Debt burden eased, she seeks fresh start

When her divorce was finalized a year ago, Renee Hernandez was left with more than $300,000 in debt.

Between an underwater mortgage, a car payment, credit-card balances and student loans, the frugally raised 30-year-old Kitsap County resident had been struggling for two years to keep up while recovering from the effects of being in a relationship that was a financial mismatch.

"I grew up in a lower-middle-class family, and we were always pinching pennies," Hernandez said. "My parents would always say, 'Live within your means. Boil beans rather than buying a can because boiling is cheaper and it makes more.' "

Hernandez said she always wanted to apply those lessons she learned as a child.

"But it's very difficult to do that when you're matched with someone that has a different mind when it comes to money," Hernandez said.

In addition to her full-time job as a supervisor for an Early Head Start program, Hernandez, an animal lover, opened her own licensed pet-sitting business, Four Paws and Cold Noses, to earn extra income during her off-hours.

She took in renters, then later moved in with her boyfriend and rented out the entire house, but still found herself unable to keep up.

"It became too much," Hernandez said, adding that she finally cracked and decided to file for bankruptcy when her boyfriend asked her to pick up eggs on the way home and she realized she didn't have enough money to buy them.

Entering bankruptcy discharged her share of the mortgage and credit-card debt, though her student loans (about $65,000) are still her responsibility and she asked to reaffirm her car loan since she needs the vehicle for work.

With a recent raise to a $36,000 annual salary at work and regular pet-sitting clients, Hernandez calls being able to start over a "wonderful gift" and wants to get off on the right foot.

"I have control again and I made a promise to myself that I would never be a ghost when it came to my own finances," Hernandez said.

The financial plan

To help her get back on track, Hernandez turned to Ken Smith, chief executive officer at Empirical Wealth Management in Seattle and a member of the Financial Planning Association — Puget Sound chapter.

Smith told Hernandez that she needs to focus on paying herself first in terms of saving for emergencies and retirement, then building lifestyle expenses around what's left in her budget.

Smith recommended she use a free online budgeting service like mint.com to keep track of her spending and monitor how well she is sticking to her budget.

Hernandez said her main concerns, apart from living within her means, were funding her retirement, paying off her student loans and rebuilding her credit.

"I began by documenting Renee's current situation and showing her what would happen in retirement under her current strategy," Smith said.

Hernandez had saved about $1,700 in a 401(k) from a previous employer, which she knew about, but she was surprised to learn she had $5,000 in her current employer's plan.

Until Smith helped her delve into it, she didn't realize her employer had been contributing 6.5 percent of her compensation annually as part of her benefits package.

Smith said that both of Hernandez's retirement accounts were invested in the most conservative option, the stable value fund that avoided stocks and would likely offer bond-type returns.

"If she does not begin making her own contributions to her retirement savings and continues investing in the most conservative options (bonds)," Smith said after running the numbers and assuming a retirement age of 65, "Renee will run out of money after being retired for only nine years."

A shift to stocks

Smith recommended switching to indexed mutual funds, with a 100 percent allocation to stocks from now until age 40, reducing that to 80 percent after age 40 and 60 percent after age 50.

"Renee understands the short-term volatility that comes with stocks and is OK with it because she has a small amount of savings at stake and a large need for growth over a long period of time," Smith wrote in his recommendations.

The financial planner said Hernandez should consider converting her 401(k) with the former employer into a Roth IRA.

Ideally, she would have done this last year since with education deductions (she's pursuing a master's degree), a business loss and mortgage interest to deduct, she did not have to pay any taxes in 2009.

"Potentially she would have paid little or no tax on the transaction and money converted to the Roth would be exempt from future taxation if used for qualified withdrawals," Smith wrote in her plan.

Hernandez said she's already started the paperwork to roll over the old 401(k) and convert it to a Roth IRA.

Going forward, Smith said Hernandez should direct more to her 401(k) in years when her income pushes her into higher tax brackets and more to her Roth IRA in years when she pays little or no income tax.

"At this time I'm recommending half go into each account," Smith wrote. "I like a combined approach to saving for retirement because predicting Renee's tax bracket and the tax code 30 years from now is a difficult task. Having both provides options when she arrives at the withdrawal stages."

As for her shorter-term goal of rebuilding her credit, Smith acknowledged that Hernandez will have difficulty getting a credit card or establishing a loan with favorable terms since her bankruptcy will remain on her credit report for several years.

"This is a good reason to begin building her emergency reserve immediately," Smith wrote in his recommendations. "The fact that she will not have immediate easy access to credit may be a blessing in disguise if she uses it as motivation to build a safety net and become self-sufficient."

One option is for Hernandez to apply for a secured credit card. For this type of card, Hernandez would have to deposit money with the credit-card company before she could use the card, and would be limited to charging up to the amount she had already deposited.

It is important to make sure that the bank or credit card is reporting the account to the credit-monitoring companies to help her improve her credit score, Smith said.

Another alternative is to find a co-signer for a credit card, but he cautioned her that doing so may have negative effects on the co-signer's credit score.

One of the areas Hernandez said Smith helped her the most was in getting a better handle on her student loans.

"Just knowing the right questions to ask the student-loan companies — and he gave me a list — to best understand how the loans will work when I get out of school, has been a big help," Hernandez said.

After building a spreadsheet of her four student loans to show how the balances of her loans would drop if she were to make the normal loan payments, Smith found a few programs that might have a huge impact on how much Hernandez ultimately will pay for her education.

• Income-Based Repayment (IBR): For a student who takes out loans before 2014, loan payments can be capped at 15 percent of the amount of income that is above the poverty-line level. Smith calculated this would lower Hernandez's monthly payment from $692 to an estimated $250 per month if she qualifies. For more information on this program, see www.ibrinfo.org.

• Public Service Loan Forgiveness: Since Hernandez works for a nonprofit 501(c)(3) organization, she might qualify for this program, which would forgive her student loans after 10 years of payments. Smith says this could wipe out a significant amount since the IBR may reduce her payments to a level where she is only paying interest on the loans and the balances aren't going down.

"Because of this, it is very important that Renee plan on following through with the program," Smith said. "These tools would provide Renee with enormous potential in getting her net worth to the positive side!"

An emotional subject

For her part, Hernandez said she was extremely pleased with the experience of working with Smith and appreciated the fact that apart from crunching numbers, Smith also stressed financial values.

"I don't think anyone has ever asked me how I felt about money or about how money makes me feel," Hernandez said.

She said she learned that her relationship with money doesn't have to be always sad or upsetting or negative, but that it can also be very positive, like taking steps to retire at an earlier age or planning ahead to have money to leave to a charity or to grandkids.

Recently, her car started acting up. Before, she said, she would have just fallen apart at the prospect of facing expensive repairs.

"Now, I'm thinking about a game plan for what has to happen rather than just descending into tears," she said. "There's a really rational way of taking care of an issue, and working with Ken has really helped solidify those skills."