The 9 Steps to Financial Freedom (31 page)

The amount of money that you can take out of your home with this kind of loan is based on a percentage of the equity that you have in your home. Equity is the difference between what your house is worth and how much you owe on your mortgage. In other words, if your house is worth $200,000 and you have a mortgage of $150,000, it means that you have about $50,000 equity in your home.

Can you then take out a $50,000 home equity loan? Probably not. Most banks will let you borrow a total of only 80 percent of the value of your house, including all current mortgages. If your house is worth $200,000, 80 percent of its value is $160,000. Subtract the $150,000 you owe on the first mortgage, and this gives you the amount you can get on a home equity loan if you qualify: in this case, $10,000.

Another option is an equity line of credit, which enables you to borrow money as you need it against your house. Rather than a fixed interest rate, an equity line of credit usually has a rate that varies according to what interest rates are doing. Also, the payback period is not set—so be sure you’re very disciplined if you consider this alternative. With this type of loan you do not have to pay back principal each month if you don’t want to. You can just pay the interest if it better meets your needs. A home equity loan, on the other hand, works pretty much like a regular mortgage. You can get a fixed interest rate and pay back the loan over a fixed period of time, usually from five to fifteen years.

Before we compare the numbers, think about whether you are disciplined or not—it may have been lack of discipline in most cases that got you into all this debt to begin with. With a 401(k) loan you don’t have a choice. You have to pay back the loan in five years. Home equity loans, on the other hand, can go on for up to fifteen years. So you have to make sure that you don’t let the loan drag on for fifteen years, that you stick to a maximum payback period of five years, just as you would with a 401(k) loan. If you will agree with yourself to do this, and if the interest rate is favorable compared to your credit card’s interest rate, I would say in general that a home equity loan would be better.

Now let’s look at the economics.

With a 401(k) loan, fees are variable: some employers will charge you for taking out the loan and some won’t. Some make you pay a fee of up to $100 just to fill out the paperwork, and some charge a yearly fee while the loan is outstanding. The same is true of home equity loans: some can be gotten for no fees except for an appraisal on your home ($200–$350), and some will charge you fees up front to get the loan or do the paperwork, which can add another $100 or $200 to the bill. But if you look carefully, you should be able to find a home equity loan that can be gotten for no fees, no points, and a very small appraisal fee, if any.

With both kinds of loans, the application process is usually fairly easy. You may have to fill out a form, or you may be able to do it over the phone. However, loans from either source take time to process, so if you’re desperate, ask your employer or
lender how long each loan will take to process and when you will have the money in hand.

Who Decides What Investment My 401(k) Will Come From?

If you take out a 401(k) loan, it will depend on your company’s policy who decides which investments get sold. Some let you decide; others decide for you. Ask about how this works in your company. If you do have a choice, and if you have some of your money in a bond fund within your 401(k) plan, take your loan from that fund. Your equity funds will still have their full potential for growth, and since a bond fund is mainly giving you income anyway, it makes the most sense to take it from there.

I don’t think either move makes sense. Borrowing from your 401(k) isn’t nearly the great deal all your colleagues rave about. I already told you about the problems with 401(k) loans. My issue with home equity loans and home equity lines of credit is that they are what is known as secured debt. That is, you are putting your home up as collateral. Your credit card debt, however, is unsecured. There is no collateral you put up. So to take out an HEL or HELOC—that puts your house at risk if you fall on tough times and miss too many payments—isn’t a smart move when dealing with unsecured credit card debt.

Okay, if you are struggling with credit card debt, and I am telling you that tapping your 401(k) or borrowing against your home isn’t the right move, what is?

First, call up your credit card issuers and see if they will lower your rate, or work out a payment plan with you. When you are at your wit’s end, you might want to check out a nonprofit organization that has been set up to help educate you on your money and at the same time, set up a payment plan with you so that all of your cards will be paid off within five years at most.

My favorite of them all is a group known as National Foundation for Credit Counseling (NFCC). To find the office nearest you, please call 1-800-388-2227 or visit
www.NFCC.org
.

This is how they work: You hand over all your credit cards to them, and for about fifteen to thirty dollars a month, you will pay them one check and then they will pay your creditors for you. Most likely they will be able to get you a lower interest rate on your cards than what you are currently paying. They can do that because they have deals with many of the credit card companies themselves, so that they are able to negotiate a better interest rate with your current cards than you are able to. In fact, it is the credit card companies that help to fund most of these kinds of companies, for they believe that it is better to get some of their money back rather than none at all. Many people take advantage of organizations such as the NFCC, but they do have their drawbacks as well.

Below is an interview with Caryn Dickman, who is the woman in our story here and who has worked for the NFCC. Please read it carefully; it will help you answer many of the questions that you may have about NFCC.

CD: Can you talk to us a little about what a debt management program is?

NFCC: A debt management program is when we negotiate with the creditors to reduce the interest rates or to eliminate them altogether. A lot of creditors, because they’re going through
NFCC, will go ahead and completely eliminate the interest rates. This is really great. In other words, if I, as Joe Consumer, were to call the creditors and say “Let me work out a payment arrangement”—sometimes what they’ll do is say, “Okay, fine, we can do that and we’ll lower your payment, but your account is going to continue to age.” So you’re constantly going to be behind. Most of the time when going through NFCC, you don’t have a problem because we negotiate that by saying we don’t want any of this in arrears, we don’t want the person to be continually showing as behind. I want them brought up-to-date as of today. When we sign the contract, I want the interest rates either eliminated or reduced and this is what we do. Sometimes we have to get nasty with creditors.

