Preventive measures are great, but if you’re burdened by debt, you need more than preventive medicine to conquer it. I won’t sugar-coat it: Getting debts under control can be a bitter pill—but the alternatives are even less appetizing. The rewards, though, are delicious. Imagine getting actual cash from your credit card issuer instead of paying the company all the interest and fees. Imagine a time when no more bill collectors are calling.
I know how hard it is to imagine those scenes when you’re worried about how you’ll get through the next month. If it’s any consolation, you’re not alone. With these difficult economic times, the subprime mortgage crisis, and the credit crunch, far too many hard-working American families are one paycheck away from financial ruin.
Foreclosures filings are on the rise, up 75% in 2007, and bankruptcies are surging as well, up 27% nationwide in the first quarter of 2008, compared with the first quarter of 2007, according to the American Bankruptcy Institute. Credit card debt has more than quadrupled during the last two decades. All it takes is a job loss or a serious illness, and a middle-class family can find itself living below the poverty level.
Too many people don’t fully grasp the gravity of their debts until it’s too late. As credit expert Gerri Detweiler explains:
Americans are pretty optimistic, so it often takes a long time for a consumer to realize that debts are a problem. Most of us are counting on something to help us get rid of the debt quickly—a raise, business income, even an inheritance or lottery ticket.
It’s too costly to hope for fate to bail us out of debt trouble. Instead, let’s roll up our sleeves and get to work.
You don’t want to be one of those statistics, but it’s not always easy to tell when it’s time to get serious. Detweiler says the following warning signs should serve as a “you’re-over-your-head-in-debt” wake-up call:
You have no clear plan for paying back the debt.
You have no idea know how long it will take or how much it will cost.
Your credit card balances continue to go up instead of down, even though you make monthly payments.
You’re juggling, using one credit card to help pay the balance on a different credit card.
Just moving debt around to other cards with similar or higher rates (low rate balance transfer offers excluded), which I call “credit card Russian Roulette,” is a very dangerous, expensive game to play. Credit cards often charge the highest rates around, so you’ll pay plenty of interest, and often, you’ll add even more to your balance through various fees and rate hikes.
Does any of this hit home for you? If so, keep reading—I show you how you can master your credit card debt, keep more of your money, and start living debt-free.
Diagnosing the underlying problem is the first step in a successful debt-busting strategy. Too often, people decide to pursue debt relief without facing the underlying reason for their debt, which is usually overspending or poor money management.
Then within a couple of years, the person is often right back where he or she started, only this time, trying to pay off a debt consolidation loan while also figuring out what to do with new card charges. This can result in a vicious cycle, adding layer upon layer of debt.
Tip
Admitting that you have a problem is half the battle. So, the fact that you’re reading this chapter implies that you’re well on your way to becoming debt free!
Diagnosing the underlying problem(s) can be challenging. In some instances, it might require the intervention of an objective third party, such as a credit counselor, to help you figure out what’s going on and to get you on the right track.
Many financial counselors advise that you choose a company affiliated with the nonprofit National Foundation for Credit Counseling (NFCC), which provides services in more than 1,300 locations. More than a third of people who consult with an NFCC counselor are soon able to manage their debts on their own. Go to CardRatings.com/Book to locate an office near you. More on credit counseling comes later in the chapter.
If your problem is a serious overspending issue, therapy or DebtorsAnonymous.org might help you overcome the habit—or addiction.
On the other hand, the diagnosis might be very simple. For many people, large credit card balances are caused by medical bills, not overspending. Believe it or not, doctors and hospitals have been known to lower their fees and offer more lenient repayment terms. I know this is true from personal experience. Ask and you just might receive.
For other people, debt can often be traced to one significant life event, such as a wedding. Many couples charge tens of thousands of dollars to pay for dream weddings. Caught up in the excitement and emotions of the event, it can be difficult, although not impossible, to remain level-headed. Unfortunately, the honeymoon soon ends, and the reality of large bills can be a source of major stress for newly married couples, according to Cindy Morus, a certified Divorce Financial Analyst and the founder of MendYourMoney.com.
