On the edge of disaster

Two months ago, Sheila Leeman, 33, was sitting at the kitchen table surrounded by overdue bills and crying with frustration. The phone wouldn’t stop ringing. She knew without answering that it was creditors looking for payments on more than $60,000 in consumer debt that she and her husband Malcolm had accumulated in the last few years. With all their credit cards and lines of credit maxed out and a hefty bill for $11,000 in overdue property taxes in need of urgent payment, the couple was contemplating the worst—selling their home. “In April, we missed a hydro payment and our power was shut off,” says Malcolm, also 33. “We panicked. How were we going to heat the baby’s bottle if we couldn’t turn on the stove? We settled it but one of the credit cards didn’t get paid that month. That’s how close to the edge we are.” Both Sheila and Malcolm insist they are not frivolous and irresponsible people. (We’ve changed the couple’s names to protect privacy.) In fact, Sheila explains how a long string of unlucky life events pushed them to the edge of fiscal disaster. “In the past fourteen months, Malcolm lost his job, our 10-month-old son Christopher was born with an immunological disease and, to top it all off, I had a bout of postpartum depression,” explains Sheila from the living room of the couple’s three-bedroom bungalow in St. Catharines, Ont. “It was overwhelming. We shut down, put our heads in the sand and started putting everything on credit cards—food, groceries, gas. Before we knew it, we were in way over our heads.” Married for 11 years, they are ecstatic to finally have the baby they so anxiously anticipated after six years of expensive fertility treatments. But they never imagined they would have no savings and little income for such a long period. “We were blindsided,” says Malcolm. “We never saw the hard times coming. We need to get back on track.” The good news is their luck is turning. Malcolm is back at work full time with a good union job earning $70,000 a year as a carpenter (plus benefits and pension). Sheila is returning in July to her full-time administrative assistant’s job earning $44,000 a year. That’s on top of the $11,000 annually she’s earning from a part-time job as a dental office receptionist. In the meantime, they’ve been making small payments on all their consumer debts and are fast-tracking payment on the $9,600 remaining in overdue property taxes so they don’t lose their house. “It’s stressful for us,” says Malcolm, who’s eager to pay down their debt as quickly as possible. “We’re both anxious all the time and our health is suffering. Stomach aches are a common occurrence for me now and I know it’s because of stress from the debt.” Now the Leemans are considering the drastic measure of putting their house up for sale. They bought it for $300,000 four years ago and it’s worth about $375,000 today. There is a $290,000 mortgage on the property. “I don’t hate the idea of selling the house, but I do hate renting,” says Malcolm. “And there would be that feeling that we had failed at home ownership, which bothers us. But we’d really consider selling if there was no other way.” For now, the Leemans also worry about their credit score. As it stands, the couple won’t be able to get more credit until they put a big dent in their debt—effectively putting them in the position of being one small disaster away from financial ruin. “Last month, I couldn’t go and pick up our car at the mechanic because I didn’t have the $300 to pay them and couldn’t put it on credit,” says Malcolm. “I had to wait three days until my paycheque came in and then go down and pay them in cash. We don’t want to live like that. We need a decisive plan to pay our debt off quickly and start saving for our future.” The Leemans used to be proud of their track record in avoiding debt. Sheila earned a diploma in accounting, while Malcolm, who is originally from Florida, trained to become a carpenter without taking on any student loans. Four years ago, with Malcolm employed at a small construction company and Sheila working as an administrative assistant at an insurance company, they bought their first home, a three-bedroom fixer-upper. Soon they racked up $35,000 in debt, mostly for necessary repairs and maintenance, but also for continuing fertility treatments. It was an extremely stressful time. “Imagine having a goal in sight, but no matter how you plan, or how hard you work, there’s no guarantee you will achieve it,” says Sheila. “That’s what those six years of fertility treatments felt like.” So in 2010, when Sheila finally became pregnant with Christopher, they felt their dream of starting a family was finally coming true. “We were so happy and were faithfully paying down the debt until four months later when Malcolm lost his job. That was a huge setback for us.” Now, with $64,150 in consumer debt and counting, the Leemans are just trying to stay afloat. They figure that if they spend every free penny on debt repayment, they may have a chance of paying off the debt and getting back on track to saving. Or, they could sell their home. That would net them $60,000 that they would immediately use to pay down their debt, making them almost debt-free. “It sometimes feels like our only option,” says Malcolm. That’s because debt repayment is already their single largest expense (apart from taxes) and they’ve budgeted all they can to make a repayment plan work. “We live as frugally as possible,” says Sheila. Apart from the $1,200 they spend each year on gifts sent to Florida for their nieces’ and nephew’s birthdays and $1,200 on restaurants, every other penny is spent on needs. These days, the Leemans lead a simple life that centres on spending time with their baby. They indulge only in a few small frills, like dinner out every month at their favourite sushi restaurant and the odd pay-per-view movie with friends. Their one big dream? To visit Florida before Christopher reaches school age so Malcolm’s two older sisters and their families can meet him for the first time. “They’re always inviting us down to visit but there’s just no money now,” says Malcolm. “One day we’d like to take that trip. Hopefully, it will be sooner, rather than later.”

