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Selling the house/stock/car/etc to pay off debts?

Date: Fri Mar 30 2018 18:03:23 GMT-0700 (Pacific Daylight Time) ; Tags: Personal Finance »»»» Credit

Being deep in debt, near bankruptcy, becomes a survival issue. The debt is too huge to pay off and events start to get out of control, for example the bank might start threatening to take "your" house away from you. At the same time you probably own a few expensive assets that could be sold, and the money used to pay off the debts. Selling some "things" can seem like a good shortcut to take.

Speaking for myself, in my debt years I had also acquired some Microsoft stock. This stock came because I worked for a company that ended up being bought by Microsoft, and they (Microsoft) paid off my employee stock options with Microsoft stock. The purchase price was ridiculous, pegged at 15% of the then-current Microsoft stock price, and I held the stock for a couple years as they grew enormously (the late 90's, sigh) and then flattened in 2000 and 2001. It was during that time when I had my debt halfway paid off, and the value of the Microsoft stock approximately equalled the debt, so I pulled the trigger, sold the stock, and paid off a huge chunk of the debt.

Something I did which was important, to me, was to wait before selling the stock. Not only did I get a better price, but I learned some financial lessons first. These lessons were about financial responsibility, and some exploration of my real needs versus the "toys" my inner child wanted. (Such as the minidisc player I bought once, brought home, and while unpacking realized I didn't need it, and took it back to the store)

Now, lets get back to the story. Let me paint the scenario I want to talk about:

  • A person deeply in debt
  • Struggling to make headway in paying off the debt
  • They see an asset in their life which could be used to pay off the debt
  • Perhaps a large part of the debt is tied to that asset, which means a large part of the monthly payments go to paying for that asset
  • Maybe this is a house, and the mortgage payments are well above the 25% rule of thumb (specifically, the rule of thumb is that housing costs should stay below 25% of your income)

The question is, do you sell the asset or not?

This question is a little complex, as the considerations differ based on the type of asset.

We also discussed these ideas in Should you sell stock to pay credit card debt?

401k, IRA or other retirement investments

Stay away from selling out of these. There are severe penalties for cashing these out early. The penalties are a 20% early withdrawal fee, plus the money counts as income on your taxes.

Second, there is a severe opportunity cost in that the retirement money is required later in your life to provide comfort later on. The magic of investing is the compounding over the years, and if you tap that early the compounding effect will be greatly diminished. Do you really want to risk your livelihood later in life, when you won't be able to work?

Interestingly the IRS rules allow you to tap an IRA for part of a house purchase.

If you "must" tap your retirement funds, do so with eyes wide open. Understand the costs in great detail.

Car, motorcycle, etc

There's a couple angles here to look at.

First, one way many get in trouble is buying an expensive car they end up being unable to pay off. The car payment can be a great hurdle to getting to fiscally sound footing. It can make a lot of sense to sell the expensive car. Especially if you have more than one car, or motorcycle, etc. Motorcycles can be a necessity, or not, depending on whether your bike is used solely for joyriding, or for actual transportation instead of a car.

Cars are generally seen in the U.S.A. as a necessity. For better or worse our cities have moved from having good mass transit systems to having dysfunctional mass transit while having great roads. If you sell your car you probably need to plan for getting a new one. If you live in the right place, the mass transit system might be good enough for you to get around town without a car.

If, though, you are "upside down" on your car loan selling the car can be more expensive than keeping it. What's "upside down"? That means owing more on the car than you could get from selling it. For example, as soon as you sign the purchase papers and drive the car off the lot, the selling price drops precipitously.

Primary residence (house, condo, etc)

Expensive houses are also a frequent way people get into debt trouble. Many of the things I said about cars apply here. But there are a couple unique twists.

Selling a house can invoke a capital gains taxation issue. Research the holding period required for a long term capital gains, and the rules for rolling over house equity into another house.

Also you need to plan where you will live once you sell your house. Rent an apartment? Buy a cheaper house? What will you do, and while with a car you have the option of mass transit, you simply have to have a place to live.

Selling your house gives you an opportunity to choose a new location with good mass transit. If the bus/train system is good enough so you're driving a car only on weekends, do you really need to own the car?

Boats, second houses, etc

Another frequent way to get into debt trouble is these nonessentials. It doesn't matter how much you value your weekends away in the country, or the fishing on the weekend, or whatnot. Debt is debt and these things are nonessentials making them an excellent asset to shed to find the money to pay your debts.

Stocks, Bonds, or other investments

Consider what I said in the retirement section about opportunity cost. Over the long term stocks generally grow in value around 10% per year. Having bought the stock, do you want to pass up its future appreciation? The same goes for other kinds of investments.

Bonds, however, are different in that the face value remains the same. What bonds represent are an income stream, which may help you in paying the debt you have. That income stream may seem too small however making it attractive to sell the bond. As with any bond sale you must consider your purchase price, and whether the current price is above or below the current price. This is compounded by the general difficulty for a normal ("retail") investor in participating in the bond market, since it's not an open market you may have huge trouble actually getting the currently quoted bond price.

Also a consideration is the capital gains tax. Have you held the asset long enough for it to be a long term capital gains? If so the taxation will be better than if it's a short term capital gains. But another consideration of capital gains is how many times will you be taxed?

That is, if you buy a stock, then sell it, then buy another stock, then sell that, and so forth, you see capital gains taxation on each sale. On the other hand, if you buy a stock, then 50 years later you sell that same stock, you are taxed only once. Stocks are a long term investment regardless of what the day traders tell you. If you sell the stock to pay off a debt, this of course incurs capital gains taxation, and the consideration of how many times will you have the capital gains taxation?

Investments tend to fluctuate in value. Maybe you bought the thing and the price has dropped since the purchase. What then? Are you waiting for a rebound and don't want to sell at a loss? If you do sell at a loss not only do you regain some money, but the loss becomes a tax writeoff. And, this also makes it tricky to plan for a stock investment to grow to a point where you can pay off your debts. The market might not cooperate with your plans.

While I've talked about stocks and bonds, there are other kinds of investment such as real estate, art, jewelry, collectibles, etc. The same considerations hold for all of them.