After you diagnose the problem, it’s time to set in motion a strategic plan of attack to defeat your debts. I know how stressful and overwhelming this can be, so remember, if I can do this, you can too. It might not be simple and it won’t happen overnight, but with a little persistence, you can do it.
If you want to really get serious about controlling your debts, decide right now, at this very moment, to stop using your cards. Going cold turkey could be one of the hardest things you’ve ever done, but I’m convinced that it will be a very significant turning point in your life.
No need to close the accounts—just take those cards out of your wallet and put them somewhere where you can’t easily retrieve them. I recommend cutting them up into little pieces because if you’re tempted to start charging again, it’ll take days for a replacement card to come. Freezing them in a cup of water at the back of the freezer or locking them in a safe buried five feet underground will also work—whatever it takes to get rid of easy access!
Tip
If you’re an online shopper, chances are, you’ve typed your card number into online forms so many times that you’ve committed it to memory or your number is saved on your computer. You’ll have to delete those digits from your mind and computer, or figure out a way to exert extra self-control. Otherwise, you might have to stay offline, and I know you don’t want to do that. 
It’s not easy, but forget about your credit cards and don’t apply for any more, especially at retail stores. Even if they promise to give you 50% off all purchases for the next 60 days (they normally offer only 10% to 20% off one purchase), remember that half of $500 is still $250 more than you would have spent if you hadn’t signed up for the card. If you have the $250, you’d be smart to use it to pay down your debt.
To avoid adding to your problem as you pay down your existing debts, ask yourself, “Am I living within my means?” If you aren’t able to honestly answer this question, you have a problem with budgeting, denial, or both. If the bills keep coming in and you don’t know where you stand, you’re not managing your money effectively. You’ll likely continue to charge more than you can afford going forward, which will make your existing financial problems even worse.
Certainly, if you have a pile of bills, not only are you paying a lot in interest, but those bills are preventing you from making the most off your money. Moreover, until your lifestyle changes and you no longer pay credit card interest, you won’t be able to truly benefit from card perks. Fortunately, it’s easy to make some simple changes that will make a big difference.
The more you can pay toward your bills, the faster and cheaper it will be to get rid of your debts. Here are some tips to help you find extra money as you rein in your lifestyle a bit:
Reduce housing costs. You could move to a smaller house, but remember that moving is not free. What about a roommate? When I was struggling to pay off my debt in Dallas, Texas, my rent payments were pretty steep. I decided to move back home to Arkansas to live rent-free in a small house my parents owned. Think creatively.
Conserve. Set your thermostat a couple degrees higher in the summer and a couple degrees lower in the winter. Check with your electric, gas, and water companies for conservation tips.
Distinguish between wants and needs. Do you really need high-speed Internet, satellite or cable television, a cell phone for every family member, a new living room set, high-priced sneakers for the kids, and so on? You get the idea.
Don’t go overboard, but do get the whole family involved in cutting back. A family meeting might be just the thing to help facilitate change. Be realistic, though: Too much deprivation is bound to backfire. But remember, some belt-tightening changes might need to be only temporary.
Become a one-car family, especially if your city has good public transportation or well-developed bike routes. Not only will your financial health improve, but your physical health could as well.
Get a second job. Although it might be humbling, temporarily being willing to work in any type of environment will likely leave you with a feeling of purpose and control over your finances.
Quit your vice. How much do you spend a month on shoes you don’t need? Maybe now is a good time to finally kick the smoking habit. Or did you ever think about how much you spend a month on coffee or soda?
Lead yourself not into temptation. Buying name brands at a trendy boutique or eating out at fancy restaurants is nice, but if you can’t afford it, don’t even go there. Rummage through your closets for something that’s back in style (after all, what goes around, comes around), and cook a great meal at home.
Cut entertainment costs. Watch free movies from the library and make your own popcorn instead of going to the theater and buying high-priced treats there. Take a walk at sunset. Play board games. (It’s so much easier to recover from a bankruptcy playing Monopoly than from one in real life!)
Use your savings. The interest rate we earn on savings accounts is typically far lower than what we have to pay on credit card balances. It makes sense to use money earning in the range of 1% to 5% to pay off bills at much higher rates. Then when your debt is paid off, work to replenish your savings. Note, however, that I’m not suggesting that you deplete your entire emergency savings fund.
