on your morning commute to work? Well, I think it’s time to make some coffee at home (or for you brave ones, try drinking water instead)!

Remember, this is how to undo your debts the hard way. Anywhere worth going is worth the extra effort, and paying off debt is no different.

Step 2: Get A Second Job, Or Third Job!

Once you’ve cut your expenses the most you can, it’s time to start thinking about getting another job:

• Deliver pizzas.
• Clean houses.
• Mow lawns.

The rich rule over the poor, and the borrower is slave to the lender. – Proverbs 22:7

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Today I was checking my free credit scores and reports (Here’s how to check your credit for free) to make sure all was OK with my credit situation, when I decided to look a little deeper at my credit report. I wanted to take a jog down memory lane and see just how much debt I have incurred over the years, what those debts were for, and how long they took me to pay off.

What loans have I taken out, and what lines of credit and credit cards have I used?

If nothing else i thought that this exercise may remind me of just how much spending I’ve done over they years, much of it unnecessary.

What Debts Have You Had?

When I opened my credit report from Experian (the credit agency I’ll be using for this post), I see a total of  15 different real estate or car loans, credit cards and other credit accounts.  So what accounts were they?  I’m thinking that’s probably less than the average family.

Real Estate Related Accounts

I have 3 real estate related accounts on my credit report.  Two are associated with my current home – once when we bought the home and once when we refinanced.  The other was a home loan for our townhouse that we bought when we were first married.

• Bank of America: Current mortgage and our only debt.
• Mortgage 2: Paid and closed  upon refinance.
• Mortgage 1: Paid and closed upon sale of our first home.

 Credit Cards And Other Revolving Accounts

I’ve had a total of 7 credit cards or other revolving credit accounts. Of those 2 are currently open and 5 are closed.

An Experian marketing insight  study shows that  overall, consumers had an average of 5.4 open credit cards.  So we’re below the average with our 2 open cards.  To be completely honest, one of the open credit accounts is a JCPenney card we opened a couple of years back when buying a bunch of furniture to save 15%.  I used that card once, paid it off and cut it up.  I forgot to close the account and keep forgetting to purge it every time I check my credit.  Here are the accounts I’ve had.

• Chase Cash Rewards Mastercard: My only open credit card.   We don’t use it very often except for some trip reservations, renting a car and a few other high ticket items because of the extra protection and insurance the card gives. Zero balance.
• JCPenney Store Credit Card: Opened to buy some furniture and never canceled or used again.  I’ve still got to cancel this card.   Zero balance.
• American Express Blue:  Amex card that I got while I was in college and only canceled a year or two ago while taking the Dave Ramsey FPU class.
• PayPal Credit Card:  I honestly don’t remember having this credit account, but it is closed now and wasn’t ever really used.  It must have come with my PayPal account or something?
• Sears Store Credit Card:  I believe I got this card while I was in college and buying a TV in order to save 10%.   Used once and then canceled.
• Chase Visa Card: Another credit card opened during college for a free t-shirt. I had the card (and used it!) for several years before wising up and canceling.
• US Bank Line Of Credit: Line of credit at our old bank.

Installment Accounts Including Car, Boat, Student Loans

I’ve had another 5 loan accounts over the years for things like cars, student loans and a wedding ring.  I think this number might be quite a bit lower than a lot of families as well as I’ve only purchased a couple of cars using a loan, and had one student loan.

• Topline Credit Union: 3 year car loan that was paid off early.  This was my last ever car loan.
• Chase Automotive Finance: 3 year car loan paid off in 2 months.  I got the loan, and then paid it off fast after getting a loan with a better rate (see above).
• US Bank Auto Loans: 5 year car loan paid off in 3 years.
• Jewelry Store Financing:  Buying my wife’s wedding ring.   0% interest over 1 year, paid off in 1 year.
• US Department of Education: 10 year student loan, paid off in 6 years.

So there it  is, that’s the extent of my credit and borrowing since I turned I turned 18, so many moons ago.  If you add up the total amount of credit used or loans taken out across all 15 accounts, the total comes out to well over $600,000.  Of course the actual total is much lower than that since we never had to fully pay off 3 mortgages.   Still, that’s a lot of loans and credit, and interest paid.

What Could You Have Done With Money You Paid In Interest?

While we feel pretty good with where we’re at today in our financial lives, looking back over the amount of credit and debt we’ve used over the years is really eye opening.

What could we have done with all that money we spent on interest and credit over the years?  Would the amount we  paid on credit total up to a nice nest egg for your retirement?  How much could that money have turned into had we invested it at 25 instead of getting used car loans and using credit cards and paying a ton of interest?

How about you?  How many credit cards, real estate and other credit accounts do you have on your credit report?  Does looking at your credit report make you realize just how much money you’ve spent over the years on principal and interest?

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Yesterday an interesting discussion started in the comments section of a mortgage company review on this site.  A regular reader was asking the question of whether or not it was OK for a Christian to take on debt of any kind, or whether debt should avoided at all costs as being biblically a bad idea.

