06 Sep My nephew has credit card debt. How can he lower his payments?

Q. My nephew has accumulated a large amount of credit card debt on one credit card. He is unable to pay the required minimum payments especially with the high interest charged. Are there any steps he could take to lower his monthly payments?
— Auntie

A. Credit card debt can creep up on you.

It is some of the worst kind of debt to have because it is so expensive.

To pay this down, your nephew will need to tackle two different issues, said Jeanne Kane, a certified financial planner with OneDigital in Boonton.

He’ll need to find a way to make payments more manageable and importantly, analyze how he accumulated the debt.

“He’ll need to address both or he’ll likely end up in this situation again in the future,” Kane said.

Let’s start with the payments.

If he had several cards, one option would be to consolidate. But you said he only has one, so he may want to consider a balance transfer.

“He can move his debt to a new credit card with a lower interest rate or with a teaser rate that is initially lower,” Kane said. “· This doesn’t solve the problem but could make it easier for him to pay down some of the debt today.”

There are more dramatic options, such as taking a personal loan to pay off the card.

“These are unsecured loans. He would pay a fixed monthly amount. Interest rates are generally lower than with credit cards,” Kane said. “Banks tend to only want to loan money to people who can easily repay it so your nephew may have to check out various banks to find one that is willing to loan to him.”

If your nephew owns his home, a home equity loan or line of credit would allow him to tap into the equity he’s built up in the home.

A home equity loan would give him fixed payments to make over a specific time, and the rates are probably lower than the credit card interest rate. The home equity line of credit would have variable interest rates that fluctuate with the prime rate, Kane said.

“This means that what may start out as a low interest rate can climb over time. The amount you will climb with that higher interest rate,” she said.

Then there’s a 401(k) loan or hardship withdrawal.

“If your nephew has money saved in a 401(k), he can borrow up to 50% of his vested balance up to a maximum of $50,000,” she said. “A 401(k) loan requires him to pay it back within a period of time. Interest rate will be lower than a credit card.”

He will lose out on his savings and the growth of those savings during the time that he is repaying himself, Kane said.

A 401(k) hardship distribution is company plan specific and there may be requirements to qualify, Kane said.

He would need to demonstrate a hardship to get the funds, and the distribution will be fully taxed and if he is under 59 ½ he’ll pay a 10% penalty as well, she said.

“In 2024, a Secure Act provision called the Emergency Expense Distribution went into effect that allows up to $1,000 per year distribution from a 401(k),” she said.

He can repay the distribution within three years, and he’d pay taxes on the distribution but won’t pay a 10% penalty if he’s under 59 ½, she said.

“I am not a fan of borrowing or withdrawing money from your 401(k). My mother always said just because you can doesn’t mean you should,” Kane said. “Your nephew will lose out on his savings and the growth of those savings during the time that he is repaying himself.”

Your nephew also has to look at why and how he accumulated the debt.

“While there are options to fix the immediate problem, more important is to understand how your nephew accumulated the debt to begin with and how long it took for him to build it up,” she said.

She suggested he consider using online tools and apps to help track his spending to make it easier to see where he can focus on cutting back.

He should establish a budget, she said, using a 50/30/20 strategy: 50% of net pay would go to needs, including rent, minimum debt repayments, groceries, etc. 30% would go to wants, such as vacations, and 20% should go to savings, including an emergency fund and retirement savings.

“An emergency fund is critical to build up. This is the place to go when he has an emergency and needs funds, not his credit card,” she said. “Since your nephew can’t pay the minimum payments, his budget breakdown should have a higher percentage in needs and less in wants.”

“It is critical for your nephew to have a plan to pay down the debt but also to keep it off. Tracking spending and having a budget are excellent ways to help him spend less than he makes and save for his future,” she said.

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This story was originally published in September 2024.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.