Declutter and sell some of that extra “stuff.” There’s money to be made off whatever is taking up space in your house or apartment. Have a garage sale, go to a flea market, or use an online auction site, such as eBay. How many televisions, sweaters, baseball cards, pieces of Depression glass, and so on do you need? Dust less and put the money toward your debts.
Throw a party. As Danny Schechter put it in his documentary In Debt We Trust,
In America’s earliest days, there were barn-raising parties in which neighbors helped each other build up their farms. Today, in some churches, there are debt liquidation revivals in which parishioners chip in to free each other from growing credit card debts that are driving American families to bankruptcy and desperation.
Paying only the required minimum amount will often keep you in card debt for decades. These minimums typically range from 2% to 3%, and the lower the percent, the less you’re required to send in every month. The less you send in, the more you’ll pay over the years. For example, consider a $5,000 credit card debt at 17% with differing minimums (see Table 5.1).
Table 5.1. What a Difference a Fraction of a Percent Makes
Card | Minimum % Payment | First Month’s Payment | Interest Cost | Years to Pay Off |
|---|---|---|---|---|
A | 1.67% | $83.50 | $25,354 | 81 |
B | 2.00% | $100.00 | $11,304 | 40 |
C | 2.50% | $125.00 | $6,210 | 24 |
D | 3.00% | $150.00 | $4,296 | 18 |
Table 5.1 reprinted with permission from Slash Your Debt: Save Money and Secure Your Future, by Gerri Detweiler, Marc Eisenson, and Nancy Castleman (Financial Literacy Center, 1999). | ||||
For the total cost, add $5,000 to the interest cost. Paying only the minimum on Card A, for example, would result in a total cost of $30,354 ($5,000 + $25,354).
Look at the numbers in bold. If you send in only the minimum, you could spend anywhere from $25,354 down to $4,296 to pay off the exact same amount, at the same interest rate. Isn’t that amazing?
There’s just a $50 difference between Card B’s and Card D’s first month’s required payment, but Card B ends up costing an additional $7,000 over the years. Wouldn’t you rather have that money than send it to a bank?
Although the 3% minimum would clearly be much better on your wallet, remember that all minimums are set up to make the card issuers money, not you.
Until recently, sometimes companies set the minimums so low that 100% of a cardholder’s monthly payment might be applied to interest and fees, with none of it going toward the original card balance. Then in 2005, in response to growing criticism, the Office of the Comptroller of the Currency (OCC), which regulates national banks, issued new guidelines regarding minimum payment policies.
Now the minimum monthly payments must be high enough to cover all fees and interest—and pay down at least a small portion of the debt. Some minimum payments have gone up, but there hasn’t been any dramatic change. Most members of the CardRatings.com forum report minimum payments in the range of 2% though minimums do vary. Some issuers, for example, compute minimums as 1% of your balance plus any interest charges and fees.
Even with a higher required minimum payment, you’ll save more money by always paying more than that amount. Even paying a little more than the minimum can result in significant savings.
It’s not hard to create a repayment plan that will work for you. Take it one step at a time, and you’ll have a strategy in place in no time.
If you’re like many people in debt, you don’t have a clear idea of how much you actually owe. Let’s find out—it’s not hard.
Gather your most current card statements, and call the toll-free customer service numbers, or go online to find out the most up-to-date balance, interest rate, amount due this month, due date, and minimum percent. Don’t forget about your other debts, including student loans, car loans, and mortgage.
You can make a simple spreadsheet on your computer with a program such as Microsoft Excel, but a handwritten chart will certainly work. Your spreadsheet might look something like Table 5.2 (leave room to add two more columns):
If these were your debts, you’d owe a total of $11,950, and you’d have to come up with $295 this month just to make the minimum payments. Believe it or not, if you stop charging and can come up with that same amount every month from here on, you can get out of debt in just a few years.
Create a similar chart for your debts, and I’ll show you how you can achieve incredible savings, just like I did.
Unfortunately, because of the interest and fees you’ll pay over time, the real cost of your debt is usually much more than the total of what you owe ($11,950, in our example).
