Downsize Your Debt Before You Retire

EDITOR'S NOTE: This article was originally published in the February 2013 issue of Kiplinger's Retirement Report. To subscribe, click here.

More and more Americans are stumbling through their final working years carrying a heavy debt burden. Those hoping for a long and happy retirement need to find a way to lighten the load.

Mortgages and credit card debt, along with the financial needs of college-age children and elderly parents, are taking a heavy toll on baby boomers and older retirees. Nearly half of boomers expect to retire with debt, according to a recent survey by Fidelity Investments.

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Over the past two years, there has been a 27% spike in the number of retirees seeking help from members of the Association of Independent Consumer Credit Counseling Agencies, says David Jones, the group's president. "Older people, especially retired people, are the biggest growth area we've seen," Jones says. He notes that "it's a very serious situation," since seniors often have health problems and limited ability to return to work.

For many older people, the debt burden is growing intolerable. People 55 and older accounted for 28.6% of bankruptcy filers in 2011, up from 22.9% in 2008, according to the Institute for Financial Literacy, a nonprofit education organization.

In years past, older people often found it easy to borrow their way out of a tight financial spot—perhaps using a home equity line of credit to pay off high-interest debt. But because the financial crisis devastated home values as well as retirement accounts, many seniors find that safety net has dropped away. With emergency funds depleted and little time to recover from market losses, many retirees end up charging basic living expenses on credit cards. To make matters worse, financially strapped seniors are prime targets for mortgage modification scams, pricey loans pitched as bank "overdraft protection" and "debt settlement" programs that in some cases only dig consumers into a deeper hole.

Even if you've never struggled to pay the bills, you can boost your retirement security by learning to spot the debt traps that tend to snare retirees. And for those already burdened with debt, a host of resources are available to help you move toward retirement with a lighter step.

The burden of credit cards. Whether coping with rising health care costs, investment losses or family obligations, many seniors come to the same conclusion: Credit cards are the only way to make ends meet.In a recent survey of low- and middle-income households carrying credit card balances, research and advocacy group Demos found that people 65 and up have more credit card debt than any other age group—nearly $9,300, on average. And while younger folks have unloaded much of their debt burden since the financial crisis, seniors' debt level has barely budged.

A worst-case scenario—credit card debt leading to bankruptcy—is becoming all too common among seniors. In a study of the significant increase in bankruptcy filings among older Americans, John Pottow, a professor at the University of Michigan Law School, found that these debtors most often cite credit card interest and fees as the cause of their financial problems.

When faced with overwhelming credit card bills, focus on paying down the debt with the highest interest rate first. And if it will take more than a few months to pay off the cards, consider consolidating your balances on a card offering a 0% interest rate—bearing in mind that you could face a steep rate increase when the promotional period is over.

Be wary of credit card "add on" products pitched by telemarketers. Regulators in recent months have cracked down on major card issuers for deceptive marketing of such products as credit monitoring or "payment protection," which promises to let consumers suspend payments for a limited time in event of unemployment, hospitalization or other troubles. Some consumers were signed up without their

consent, the regulators found.

Review your bank and credit card statements regularly for any unusual charges. And if you're interested in any bank or credit card services, get the information in writing rather than signing up over the phone.

Don't hesitate to ask for help. Seniors seeking to conceal financial problems from family members or friends may be attracted to the anonymity of credit cards—and drawn into overwhelming debt. "Rather than have an awkward conversation with the kids or asking someone else for help, they're borrowing to finance consumption," Pottow says.

Mortgage-debt pitfalls. Paying off the mortgage before you hit retirement may be a worthy goal. Given today's rock-bottom yields on savings accounts and certificates of deposit, you'll likely save more money eliminating mortgage interest payments than by stashing cash in the bank. But homeowners near retirement shouldn't accelerate mortgage payments if it means ignoring other high-interest debt or cutting their cash cushion to the quick. Also, if you withdraw from a 401(k) or traditional IRA to pay off the debt, taxes due on the distribution will counteract the benefits

of paying down the mortgage. Online prepayment calculators such as the one at www.hsh.com can help you weigh the benefits of accelerating payments.

Over the past two decades, a steadily growing number of homeowners have been carrying mortgage debt well into their retirement years, according to a recent study by AARP. And among those age 50 and older, 6% of mortgage loans were seriously delinquent in 2011, up from 1.1% in 2007, AARP found. "I don't think people are making a conscious decision to carry debt," says Lori Trawinski, senior strategic policy adviser at AARP Public Policy Institute and author of the study. "People have no choice, because they have other obligations they need to take care of." Many older people have relied on home equity to cover health care, home repairs and other big-ticket items.

Some seniors struggling to make mortgage payments may be able to downsize to a smaller home and slash their maintenance, insurance and tax bills at the same time. Alternatively, those who have good credit may be able to take advantage of today's low interest rates and refinance their mortgage. If you are current on your mortgage payments but having trouble refinancing because the value of your home has dropped, the Home Affordable Refinance Program (HARP) may help. This federal program, which is available for mortgages owned or guaranteed by Fannie Mae or Freddie Mac, helps borrowers refinance even if they owe more than the value of their home.

For information on HARP and other programs designed to help homeowners, go to MakingHomeAffordable.gov. Also get in touch with a government-approved housing counselor by calling 888-995-4673.

