A Debt That Is a Lesser of Evils?

[ejchase]

I'm in a bad financial situation. Suffice it to say that for the next four months I will be spending much more than I'm earning, and there is not too much I can do about it for a variety of reasons.

Currently, I have no debt, but I am thinking that I may have to incur some in these next few months in order to avoid draining the last few drops of an already too small emergency fund.

So my qurestion is this: is there any intelligent, conscious way to choose some kind of debt that is less terrible than other kinds?

Here are what I see as my options:

1. Apply for a home equity line of credit - I don't know if I can get one, though. Our house is new, but we put 20 percent down, so maybe that will make it possible for us to get a line of credit?

2. Get a zero percent interest credit card - though I think the interest rate might go up before I am able to pay it off.

3. See if I can borrow from my 401k or withdraw money from my 401K or Roth, though I hate the idea of this so much it's hard to write it. I think I'd rather deplete my emergency fund.

I'm guessing the debt will be in the ballpark of $8,000 and that I will be able to pay it off by around the end of 2012 or possibly mid-2013.

I *am* also looking into other possible sources of income, but I need to approach this from a lot of different angles.

Advice? Suggestions? Thanks in advance for your help.

[RosieTR]

If you are pretty dang certain you could pay off the HELOC by mid-2013, I would guess that's a least-worst sort of way to go. You would be putting your home at risk, of course, but it IS dischargeable debt and interest rates are very unlikely to go too much higher than now by then, so if it's pegged to a benchmark like the Fed rate you'd have a known quantity. Next I would go for the credit-card. Sure you're at the mercy of possibly astonishing interest rates but you could possibly negotiate that and such. The 401K is pretty risky...lots of potential fees, taxes and loss of future income. Anyway, FWIW that's my ordering of them and the reasons for it. You may have a different feeling after reading different responses or thinking about it awhile longer. There's also nothing wrong with doing something like taking out the credit-card but having the backup plan of paying down the balance with the e-fund depending on how everything goes (extra income, nasty interest, whatever). I also don't know the feasibility of getting a personal loan from a bank. I don't know what they would ask for in collateral or charge in interest but it's another thing to think about. Good luck.

[CathyA]

What's good about home equity loans is that they are tax deductible and the rates are very low right now. You'd just have to pay the minimum each month, or as much as you can. I think ours is 3%. Maybe you could try to get the home equity loan, but not use it until your zero percent credit card rate goes up and you can pay the balance with the home equity loan? But stuff on credit cards isn't deductible.

[catherine]

How much is your emergency fund? Doesn't this qualify as an emergency?

Having gone through the "this debt will be short-lived" period of my life, where it actually was not short-lived, I would say: do NOT dip into your 401k!! I wish someone had hung up the phone for me when I was speaking to my Fidelity representative, taking money out at the worst time in the recession.

I would also say do everything possible NOT to drum up living expenses on a credit card. Bad idea. So depressing to be stuck with a bill for eating food you ate nine months ago.

I would also discourage the HELOC, despite what others may say. If you're going to debt, I guess that makes the most sense, but, I did that too, and it bit me in the butt just like the CCs to get by and just like the 401k which I was going to put back as soon as the crisis was over (which in some ways it's still not over).

I would use the emergency fund. You'll be FAR more motivated to sell stuff, find p/t work or do whatever it takes to get the crisis behind you than you will be if you walk out of the bank with a nice check.

[Weston]

If you are pretty dang certain you could pay off the HELOC by mid-2013, I would guess that's a least-worst sort of way to go. You would be putting your home at risk, of course, but it IS dischargeable debt ...

Well, yeah it would be dischargeable in a bankruptcy but so would credit card debt. And if you don't pay your credit cards you don't lose your home (assuming that your state has some sort of Homestead protection)

I consider the HELOC as the worst of the three options. Seen way to many people lose their homes due at least in part to HELOCs. Obviously none of them are good options so I would recommend that catherine's suggestions be tried first.