To take a look at the impact of interest and fees over time, let’s compare how much you’ll pay if you send in only the required amounts to how much you’ll pay if you keep sending in this month’s required payment. We’ll get the computer to do the math, so it’ll be easy—as well as eye-opening.
Start by adding two additional columns to your spreadsheet. Label them “Cost in Dollars and Years—Minimum” and “Cost in Dollars and Years—Early.”
This is when an online calculator comes in especially handy. On CardRatings.com, click on “Credit Calculators” and then choose the calculator called “The Minimum Payment Trap.”
Plug in the info from your spreadsheet for the first debt—your balance, interest rate, and minimum percent (where it says “How is your minimum payment calculated?”). After you select the minimum percent, you’ll see how much the calculator thinks you should send in this month. Make sure it squares with the number on your spreadsheet.
The last question to answer before you press the Calculate button is “What fixed payment could you make each month?” For now, let’s assume that you can send in as much as you sent in this month. Type in that same amount, and then select a payment schedule based on a fixed payment. (Can’t afford this amount? There’s debt-management advice tailored to you toward the end of this chapter.)
Presto, the calculator shows the difference between paying each month’s required minimum and paying the first month’s minimum every month. Add the numbers to your spreadsheet.
Go back and run the same calculations for each of your debts. After you do the first one, it’ll be a snap. Table 5.3 shows the spreadsheet for our sample bills.
Table 5.3. How Much Will My Debts Cost Me?
Card | Balance | Interest | Minimum | Due | $/Yr—Min | $/Yr—Early |
|---|---|---|---|---|---|---|
#1 | $2,750 | 14% | 3% ($83) | On the 5th | $1,629 13 years | $753 3.6 years |
#2 | $3,800 | 12% | 2.5% ($95) | On the 15th | $2,380 16.8 years | $1,077 4.3 years |
Up-scale store | $900 | 20% | 3% ($27) | On the 10th | $866 10.3 years | $425 4.2 years |
Bank #3 | $4,500 | 13% | 2% ($90) | On the 25th | $4,951 25.9 years | $2,016 6.1 years |
Total | $11,950 | ($295) | $9,826 | $4,271 |
If these were your debts, paying the minimums would cost you $9,826, plus the $11,950 you owed in the first place (assuming there are no additional charges to the cards). Remember, these are after-tax numbers. Assuming that you pay 28% in taxes, you’d have to earn $13,647 to cover that $9,826 interest tab. Also, you’d be paying on all the bills for more than a decade, when the up-scale store charge would finally be paid off. You’d be paying Bank #3 for almost 26 years.
Now look at what happens if you continue to send in this month’s required minimums until the balances are paid off. There’s a dramatic difference. Although you’d pay $4,271 in interest, simply by sending in your first month’s minimum payment each and every month, there’s another $5,555 in interest you would never have to pay ($9,826 – $4,271). It would cost you $7,715 before taxes to come up with that $5,555.
Isn’t it amazing? Simply by sending in the same amount you managed to come up with this month (a total of $295, in our example), you’d save 57%, compared to just paying the minimums. All your debts would be retired in around 6 years instead of almost 26 years!
If you’re wondering how this could be possible, it’s because you’d be putting the power of compound interest to work for you, not for the bank. Over time, more and more of each payment would go to paying off what you owe. The less you owe, the less interest you have to pay.
Always pay more than the minimum, preferably a fixed amount every month. I suggest a fixed amount so you can see in advance how much you’ll save. You can use that same calculator on CardRatings.com to plug in any steady early payment amount. Play around with the numbers a little, and you’ll hopefully get encouraged.
Here are a few examples, and to keep you from glazing over all the numbers, I’ll keep it simple. We’ll start with the same $11,950 debt, but we’ll pretend it’s all on one card that charges 14% a year and has a 2.5% minimum.
Tip
When you’ve crunched the numbers for your debts and know how much you’ll save, give yourself a little extra motivation. Write that number in big, bold print. Put it someplace where you will see it regularly.
If you add another $100 to the first month’s required amount and send that in every month until the bill is paid off, your interest bite would be $2,840. Consistently paying $100 above the minimum would save you more than $7,400.