Be wary of advertisements or other promotions promising to help you modify your mortgage or avoid foreclosure. The Consumer Financial Protection Bureau recently reviewed hundreds of mortgage-related ads, particularly those targeting seniors and veterans, and found that many misrepresented a government affiliation or promoted misleadingly low rates. And if a mortgage-relief firm asks for money upfront, "that's a huge warning sign," says consumer debt expert Steve Rhode, who runs the Web site GetOutofDebt.org. Under Federal Trade Commission rules that took effect in 2011, firms offering mortgage assistance aren't allowed to charge upfront fees—although there's a loophole for some services offered by lawyers.

A reverse mortgage, which allows a homeowner 62 or older to convert some home equity into cash, can make sense for some seniors who understand the risks. The loan must be repaid with accumulated interest when the borrower dies, sells the home or no longer uses it as his primary residence. There are no monthly principal or interest payments while the homeowner lives in the house, but the borrower must stay current on tax and insurance premiums. "We see people coming to us in a panic" after taking a reverse mortgage and being threatened with foreclosure because they don't have the money to pay the taxes, says Jones of the credit counseling agency group. A government-approved housing counselor can help you weigh a reverse mortgage against other options.

Assuming a child's loans. Even the most scrupulous savers can feel squeezed when confronted with simultaneous financial demands from elderly parents and college-age children or grandchildren. As college tuition costs soar, older Americans are loading up on student loan debt in order to put a younger generation through school. As of the first quarter of last year, 2.2 million student loan borrowers were age 60 or older, more than triple the number seven years earlier, according to the Federal Reserve Bank of New York. That makes the 60-and-older crowd the fastest-growing age group among student loan borrowers. What's more, 9.5% of older borrowers are more than 90 days delinquent on the loans.

Much of the trouble starts when older people co-sign student loans for children or grandchildren. More than 90% of private student loans now require co-signers, says financial aid expert Mark Kantrowitz. "A co-signer is a co-borrower, equally obligated to repay the debt. And if the borrower is delinquent, it affects your credit history, too," Kantrowitz says.

What's more, the volume of federal PLUS loans to parents has skyrocketed in recent years—and some parents are tapping retirement accounts to pay them down. Paul Kuon, 59, a hospital lab worker in Lafayette, La., paid his oldest daughter's tuition out of his pocket. Now that his youngest son is in college, "education costs have ballooned beyond belief," he says, and he's covering the cost with cash, scholarships and about $18,000 in parent PLUS loans.

With the interest rate on the PLUS loans topping 7%, Kuon is eager to pay down the debt—and he's planning to draw money from a traditional IRA to do it. The tax due on the IRA withdrawal will be another headache. In retrospect, he says, he wishes he'd had more liquid savings, "and we never would have gone with the PLUS loans."

With no cap on the PLUS loan amount, it's easy for borrowers to get in over their heads. When older borrowers default on federal student loans, the government can garnish up to 15% of their Social Security benefits.

Rather than signing their name to a loan, parents and grandparents can help with college costs by contributing to a 529 college-savings plan, helping to make tuition payments directly to the college or helping the student pay down his loans after graduation. If you must take out loans, borrow no more than you can afford to repay in ten years or by your retirement date, whichever comes first, Kantrowitz suggests.

If you're falling behind on federal student loan payments, visit the U.S. Department of Education's student aid site for information on repayment plans. Options may include repaying the loan over an extended period or a plan that bases payment amounts on your income.

Finding help. Use extreme caution when considering "debt settlement" services. These programs typically tell debtors to stop paying their bills and instead send payments directly to the debt settlement company or a separate account while the company tries to persuade creditors to settle for less than the amount owed. This can mean that consumers default on their debts, rack up late fees and wreck their credit scores.

Some lenders won't work with debt settlement firms, and many consumers enrolled in the programs end up filing for bankruptcy anyway, according to the consumer group Center for Responsible Lending. Plus, consumers who settle non-mortgage debt for less than the amount owed will typically get an income-tax bill for the amount of debt forgiven.

Instead, contact a nonprofit credit counseling agency, avoiding any services that charge big upfront fees. Find an agency in your area at www.aiccca.org or www.nfcc.org, the Web site of the National Foundation for Credit Counseling. Counselors will help consumers review their budget and develop a spending plan. These agencies can also help establish a schedule for repaying debts through "debt management plans," which typically involve a sharp reduction or waiver of interest charges and penalties.Seniors should carefully explore their options before raiding retirement accounts to pay off debts. William Brewer, former president of the National Association of Consumer Bankruptcy Attorneys, says he recently met with a 55-year-old man who had been unemployed and struggled with $75,000 of credit card debt. The man had contacted the creditors himself, persuaded them to settle for $25,000 and took money from his IRA to pay the bill. He then received a tax bill on the $50,000 worth of forgiven debt, another tax bill on the $25,000 withdrawal from his IRA and a 10% early-withdrawal penalty. If the debt had been discharged in bankruptcy, Brewer says, the IRA would have been protected from creditors and the extinguished debt would not have been considered taxable income.

Even those in good financial health should consider working longer to ward off financial strain. Maintain a solid emergency fund to cover two to three years' worth of living expenses. Use tools such as the National Council on Aging's Web site BenefitsCheckup.org to be sure you're getting all the benefits that you're entitled to. And at the first sign of trouble, ask for help—loudly. "No one should be worried about making a credit card payment versus paying for medicine," says Leslie Linfield, executive director at the Institute for Financial Literacy. "You've contributed to the system your whole life. It's okay to ask for assistance."

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