[RosieTR]

I had assumed EJ would or had used up much of the e-fund, and this was beyond that. Sometimes it's not a bad idea to actually plan to keep some backup-backup funds so that you don't have to scramble if something else comes up because that's sometimes when lots of high-interest, bad debt comes into play rather than debt that is not great but at least planned-for within an overall scheme. If you need $500 for car repairs and don't have $500 because you used it for this other thing, now you have to put the $500 on a credit card without any choice at all. In contrast, if you have that $500 efund but choose some other source of debt, you could choose to put it on the cc (if it's low interest or whatever) OR pay with the e-fund. All of this is about making "least-worst" choices given the current information and situation which may change. Some people would choose to go to 0 on the e-fund, some would choose credit-card, some HELOC, probably some their 401K. Any of the choices would be valid given different circumstances, even the 401K. If you're 60, have enough to retire on in the 401 anyway, the money is for life-saving medical procedure, and you are pretty sure you have a stable job for the next 2 years and will be able to pay it back, borrowing from your 401K might actually make the most sense. If you're 30, and have a job you might lose any minute, $10K in your 401K and 3 credit cards with a $10K limit each with 0% interest for 6 months each, the credit cards might make the most sense. See what I mean? With finances there's rarely a completely true statement that begins "you should never...." or "you should always..."

[Anne Lee]

Don't forget to sell stuff.
Stock pile staples while you do have resources.
Step up the tightwaddery.

[lhamo]

I would tackle it this way:

1) Reduce all expenses to the absolute minimum. If you are brave enough to post your budget, perhaps we can see things that you haven't seen yourself, or at least help you prioritize.

2) Think of any and all ways you might be able to bring in extra cash during this period. If this is something related to a disability or illness, that might not be viable. But if you have an able-bodied partner, maybe they can take on some extra seasonal work. One idea I like to suggest for this time of year is to offer to babysit for families with kids so that the parents can get out and do holiday shopping. I know your house is small, but maybe you could do this at their house. Pool a bunch of kids together to increase the income in the same amount of time (and make it easier on yourself -- I find a houseful of kids entertain themselves much better than one or two). You could also offer to help people with cleaning and organizing prior to holiday parties, helping during large parties, etc. And there are often part-time retail positions that open for the holiday season only, so that's also something to consider.

3) Use your emergency fund. This kind of thing is what it is for. No sense in taking on debt or damaging your long-term planning if you have cash in hand that you can use to tackle this problem.

4) If you have contributions to your Roth that you can deduct, take money from there first. There is no penalty to withdraw your contributions once you have had the account open for five years. If you touch earnings there will be penalties and interest, but for many people who started these accounts in the last 5-10 years, there are no earnings :(

5) Approach your bank or local credit union about a small personal loan or line of credit that is NOT tied to your house. I have never done this, but my impression is that they are available if you have a decent credit limit and the interest will be lower than a credit union. Dave Ramsey often recommends this strategy.

6) 0% credit offer, assuming you have decent credit. If you can't pay it off by the end of the 0% interest period, you should be able to transfer the balance to another 0% card

7) 401k loan. I would not do this unless you absolutely have to, due to the heavy taxes and penalties that are assessed on early 401k withdrawals.

8) HELOC. This sounds like the easiest, but is the most dangerous. You only put 20% down on your house. That sounds like a lot, but it may have already evaporated in a declining market. If things don't go as you planned, you could see this spiral out of control and lose your house. I wouldn't do it.

A couple of other options to think about, depending on your situation:

1) File your tax return as soon as possible after the new year, assuming you are due a refund. That will get that money out of the government pocket and back in yours as soon as possible.

2) Let family and friends know that you are facing a difficult time financially and will not be giving gifts this season. Suggest that if anyone wants to give you anything, practical gifts like a Target or Safeway gift card, or even cash, would be the most appreciated.

3) IF you are confident that this is really a short-term thing and that you will be able to pay back the money on a regular schedule, and if you have family or friends who might be able to help out, see if anyone is willing to give you a personal loan. I would put everythign in writing so that expectations are clear. And then obviously make this your #1 priority and don't fail to live up to your commitment.

If you are comfortable sharing the reasons for this income/outgo mismatch, people here can be pretty creative with suggestions about how to address those issues, too.

Good luck and let us know what you decide/how it goes.

lhamo

[Zippy]

I would not do a HELOC, because you're putting your entire home at risk for $8000. I think a loan against a 401K is fine, as long as your job is fairly secure. And maybe if you go that route, see if you can take it out in phases.... I think to take it from a Roth IRA is fine, too. Savings is savings. You're not being frivolous; that's the main thing.

Is the debt a one-time thing, or the start of what could be a snowball? Is anyone's job at risk? If you can post more factors that are in play, people may be able to help more.

[ejchase]

Belated thanks to you all for your responses.

I will post more later. At the moment, I'm a little sick, so need to get to bed early tonight!