If that’s more than you can afford, how about paying another $25 a month? Your interest tab would be $3,771. You’d have over $6,400 more to use however you saw fit, and you’d be completely out of debt in four years.
Here are some other tactics that can help you get out of debt.
Calling your lenders and asking them to work with you is always a good move, especially if your situation is only temporary. Many people assume this is a waste of time, but studies show just the opposite. Also, I know this works from personal experience. I’ve already explained how to call and negotiate with your card issuer for a lower interest rate (see Chapter 3, “Unlock the Key to Huge Savings: Master Credit Card Rates and Transfer Offers”). You can also ask to be enrolled in a hardship program or ask for a break as you try to pay them back.
Most consumers don’t realize that a card issuer has a lot to lose if you end up defaulting and/or declaring bankruptcy. According to John Ventura, Director of the Texas Complaint Center at the University of Houston and author of Managing Debt for Dummies (Wiley Publishing, 2007), depending on the type of bankruptcy you file, they might never see another dime from you. It’s definitely in their best interest to work with you (more on bankruptcy at the end of this chapter).
These are tough times for creditors as well, who are reporting significant increases in “serious delinquencies”—that is, accounts that are at least 90 days late. They’re giving up on an increasing number of these accounts and are planning for continued problems with delinquencies throughout the rest of 2008 and even into 2009.
Before cutting you any breaks, a creditor might require your participation in a debt-management program (DMP) run by a credit counseling agency (more about DMPs soon). Bottom line: Always ask the banks to work with you—the worst they can say is no.
If you’re wondering why the banks want people in credit counseling, it’s not out of the goodness of their hearts. Gerri Detweiler says lenders do this to get a fair shake. They know all your creditors will generally be asked to participate, and all creditors will be treated fairly. American Express doesn’t want to settle for less in interest if you’re still paying Chase full price.
To save the most money, first focus on paying off the balance at the highest interest rate. Be sure to pay the minimums on all your other bills, and pay them on time. The last thing you want is to be hit with a more than 30% default rate because of late payments.
Every month, send in as much additional money as you can toward the balance at the highest rate. When I tackled my $45,000 credit card debt, I made lifestyle changes and put all that I could toward my highest-rate card. When that card was paid off, I tackled the one with the next-highest rate, and so on.
If at all possible, be sure to keep sending in at least as much every month, as you go from debt to debt, and you’ll be out of debt faster than you ever thought possible.
This tactic is sometimes more of a mind game than a sound financial strategy because your lowest balance could very well have your lowest interest rate. The idea here is to give yourself a “quick fix” so you can benefit from a dose of immediate gratification. The hope is that if you knock off a card’s balance fast, you’ll gain confidence and be motivated to move on to the next balance. Please note: I would only recommend this strategy if your lowest balance is very small (under $1,000 or so). Otherwise, you will likely pay much more in finance charges than if you paid off your highest rate card first.
Keep paying the minimum on all your credit cards except the one with the lowest balance. Send in as much as you possibly can above the required amount. When you’ve paid off the card with the lowest balance, choose the next balance to pay off.
Do you need another quick victory, or do you want to save the most money and pay off the card that charges the highest rate? Or is there another debt you’d rather wipe out? You decide. Keep plowing in at least as much every month, and you’ll save big!
Debt consolidation is invariably a hot topic. Wherever you look, someone is advertising new ways to consolidate your debt into “one low payment,” at rock-bottom rates. As you might expect, there are a few hitches with the hype.
First, if you’re not careful, that low payment will cost you more over the long run than if you stick with the payment plan that you have now. To finance that low monthly payment, there’s usually a higher interest rate and/or a longer term for the new loan. Although all your payments might be lumped together and you pay less a month than you do now, your overall tab will go up, not down.
It pays to consider a debt-consolidation loan only if it offers significant savings and it comes from a reliable source. You can use the calculators on CardRatings.com to compare possible loans to your current card balances.
Another problem with these heavily advertised loan offers is their use of phrases such as “up to” and “as low as.” For example, Alecia, an active member of the CardRatings.com forum, got an offer with a 7.99% rate advertised on the front of the solicitation, but when she got to the fine print, the rate was from 7.99% up to 19.99%.