There was a bit of back and forth, and I think we agreed on some points, but not on others. So today I decided to open the topic up for further discussion.

Here’s how the question was framed by Matt from DiscipleshipGuy.com:

Before I get to my comment I want to say that I currently have a house that we use to live in that we have outgrown and since have turned it into a rental due to not being able to sell it. So we currently rent.

That being said, I have spent a lot of time lately thinking about our next step, would we try to buy again, and if so, would we finance. This isn’t always an easy thing to think about, many of us, if we had to do 100% down (as Dave Ramsey recommends), wouldn’t be able to buy for a long time – at least not what we want to buy. That being said, since this site is Bible Money Matters, is there anyway that we as Christians, can justify getting a mortgage? I know that culturally that we do it, but we aren’t to be a part of the world. Is there any Biblical position that allows for getting a mortgage or loan of any kind?

I am not trying to attack you or anything, I like you and your sites. But, sometimes I think about all of the Christian financial blogs out there, giving advice on living frugally, Biblically, and being good stewards, and I wonder if sometimes we miss the mark and just give good advice rather than Biblical advice. Basically my question for us to think about is this: is it Biblical to get a mortgage or to even recommend a mortgage (or loan of any kind)?

…there are several verses that lend to the idea of not borrowing. I definitely never see borrowing encouraged in the Bible. My overall point is this: As Christians, we see mortgage as an acceptable way of life, but is it a Biblical way of life? I am not saying for sure where I fall on this issue, but it is something I am debating right now. After all, if we are a slave to the lender, then we cannot serve God as he requires.

So what do you think?  Is it biblical to take on a mortgage, or to recommend a mortgage or a loan of any kind?

Is Debt Considered Sinful?

The first question that I think we should consider is whether or not going into debt can be considered a sin.  From the verses that I’ve read I don’t think that we can say that it is.   There are several verses that talk about debt and repaying debt, and in none of them that I can find anything that being in debt is a sin, or that it is sinful to be in debt.

Let no debt remain outstanding except the continuing debt to love on another.. Romans 13:8

The wicked borrows and does not repay, But the righteous shows mercy and gives. Psalm 37:21

The verses that I’ve found do talk about the fact that the wicked don’t repay, or that it is sinful to allow debts to remain outstanding without repayment.   But none of them say that it is sinful to take on debt in the first place.

Also, if borrowing was considered sinful, then lending would also be frowned upon as sinful as well wouldn’t it?  But look to the words of Jesus himself:

Give to him who asks you, and from him who wants to borrow from you do not turn away. Matthew 5:42

But love your enemies, do good, and lend, hoping for nothing in return; and your reward will be great, and you will be sons of the Most High.

I do think that some verses caution against lending in cases where doing so can cause hardship for borrowers, or where outrageous interest is being charged, but I can’t find anything saying that we should never lend or borrow.

Are We Cautioned Against Going Into Debt?

Even if it isn’t sin to go into debt, are we cautioned in the bible about the pitfalls of taking on debt?  I think we are:

The rich rules over the poor, and the borrower becomes the lender’s slave.  Proverbs 22:7

No one can serve two masters, for either he will hate the one and love the other, or he will be devoted to the one and despise the other. You cannot serve God and money. Matthew 6:24

The bible in numerous instances cautions us about the dangers of debt.  It tells us about how being a borrower puts you in a power relationship with the lender, and you become slave to that debt and lender.  It tells us that by taking on debt, those debts can quickly become our master and it can cloud our relationship with God, and quickly overtake our relationship with Him.  We need to be wary of debt because it restricts our freedom.

Is It OK For A Christian To Have Debt?

Here’s where it gets a bit tricky – the question of whether or not it is ever OK for a Christian to take on debt. While I think not using debt is preferable if possible, in some cases I think it’s OK to take on debt.   You just need to be sure that the debt isn’t restricting your service to God in any way, and that it isn’t debt in order to facilitate sin in any way.  It has to fit into your financial plan and be reasonable and not for foolish purposes.  Paul from ProvidentPlan.com, in his own post about debt and sin, put it like this:

None of this means that debt does not have its proper place in our finances. But foolish debt – to buy things we can’t really afford – is not going to glorify God. Christians should only be going into debt when they are reasonably sure they can repay the loan and they are not using the debt for foolish or sinful purposes.

To me they key is that we shouldn’t allow ourselves to go into debt to the degree that it interferes with our service to God, and to the degree that becomes overpowering.  We should only use debt when absolutely necessary, and only when we can easily afford it.

At this point I want to open it up for discussion.  What are your thoughts about going into debt as a Christian?  Is it ever acceptable for a Christian, and if not, why not?  Tell us your thoughts in the comments.

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Over the years I’ve never really been someone who spends large amounts of money, but if I’m completely honest I haven’t exactly been frugal all the time either.  When I was younger I never really denied myself the things I wanted, even when I didn’t necessarily have the cash on hand to buy it.  If I could put it on the credit card and pay it off within a month or two I’d do it.  I had fallen prey to the idea that using credit is normal and acceptable, and that saving up and paying cash was for suckers.   Over time, however, smaller purchases have a way of adding up.

