Downsizing Debt in Retirement
Retiring with debt is the new reality for the majority of Americans. You may not be able to continue working until you have “enough” money in retirement accounts or have paid off all of the existing debt you have accumulated over the years. The result is a smaller retirement budget available for daily living expenses.
Debt generally falls in four different major categories and each might be handled differently based on your personal circumstances. These include mortgage debt, student loan debt, consumer debt such as car payments, and unsecured debt like credit cards.
Mortgage Debt
This is likely your highest overall balance but often carries the lowest overall interest rate. Mortgages can include first and second mortgages along with home equity lines of credit. Mortgage debt encompasses your housing costs which can be 30% or more of retirement income, making it a debt that should not be ignored. If you decide to sell the home to pay off the debt, you may still incur rental costs that may be just as high, and less predictable than a fixed mortgage payment.
Other options include leaving the current mortgage in place and paying it off on the current schedule. You may refinance to shorten or lengthen the term, downsize your home to a smaller mortgage or a home you can pay cash for based on existing equity.
Leaving the mortgage in place may be the right option if you have a low fixed rate, have a 15 year mortgage, and/or have lived in the home a long time. You can increase monthly payments to shorten the term and reduce the number of years you will be required to pay the debt in retirement. There are online amortization tables’ ( http://www.bankrate.com/calculators.aspx?ic_id=home_smart-spending_calculators_globalnav ) which will help you determine the payment needed based on your goals.
Refinancing can cost several thousand dollars upfront and you must qualify for the new mortgage. This route would be best to choose before retirement, in the event your income declines. Refinancing can lock in a variable rate, lower your current rate, or extend the loan term back out to 30 years. Extending the term will result in a lower monthly payment, however, you will pay more in interest and could be paying a mortgage the rest of your life.
Downsizing is a popular option if you are struggling to make payments while you are still working. A smaller home may be easier to maintain and a smaller mortgage (or no mortgage) is much easier to manage in retirement. Downsizing will also require qualifying for the loan but could result in saving thousands of dollars a year from lower interest and payments.
Student Loan Debt
Student loan debt is the new kid on the block when it comes to debt management. Currently, the amount of student loan debt carried by consumers has exceeded the amount of debt and has grown to over $1.3 trillion. This used to be a payment only young people had to deal with. Today many older workers have returned to school in an effort to retrain or advance careers. If the additional schooling did not result in significantly higher income, you may find yourself still managing payments well into retirement.
Atraditional student loan repayment plan will pay off the debt in 10 years and can eliminate debt at or before retirement. This is the least expensive option and results in the lowest amount of interest paid. It also can create a payment the size of a small mortgage if you have large debt balances.
Extended Payments can be made through an income based repayment plan which will extend payments up to 25 years. This option may result in any remaining balance being forgiven at the end of that period. If your income is too high this may result in doubling your balance through interest charges. Keep in mind, that any loan amounts forgiven will be taxed at your current income rate are are due an payable in that tax year.
Loan Forgiveness. For seniors with few assets and lacking the ability to make even minimum payments, you might be able to qualify for loan forgiveness through a bankruptcy discharge. If seniors are able to show inadequate income to cover payments and living expenses, they may qualify. Teachers, military and some government workers may also qualify for loan forgiveness programs. For more information about student loan foregiveness programs and income based repayment plans, you can visit the Department of Education’s website on student loan forgiveness where you will find helpful links on these topics. http://www2.ed.gov/fund/grants-college.html
Consumer Loan Debt
Consumer Loan Debt includes loans for things like cars, RV’s or boats. They are generally short term loans for 4 or 5 years, and can be eliminated before retirement. RVs are the exception and may be financed like a home with a very long term. The best strategy for vehicles is to pay them off and then service the vehicle regularly so it will last as long as possible. Today, cars can be on the road for 10 years or more, giving you a period of time with a good working vehicle and no payments.
When you are struggling to make payments it can be tempting to “give the car or boat back.” When you do this it is still considered a repossession on your credit. The only way out of the loan, leaving your credit intact, is to pay it off or sell the asset for the full amount owed.
Unsecured Credit Card Debt
Credit card minimum payments are only 2% or 3% of the balance, making extending the time period generally not an option. If you can only manage minimum payments while you are still working, it could take 30 plus years to pay off the debt. This strategy may also result in paying around 3 times the original balance, without considering late fees or penalties.
For credit card debt reduction, the best solution is to double or triple the minimum payment to get the debt under control and get it paid off in 5 years or so. But, this strategy only works if you stop using the cards to prevent balances from increasing even further.
Making on time payments may put you in a position to request a rate reduction from the credit card company. This would allow you to pay more each month toward paying down debt, though it is not likely to significantly reduce the monthly amount owed.
If you are struggling to make the minimum payments it may be time to get professional assistance before you retire. Companies like Finance Solutions, using a credit card modification program, might be able to reduce monthly payments immediately and eliminate the debt in 5 years or less if you qualify. This option provides relief from current debt and may put you in a better financial position during your retirement years.
Final Thoughts
Taking debt into retirement is risky because your income is set and you have unknown expenses. If your health declines, medical bills can rise sharply preventing you from making up for financial shortfalls down the road. Reducing as much debt as possible before retiring and having a long term plan for debt reduction, will help you create a retirement free from the stress and anxiety caused by a lack of cash flow.