It’s a common misperception that debt problems only affect poor people. In fact, many couples and individuals who earn healthy salaries also have more debt than they can manage despite their comfortable incomes.
A recent case in point was a story reported by The Globe and Mail, a Canadian newspaper, about a married couple who had so much debt they could barely afford their monthly expenses even with a combined annual income of $128,000. With their first (unplanned) child on the way, they would soon be “living dangerously close to their financial edge,” the paper reported.
The couple, Mr. and Mrs. Bhardwajs of Mississauga, a town near Toronto, were so over-extended with two car loans, multiple credit cards, at least one line of credit and a $650,000 mortgage for a 3,500-square-foot house, that they were turned down from any additional debt.
Clearly, a little debt relief would be welcome.
But what options would someone in this situation have?
1. Decrease spending.
The most obvious way to reduce debt is to curtail spending and reallocate income to paying down what’s already owed.
The Bhardwajs told the newspaper that they’d planned to put a swimming pool on their home’s 11,000-square-foot lot, add landscaping and finish the basement. Those plans were put on hold to get ready for their baby.
Paying off debt means paying less money every month toward interest, which can be a huge expense for people with a lot of debt. Paying off all debt means paying no money toward interest. That might not be practical for everyone, but it’s still a nice goal to keep in mind.
2. Increase income.
A second way to reduce debt is to try to earn more income to put toward paying off what’s owed.
Mrs. Bhardwaj, who works in financial services, told the newspaper she planned to sell more insurance policies, which would raise her commission income by $10,000 to $15,000.
This strategy might seem surprising since debt reduction usually focuses on budgeting and cutting expenses, but in fact, increasing income can be smart, too, especially if the added funds aren’t used as an excuse to accumulate more debt.
3. Ask friends or family for help.
A third option is to get a loan or gift of money from a family member or friend to help manage the debt.
The Bhardwajs borrowed $80,000 from their family to pay down existing debt so they could qualify for their mortgage, and Mr. Bhardwaj’s father offered them up to $500 a month from his pension to help out with his expected grandchild.
If a loan or gift is put toward the principal owed on the existing debt and no additional debt is piled on, the future debt payments will be reduced, freeing up more money in the household budget for living expenses or additional debt reduction.
By the way, any debt reduction plan should include an emergency savings account even if the savings is only a few hundred dollars. Without a savings cushion, a major adverse life event like a job loss, illness, short-term disability, or jump in interest rates could derail any effort to pay off debt no matter how smart the strategy.
4. Get a debt consolidation loan.
One reason debt is so difficult to pay off is that interest consumes a big chunk of the payments that are made. A debt consolidation loan can help to ease the pain.
The way it works is that rather than pay multiple separate bills, all with different interest rates, every month, the consumer gets one new loan, uses the money to pay off all the other debt, and then has only one payment to make going forward.
The new loan can be a cash-out home refinance, or home equity loan, or line of credit. Home loans usually have lower interest rates than car loans, credit cards, unsecured lines of credit, and personal loans. As a result, combining debts into a new home loan can dramatically lower the monthly interest, making more money available for other needs.
There’s one risk that’s important to remember. That is, a home loan is indeed secured by the home, which means the lender can foreclose and take the property if the payments aren’t made. With the exception of car loans, most other types of loans are unsecured.
The interest paid on a home loan also can be tax-deductible while interest paid on other types of loans usually doesn’t offer any tax advantage.
The bottom line is that people who are income rich but financially poor have reasonable and realistic ways to reduce their monthly income expense, pay down their debt, and improve their personal financial situation.