When I was at college I can remember walking through the student union on campus, seeing the multiple tables set up by credit card companies to sign up unsuspecting students to their first credit card.  Some of those tables actually had lines of people waiting to sign up and get their free t-shirt, school blanket or cheap school frisbee – in exchange for taking on a credit card, and starting their financial lives on the wrong foot.   Most people probably didn’t have those free t-shirts or frisbees for more than a year or two, but in the end those credit cards followed  many of us around for years to come.

While at school I also amassed what felt like a fortune in school loan debt.  In the end I had about $23,000 or so in school loans. Today that doesn’t seem like much, but at the time for me it seemed like a lot.

While I was busy building up my debts in school through school loans, credit card debt and irresponsible spending – I always had an uneasy feeling in the back of my brain that told me I was doing things I was going to regret later.  Many in society tell us that debt is necessary, and that debt is the only way to get ahead, but it just isn’t true.   Living a cash only lifestyle is possible, and will allow you to get ahead that much faster.  Living on debt will leave you broke and borrowing to live.

A Financed Lifestyle Is Fun For A Season.. But You Have To Pay Eventually

My thoughts on debt and money didn’t really start changing until after I married my wife Maria.  She was a bit more fortunate than I in that she came to our marriage with no debt of any kind, except for the mortgage on her townhouse which her parents had helped her to buy.   Even the townhouse wasn’t purchased the traditional way for young folks – with no down payment and unaffordable payments.  They had helped her to put 30% down and keep the payments affordable.

“Debt is the slavery of the free” – Publilius Syrus, Roman author, 1st century B.C.

When I looked at her finances and then at my own, I quickly realized that it was my own debts and obligations that were the proverbial anchor holding us back as a couple.  It was my credit card debt, my car payment and my student loans that were our only debts.  I knew then that if we wanted to get ahead I had to make some changes and starting living a cash only lifestyle. No more financed fun!

The last big debts we signed up for before we started getting things under control were our two wedding rings and our honeymoon to Hawaii.  All of them except my own ring were purchased on credit.   So now we had to find a way to get out from under over $32,000 in credit and student loan debt.

That early in our marriage I wasn’t following any specific plan to get out of debt, I was just following a haphazard plan of making extra payments on our highest interest debt (the credit cards) when I could. While i was working towards paying off the debts, I really didn’t have a solid financial plan or a budget.  I also didn’t have any sources of extra income.

Despite these facts we were fortunate in the fact that we were able to pay off  over $32,000 in debt in about 4 years.  While I’m glad we were finally able to rid ourselves of all debt except our mortgage, if I could do things over I probably would have done a better job of making a financial plan and a budget, and of trying to find some temporary extra sources of income to help pay off our debts faster.

Steps For Getting Rid Of Debt

If I had it all to do over again, here are some steps I would have taken right away to get out of debt.

• Save up for a rainy day: One thing we never did at the beginning was to save up a small emergency fund of some kind.   Because of that, whenever something would go wrong – a car repair, or some home maintenance bill – we’d end up putting it on the credit card and incurring new debt.  Instead of allowing the debt cycle to continue indefinitely, save up an emergency fund of $1000-2000 so you don’t have to worry about small unexpected expenses – and worry about losing ground on your debt reduction plan.
• Make sure you track your money: Get together as a family and do a zero based budget where you allocate every dollar of income to either a spending, saving or giving category. Actually tracking your money can be a seriously eye opening experience.  We were shocked to discover just how much we were spending on eating out every month!  We currently use a great zero based budgeting software called You Need A Budget.  Check out my YNAB review here.
• Make extra income: Sometimes when trying to pay off debt the only way you’ll get ahead is to create extra income of some kind that you can put towards your debts. While your part time work doesn’t have to be a permanent thing, if you can swing it, it can be a great way to reduce your debt that much faster.
• Have a plan to pay off debts: Put together a plan of some sort to pay off your debt.  At our house we used Dave Ramsey’s debt snowball to pay off our remaining debts because it has been proven to work, and it made sense to us.  If you don’t like the debt snowball, find another debt reduction plan to use, but find something!
• Save up a larger emergency fund:   After we paid off our debts, the next step we took was to save up a larger emergency fund for bigger contingencies like a job loss or major medical event. That meant saving up about 10 months of expenses in a saving account.  Now that we’ve reached that amount of savings, we’re also planning ahead for other expected life events like new cars, kids education and other things. We’re saving up cash for those things because we would prefer to live with cash now!

Getting out of debt isn’t easy, and there is no magic bullet.  Like anything worth it in life it just takes hard work, perseverance and a bit of self control. If you make the choice to ditch the financed lifestyle and switch to a lifestyle where expenses are budgeted and planned for, in the end you’ll be happier -and wealthier.

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