By: Joseph Goldy, CFP®
The average cost of divorce in the U.S. is almost $13,000, according to Nolo.com. For high-net-worth individuals, it could be many times this amount. Making things worse is that married couples tend to carry more than double the amount of debt than single people, based on a recent Experian study.
High Levels of Debt
Expensive divorces coupled with already high debt levels and, for many newly divorced women, a significant reduction in household income is often a recipe for financial disaster. Many women are left with high amounts of debt that they may now be responsible for since it was held in joint name during the marriage.
High-Interest Rate Debt
The situation is even more daunting if the debt carries a high-interest rate, such as credit cards or personal loans. High-interest rates are insidious since much of your monthly payment goes toward paying interest rather than paying down the loan's principal.
For example, a person with a credit card balance of $25,000 carrying a 15% interest rate and paying $500 a month will pay off their balance in a little over six and ½ years and spend over $14,000 in interest during that time. In contrast, if the interest rate were 5%, that person would pay off the card two years faster and save over $11,000 in interest payments.
As seen below, average credit card interest rates are nearing a 10-year high. And although 15% is the average, many cards carry rates north of 20%.
Recognizing the importance of lowering the interest rate on debt, here are some ideas to shift high-interest debt to loans with more reasonable rates to help pay them off more quickly.
Ideas to Shift High-Interest Debt to Alternative Loans
Securities-Based Loans
This strategy involves borrowing against your investment portfolio and is generally only available to clients with a substantial taxable portfolio of diversified securities. Retirement accounts and overly concentrated portfolios are not eligible. A securities-based loan could be a valuable lifeline for people who may not have the liquid cash on hand to pay off debt but have a diversified portfolio of long-term investments.
If you qualify, a securities-backed loan may be offered through the brokerage firm where you hold your investments. This loan allows you to access a line of credit up to a percentage of your portfolio value that can be drawn on. The rate charged on the amount you're borrowing is usually based on two parts, the brokerage firm's portion (called a "spread") plus a standard benchmark base rate such as LIBOR or SOFR. Current rates at the time of this writing range from 4% to 7%, depending on the amount you're borrowing.
Of course, this option is not without risk. The loan is backed by the value of your portfolio, which naturally fluctuates with the market since it's composed of stocks and bonds. If the value of your portfolio declines too much, your brokerage firm may require funds to be deposited or a loan portion to be paid back. Not utilizing the total amount of the credit line available is an excellent way to leave an additional buffer for any market fluctuation.
Home-Based Re-Financing Options
Two options utilizing home equity to help reduce high-rate debt are a reverse mortgage and a home equity line of credit, or HELOC.
Reverse mortgages, also known as Home Equity Conversion Mortgages, allow people 62 or older to convert a portion of their home's equity into cash or cash payments without selling the home. Current rates range from 4% to 7%, depending on whether the rate is fixed or variable, along with various other factors.
A convenient feature of reverse mortgages is the many payout options available. You can elect to receive a set monthly amount, an amount for a certain period, a lump sum, or a combination of these. Reverse mortgages could make sense for people who have a lot of equity in their home, do not want to take on an additional payment, and can use the extra funds to pay off higher interest debt.
Some downsides to reverse mortgages are their cost since closing costs and fees could be substantial depending on what company you use. Another risk is not knowing if you will be out of the home for an extended period. Suppose you unexpectedly must go to the hospital or other rehabilitation facility for an extended period. Your lender may call in the loan depending on their terms and how many months you've not occupied the home. Make sure to fully understand all the terms of your loan before signing.
A traditional home equity line of credit is another home-based option that may be easier to implement than a reverse mortgage. HELOCs tend to have variable rates, which are currently around 5% - 6% but could move higher should the Fed continue to raise interest rates.
Having a HELOC in place is something homeowners can do regardless of age. It's often a good idea to establish this as a backup to your regular emergency fund should a large, unexpected expense arise. Using HELOC funds to pay off higher interest debt could make sense despite the variable rate since it will still be lower than credit card or personal loan rates.
Credit Card Options
If the above alternatives are unavailable, a final option may be to take advantage of a balance transfer offer from a competing credit card company. NerdWallet's current best balance transfer offers show cards with 0% interest for up to 21 months.
One caveat is to be aware of the card company's balance transfer fee. This fee can range from 3% to 5%, and that extra 2% on a $25,000 balance transfer translates to $500 more you're paying unnecessarily. For example, the current first and second-ranked cards on NerdWallet's list, the BankAmericard and the Citi Simplicity Card, offer a 21-month interest-free period for balance transfers. However, BankAmericard charges a 3% balance transfer fee, and Citi charges 5%.
All the above options have one goal: to help you pay off the high-interest debt in its entirety. High-interest debt is a drain on your cash flow and redirects money away from retirement savings to the credit card company's profits. For clients trying to start this new chapter on the right financial foot, focusing on reducing the rate you're paying on this debt is the best thing you can do to help eliminate it.
The foregoing content reflects the opinions of Highland Financial Advisors, LLC, and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions, or forecasts provided herein will prove to be correct.
Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns.
Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful or that markets will act as they have in the past.
Joseph Goldy, CFP®, is a wealth advisor and CERTIFIED FINANCIAL PLANNER™ at Highland Financial Advisors, LLC, a fee-only fiduciary wealth advisory firm based in Wayne, New Jersey.
Joe specializes in working with newly independent women because of divorce or losing a spouse. He understands firsthand the value of having a clear financial picture pre- and post-divorce and a plan to restate goals as a single person. When he is not helping clients, Joe enjoys spending time with his two sons outdoors and volunteering to help raise money for Type 1 diabetes organizations.