CD: Then does the client pay NFCC every month or can they continue to pay themselves?

NFCC: Well, what happens is they give us the money; they’re not actually paying us, they’re actually giving us the money and we put it in a trust account. And it sits in the trust account until Thursday of every week. We make payments on Friday mornings.

CD: In that respect, when you get a credit report it would say that the accounts are being paid by NFCC?

NFCC: A credit report will never show us because we don’t report to the credit report agencies. Everything we do is confidential. It is between us and the client.

CD: What about the company that’s owed money?

NFCC: Right. Now what the creditors will do sometimes is that they will put a line in the credit report saying paid through a NFCC. The reason why it’s a good thing when this happens is because we really don’t want the client to accumulate any more debt. And sometimes what will happen is, because somebody’s habits haven’t changed and their skills haven’t developed yet, they
will go and try to get more credit. In that case, having this line on their credit report is good because they know not to give them any more credit until it’s paid off.

CD: And when it’s all completed, then if they do want to reapply for credit, can they get it? These are the kinds of things that keep people from wanting to use your servces; they’re afraid that they won’t be able to ever get credit again.

NFCC: If they choose to reapply, that’s not a problem. We have a pool of creditors that we work with that actually want to give credit back to our clients.

CD: My question is what is the point at which you advise people to go bankrupt?

NFCC: There is a point and quite frankly, sometimes—we never say you have to go bankrupt. What we do say is you may want to contact a lawyer; that is one of your options. Another one is that you can fight your way out of this situation and we can also show you how to do that.

Basically what happens is if somebody can’t meet the basic living expenses, forget about the debts. If they can’t pay the rent and they can’t afford food and they can’t manage their fixed expenses, then that’s when we say to them you’re going to have to look into some other way of taking care of this, because there’s not enough money here to make it even with our recommendations. We try to explore all options like having people move in with their families. Maybe that’s not even an option. Maybe there’s just no other way. That’s when we’ll say it’s time to go ahead and see a lawyer.

Sometimes, however, I have had clients say that’s absolutely not acceptable. And I say, fine, let’s figure out another way of doing this. Let’s figure out how I can help you and what I can do. There are tons and tons of jobs available right now. Are you willing to work two jobs? Are you willing to go and get some training
so that you can get a better paying job? We have this huge referral book and our counselors are really well trained—some of them have been doing this for years, so they know what’s available.

CD: Is the training free?

NFCC: Sometimes it’s free; it depends on the situation. If somebody, for example, is on welfare right now, we know we can go through the county and help them get the training for free. If they’ve been downsized, there is usually a way we can figure out how to get it for free or at a very low cost.

CD: Another question I wanted to ask is how is coming to NFCC different from collection agencies?

NFCC: Collection agencies work for the creditor. We’re working for the client. That’s the biggest difference. And basically what we do is we’re not trying to get the creditor’s money back. That’s not our purpose. Our purpose is to help you by giving you the tools that you need in order to gain control so that you can sleep at night, so that eventually you can start saving money, so that you can get out of debt, so that you can have an emergency fund, so that you don’t have to constantly be worrying about this same problem over and over again. A collection agency’s primary purpose is to get money back; they don’t care how it’s done.

CD: Who pays them?

NFCC: They get paid by the creditor. What happens is most organizations have their own internal collection agency. And basically the way they work is that they’re paid a salary, for example, $24,000. Then, of course, they get commissions on top of that $24,000. So they get paid by collecting money from you. The more they collect, obviously, the more money they make.

CD: Okay, so when you go to a creditor and you say you have a client who wants to pay it off, just get rid of all the interest, why would they choose to let that happen as opposed to letting their own collection people go after them?

NFCC: Well, because a lot of times what happens is their own collection people have tried and failed. That’s usually what happens. Basically, there are a couple of reasons why. One is that our program has been more successful than their collection departments. The reason why it’s generally been more successful is because we’re on the clients’ side. Also the creditor would rather get some money back than none at all. Many people come here distraught; they’re at that point where they’re on the verge of bankruptcy. Also, we do get money from the creditors. About 75 percent of our funding does come from creditor contributions. But please remember they are contributions. We’re not getting paid. It’s also cheaper for them to use a nonprofit organization because it’s tax deductible and it’s voluntary. They have to pay their employees; that’s not an option.

A question I hear fairly often is “Is this going to go on my credit report?” And basically the answer is it’s up to your creditor. Usually it’s that line that says paying through NFCC. Is that negative? Some people look at it as negative and some people think of it as something positive because you’re doing something about it and taking control.

CD: Another question you must get a lot is “When I walk in here are you going to rip up all my credit cards?”

NFCC: When you walk in here, no. If you choose to go on the debt management program, then what we will ask you to do is cut up all your credit cards.

CD: Every single one of them?

NFCC: Every single one of them. However, if you have your own business or if you have an emergency or there may be an exception, sometimes we let you keep one.

CD: What is the average amount of time that people stay on the program?

NFCC: Basically, we don’t like people to be on the program
for more than five years. We want to get them out of debt in five years. That’s our goal. The average length of time is three and a half years with an average debt load of $22,000.

CD: I keep coming back to this question. How long does the fact that someone has been using NFCC stay on their credit report?

NFCC: Generally, things stay on your credit report for seven years. Now what we have done is with those creditors that work with us, they are usually really great about just going ahead and taking it off and showing it as a zero balance and that’s it.