How Debt Ruined This Couple
And What We Can Learn From Their Story
I’m trying something new and going to make today’s post a bit more interactive. I read an Interview on Wealthsimple about a couple whose lives have been ruined by debt. Here’s how I want to lay out the story:
- I’ll run through the facts of the story in normal text
- I’ll provide my commentary on what we can learn in italics
- If there’s a point that I think is important, I’ll write in bold
- If there’s a point you think is important you can highlight it
If you like this format please let me know and I’ll adopt it for future stories.
I want to note that I am not passing personal judgment on this couple. Their story is very sad and nearly brought me to tears. Thousands of families are in a similar situation so I hope that we can all learn from the mistakes they admit they made.
Kate and Tom are In their Late 40’s living in a nice suburban neighborhood. They have three children and make nearly $180,00 per year between the two of them. On the surface, they look to be living a happy, prosperous existence.
However, their debt, which they describe as “insurmountable” has ruined their lives. They have had so much revolving debt in their lives that I actually found it difficult to keep it all straight. Here is their current debt load to the best of my knowledge.
- $60,000 in credit cards spread over 11 cards, eight of which are maxed out
- $18,000 in personal loans
- Two mortgages on their home, totaling $360,000
- $120,000-$140,000 in student loan debt between the two of them
They both attended law school and that is how they accumulated the massive student loan debt. The sad part is that neither of them decided to become lawyers, they work in insurance.
Of all the mistakes they made this one might be the most damaging. $140,000 is more than some people’s mortgage. Anyone who is considering further education past their undergraduate, or even past high-school should think of their education as one of the largest investments you’ll ever make because it is.
Four years in University plus an additional three to four years in law school costs you much more than the tuition.
For starters, there is the opportunity cost of the seven-plus years of lost wages while you are in school. Not to mention the thousands of hours spent studying. Education can be one of the greatest investments you’ll ever make, but only if you make use of your degree.
They bought their first house in 1997. It met their needs but when they were pregnant with their Third child they decided to go big and build a bigger house in a nicer neighborhood.
I’ve written in the past, that I don’t consider my primary residence to be an investment. It is an asset, but I don’t think of it as an investment. It does not produce me any income (unless you are house hacking). Even if your house increases in value, what does that do for you? Not much, Unless you sell your house and move to a city with lower home prices.
Only buy as much house as you need and you probably need a lot less house than you think
All three of their children attend a private school. The “full price” of tuition would be $96,000 but since they qualified for financial aid they are “only” paying $15,000, which they are financing through debt.
This I struggle to understand. Thousands of families who are struggling with debt are paying tens of thousands of dollars to send their children to private school. I understand everyone wants the best for their kids. But the best thing you can do for your kids is spare them from having to financially support you most of their adult lives.
In some ways, Kate and Tom live a frugal life, but not by choice. Their debt payments account for the majority of their income. They buy their clothes at thrift stores and they grow their own vegetables because they can’t afford to eat out.
When we choose to live a frugal life it can be a very liberating feeling. Not needing to spend money to be happy is a wonderful thing. But it is easy to forget that when someone is forced to live a frugal life, it can feel like a jail sentence.
But in other ways, they are anything but frugal. For example, they describe going into whole foods and letting their kids buy a $15 serving of sushi.
They seem to be in a constant state of push and pull with their money. They know they need to make serious changes to the way they spend their money. They intentionally take steps towards reducing their spending to address their debt. But they don’t fully believe they can ever get out of debt so they quickly revert back into bad spending habits.
Our actions reflect our beliefs. If you’re ever going to get a handle on a debt problem (or any problem), you need to believe that goal is possible for you.
Things Began To Go Down Hill
“I was pretty upset about the 401(k) situation. I think it was our demise.”
A few years ago Tom and Kate drained their 401(k) savings to pay off $82,000 of debt. What they did not know is that cashing out their 401(k) comes with tax consequences and penalties. This lead to a $20,000 tax bill.
Be Aware, cashing out your 401(k) can trigger federal and state income tax. Additionally, if you are below the age of 60 an additional 10% withholding tax applies. If you have fallen on hard times financially talk to a financial advisor or your plan sponsor about the possibility of a 401(k) loan.
A 401(k) loan could have really helped Kate & Tom in this situation. Typically, a 401(k) loan does not trigger federal and state income tax unless you fail to repay the loan. If they had known this they might have been able to salvage their finances.
Kate and Tom did not have the cash to pay their $20,000 tax bill so they ended up paying the last $2,000 with their credit cards.
This hammers home how devastating the consequences of clearing their 401(k) was. To pay off debt, they sacrificed their retirement nest egg and in return ended up with a $20,000 tax bill and more credit card debt.
Shortly after cashing out their 401(k) they had accumulated $80,000 in credit card debt. With the help of a credit counselor, they negotiated that debt down to $40,000. They borrowed $40,000 from Kate’s parents and the credit card debt was gone.
Anyone who is in serious debt could potentially benefit from speaking with a credit counselor or a financial advisor about their debt. It is often possible to negotiate the terms of your debt repayment and it can be helpful to have a professional help you along the way.
They were debt free but it did not last. They did not get a handle on their spending habits and within a few years, they were back to the same level of debt they were before. Kate’s parents have no idea they are back in debt, they were too embarrassed by the situation to tell them.
Nothing makes money or family problems worse than lying about money. As painful and uncomfortable as it is to admit you have made mistakes, it is crucial to always be communicating about money. You cannot fix a problem if you do not acknowledge it.
By this point, you might be having the same thought I did, “why don’t they file for bankruptcy?”
Tom refuses to file for bankruptcy because it might impact his chances of getting a new job if he ever loses the one he has right now.
This Is Where Things Take A Sad, Dark Turn.
“Yeah, we have good life insurance. We’re better off dead.”
Kate specifically mentions that Tom’s refusal to file for bankruptcy has made her think about divorce. They admit one of the reasons they are still together is that they cannot afford to live on their own.
Their financial situation has gotten so bad they believe one of them could end up dying from stress. They feel this might be the only way to pay off their debts as the survivor would collect the insurance money.
Debt is a huge catalyst for stress and mental health problems. If you or someone you know is struggling with depression or mental health, please reach out and talk to someone, here are some resources.
Lessons We Can Take From This Story
- Our choices have a compounding impact on our life. Taking on debt early in life makes us more reliant on debt and more likely to keep piling it on
- College and graduate school is a serious Investment, so treat it that way
- Don’t buy a house that you can’t afford
- No matter how seemingly bleak our situation may feel, it’s critical that we confront the brutal truth of our reality. Only then can we recognize the steps required to address the problems.
- Be aware of the penalties and taxes that are triggered when you make an early withdrawal from your 401(k)
- Credit councilors and financial advisors can help you develop a game plan to pay back your debt.
- But it is meaningless unless you address the root problem, your spending habits.
- Communication about money is vital, especially when your family is involved.
- Debt and financial strain can cause anxiety and depression. If you are feeling depressed for any reason, reach out and talk to someone.
If You Are Interested In an Expanded Discussion On This Story
This article is for informational purposes only, it should not be considered Financial or Legal Advice. Consult a financial professional before making any major financial decisions.