What the experts had to say

Malcolm and Sheila Leeman have a massive debt problem. With their credit maxed out, all four experts we interviewed agreed the next four years would leave them vulnerable to even a small financial setback. That’s why, in this couple’s case, the right course of action may not be simply following a debt repayment plan. Their more immediate need may be a solution that will alleviate their stress and health issues while also putting them on the path to long-term savings. The experts say the couple has two options. The first is an easy choice that will give them a quick fix, but it will cost them the equity in their home. The second choice will require total dedication for several years but—barring an unforeseen fiscal catastrophe—will let them keep their house. Both are viable choices and can work with the right mindset, and it will be up to the Leemans to make a commitment to one plan or the other. Here are their options. Sell the house. More than half the couple’s household income goes to pay consumer debt and mortgage interest. “That’s huge,” says Heather Franklin, a fee-only planner in Toronto. “They should sell the house and start fresh. They’re young and can recoup.” With the $60,000 the couple nets from the sale of the house, Franklin advises the Leemans to put it all towards their outstanding debt, leaving just $4,150 on their consolidation loan. They can then pay that off in two months. That will free up almost $24,000 annually that was going to debt repayment plus $26,000 that was going to shelter—a total of $50,000. If they rent an apartment for $1,300 a month (including utilities), they will spend only $15,600 a year, leaving them $34,500 to invest. “For the first year, the full $34,500 should go into an emergency fund, maybe split equally between the two of them in Tax-Free Savings Accounts,” says Franklin. Starting in the second year and continuing every year after, Franklin advises the Leemans to allocate one-third or $11,500 to RRSPs, $2,000 to RESPs for their son Christopher and $15,000 to an account set up for a future house down payment. The remaining $6,000 should go to an annual family vacation, clothes, haircuts, hobbies and the odd movie to get their life back in balance. If they do all this, then in six years, when Christopher is ready for Grade 2, they’ll have $34,500 in TFSAs, $57,500 in RRSPs, $10,000 in RESPs as well as $75,000 in their house down payment account. “They can buy a house again at that time with a hefty 20% down payment, plus they’ll have a small cushion of retirement and post-secondary savings as well,” says Mary Prime, a fee-only adviser in Toronto. “Their credit score will recover in a year or so, they’ll have substantial savings and their work/life balance will ensure they stay healthy. And they’ll still be just 39 years old.” Commit several years to repaying the debt. If the house is important to them and they choose to hold on to it, they should totally dedicate themselves to repaying all their consumer debt over the next four years. Scott Hannah, president of the Credit Counseling Society, a national non-profit organization, feels the Leemans are committed enough to succeed if they choose to follow his lengthy debt repayment schedule. In fact, he favours the Leemans holding on to their house because he views home ownership as a key part in any young family’s psychological and financial stability. Hannah’s advice to the couple is to continue making their debt payments as they’re doing now (see “How the money is spent,” on the previous page) but with one change—he’d like to see them reduce their $800 monthly property tax payments. Hannah says now that they’re paying their debt to the city regularly, they’ll be able to negotiate a reduction in their payments to $400 a month without being in danger of losing their house. “Of course,” he says, “it means they’ll take two years instead of one to pay it off completely, but that will also free up $400 a month for other priorities.” Hannah then advises the Leemans to take $250 of that $400 each month and put it towards the department store credit cards. The remaining $150 can go into an emergency fund. The debt on the cards is smaller and can be paid off quickly, plus the interest rate (22% and 28%) is higher than the 15% the city is charging on overdue taxes. By following this strategy for a year, the couple will accomplish four key things: the department store cards will be paid off, they’ll have an emergency fund of $1,800, they’ll have paid off half their property taxes, and maintained payments on all their other debt. “That’s a great accomplishment,” says Hannah. In the second year, the couple should continue making the $400-a-month property tax payment and apply the other $400 to their line of credit, which now carries a crushing 29% interest rate. So in two years, the Leemans will have the property taxes paid off and the line of credit gone as well. “When March 2014 comes up, they should reconsolidate the rest of their debt and renegotiate their mortgage,” says Barb Garbens, a fee-only adviser in Toronto. “If they do that with the same lender, they may get a very good rate.” Of course, if there’s any financial setback—like another job loss—the couple may be forced to sell their home. Still, if their income remains strong and the Leemans don’t waver from their monthly payments, they should have no problem paying off their debt, keeping their home and building a long-term savings plan over the next few years—all key building blocks in a bulletproof financial plan. M How the money is spent Yearly disposable income Malcolm’s income $70,000 Sheila’s full-time income $44,000 Sheila’s part-time income $11,000 Child Tax Benefits $2,040 Minus: taxes and other deductions –$41,240 Net Disposable Income $85,800 Yearly Expenses Debt Repayment Lines of credit ($240/month) $2,880 Credit cards ($110/month) $1,320 Department store credit cards ($85/month) $1,020 Consolidation loan ($183/week) $9,516 Property taxes owing ($800/month) $9,600 Total debt repayment $24,336 Shelter Mortgage (incl. property taxes) $20,280 Home insurance $780 Hydro/gas/water $2,760 Cell phone/internet/TV $3,000 Total shelter $26,820 Transportation Leasing payments $6,656 Car insurance $3,360 Gas $5,200 Maintenance $720 Total transportation $15,936 Personal Groceries $10,400 Gifts $1,200 Daycare $5,200 Restaurants $1,200 Gardening $250 Miscellaneous $1,000 Total personal $19,250 Total Expenses $86,342 Annual income –$542 available for investment (total income minus total expenses) Assets Home $375,000 Chequing account $800 Two vehicles $14,000 Total Assets $389,800 Liabilities Mortgage (at 4.7%) $ 290,000 Lines of credit (at 29%) $6,650 Credit card (at 24%) $5,000 Credit card (at 19%) $3,000 Dept. store credit card (at 22%) $3,000 Dept. store credit card (at 28%) $1,900 Consolidation loan (at 12%) $35,000 Overdue property taxes (at 15%) $9,600 Total Liabilities $354,150 NET WORTH $35,650 (total assets minus total liabilities)