When you get a consolidation loan from a bank, it’s normally considered an unsecured loan, with only your word for collateral. Therefore, don’t expect a very low rate—and bear in mind your credit score will often have a strong bearing on the rate you qualify for. Also, you might get a better deal at a credit union because they often have lower rates.
If the rate and terms are better on an unsecured loan than what you’re currently paying on your credit cards, do a “gut check” and decide how much you can realistically afford to pay every month. Can you count on yourself to meet the new monthly payment? Great! As with credit cards, when you can afford to send in more, do it, and you’ll save even more.
Friends and Family
Have you considered asking a family member or a well-to-do friend if you can borrow the money you need for debt consolidation? Such a loan might be an excellent financial arrangement for both parties.
But watch out. You might start with the best of intentions—to pay a higher interest rate to your brother than he can get for his savings account—but if you don’t follow through, it can tear your family apart.
I recommend getting some tax advice, making a formal agreement about how much you’ll pay back every month, and committing to that agreement in writing. The website VirginMoneyUS.com can help you with this.
Don’t go for a family loan unless you can really trust yourself to pay it back. But if you can trust yourself, you can save a lot while you bring in some extra income for your loved one. This can be a win-win situation.
On a related note, check out Prosper.com, which offers unsecured loans directly from other people throughout the country (a new type of lending known as “peer-to-peer lending” that is gathering momentum). Because financial institutions aren’t part of Prosper, rates tend to be lower than with traditional loans. Prosper is particularly a good alternative if you don’t have any family or friends willing to loan you money!
I can personally attest to the benefits of using low-introductory-rate balance transfers to get out of debt. They were a tremendous help when I winnowed down my $45,000 credit card burden.
Although these offers can help you dramatically slash your interest charges, unfortunately, some lenders seem to be shortening the length of introductory offers and increasing the rates and fees. No-fee offers are very rare—make sure to carefully check the fine print to understand exactly what fee you will be charged. Also, there aren’t as many 0% offers for 12 months as there once were, although they’re definitely still out there. Now there are more offers in the 1.9%–4.9% range that last only three to nine months, which means you are more likely to have to resort to multiple balance transfers if you have the sort of debt load that I had and you want the best rates.
If you’re carrying a significant amount of debt, consider a balance transfer offer that has a low fixed rate for the life of the balance. The entire balance you transfer will remain at that low rate for as long as it takes you to pay down your entire balance. Rates on these offers are typically around 3.99% to 6.99%. True, the rate won’t be as low as cards hawking 0% to 2.9% teaser rates. But the interest savings can still be huge, and you won’t have to worry about transferring balances every 6 to 12 months. The other big advantage of locking in at a rate for life is you eliminate the risk of not qualifying for another balance transfer offer when your current teaser rate expires and/or there are simply no other attractive balance transfer offers available.
Using a home equity loan or home equity line of credit (HELOC) to pay down credit card debt has become very popular with homeowners in the last several years. And, despite the fact that these type of loans are harder to qualify for now thanks to the recent problems in the mortgage industry, utilizing your home equity is still an option worth considering. Home equity loans have two distinct advantages that I was glad to take advantage of when I paid off my debts. First, you will probably be able to get a lower interest rate. Second, you might be able to deduct the interest on your tax return (which you can’t do with credit card interest).
Consolidating with home equity does come with downsides, however. You might have to pay closing costs and other fees. Also, some home equity loans come with a large final payment (called a balloon payment) that you need to figure into your repayment plan. Analyze the finer details and remember that lower payments don’t always equal lower cost. BankRate.com is a good place to search for the latest rate offers.
Another downside to using your home equity for debt payoff is that you’re tying up what is often your most valuable financial resource. According to Jordan Goodman, author of Everyone’s Money Book on Credit (Kaplan Business, 2002),
I hear people say to me all the time that they are now out of debt since they used their home equity loan to pay off their credit cards, when in fact all they have done is shift their debt from one place to another and put their largest asset, their house, on the line at the same time. If you’ve used the equity in the house to pay off your credit card bills, your remaining home equity won’t necessarily be available when you have a real need for a lot of capital, like when the first college tuition bills come rolling in or you have a major medical emergency that is not covered by health insurance.
The most alarming aspect of using a home equity loan is that you’re putting your house in jeopardy. Unlike card debt, which is unsecured, a home equity loan is a secured debt, with your house as collateral. Failing to make credit card payments does lead to a lot of negative consequences, but defaulting on your home equity loan puts your home at risk. If you can’t completely trust yourself to make every single payment, putting your home on the line simply doesn’t make sense.
Sometimes tackling your debts alone isn’t the best option, but you might resist getting help and even wonder whether you need it. Take a look at some of the following statements, and see if they apply to you:
You haven’t been successful in working out a reasonable repayment plan.
Your repayment plan stretches many, many years into the future. You should typically be able to repay credit card debt within five years or so.
Your total monthly debt payments, not including your mortgage, equal more than 20% of your take-home pay.
You can’t pay the minimum amounts due on your cards every month.
You’re consistently late paying one or more regular bills (for example, utilities and car loans).
You’re hounded by creditors and collection agencies.
Do any of these statements ring true to you? If so, let’s talk about some ways to get help.
A certified counselor at a reputable credit counseling agency (ideally, a member of nfcc.org) should offer several helpful services, including these:
A personalized budget based on your income and expenses
A repayment plan based on your total debts and how much you can pay each month
Lower interest charges
A monthly lump sum that you send to the counseling agency, which then distributes it among your various creditors
The timely and accurate payment of all creditors
A lots of free educational material
Look for these characteristics when deciding on a credit counseling agency:
Accreditation by the National Foundation for Credit Counseling (NFCC) or the Association of Independent Consumer Credit Counseling Agencies.
A nonprofit agency—but don’t be swayed just because a company is nonprofit. According to Jim Young, CEO of Accelerated Debt Management (link at CardRatings.com/Book), many nonprofits don’t have your best interest at heart. In fact, the Internal Revenue Service has revoked the licenses of many nonprofits in recent years.
A clean bill of health. Contact the local Better Business Bureau or your state Attorney General’s office to see if any complaints have been filed against the company. If so, find out how the issue was resolved.
Tip
Accelerated Debt Management is the only company I know of that discloses the interest rates you can expect to pay with various card issuers if you enroll in one of its programs. There’s a link to this valuable information at CardRatings.com/Book.
Referrals. If none are volunteered, be sure to ask for some, and make the calls.
Be sure to ask these questions before you sign on with a credit counseling agency:
Watch out for these red flags:
Large up-front fees. Most reputable agencies have monthly fees, but they should be reasonable. According to Linda Tucker, Director of Education and Marketing for Consumer Credit Counseling Service in North Little Rock, Arkansas, a basic monthly service fee ranging from $15 to $25 is charged, to everyone who enrolls in its debt-management plan (DMP). This is a reasonable fee. (Bear in mind, though, that fees will vary depending on which part of the country that you live in.)
Agencies that require detailed information about your situation before sending out free information about the services they supply.
Agencies that charge for educational materials.
Agencies that won’t help you because you can’t afford their fees.
Agencies that push you to enroll in their paid DMP before they will fully analyze your financial situation.
Employees paid on commission instead of salary.
An agency whose counselors are not trained by an outside, unaffiliated source.
Unrealistic promises, such as erasing your credit history. No one can do that. Under the Fair Credit Reporting Act, accurate information about your accounts stays on your report for up to seven years.
A credit counselor should spend at least an hour analyzing your finances with you (ideally, in person). If you both agree that a DMP is beneficial to your particular situation, you’ll want to ask another set of questions:
• | Will you continue to provide budget counseling if I choose not to enroll in the DMP? If the answer is no, find another agency. |
• | How does your DMP work? Look for a program that pays your creditors before the due date and in the current billing cycle. If the agency makes late payments or misses payments, it will only hurt your credit history. Cathy, a member of the CardRatings.com forum, had a bad payment experience with a credit counseling company. According to Cathy, “They paid one account late, though I didn’t know it.” Because of this error, she has had ongoing trouble with a major card issuer. Her advice: “Proceed with caution with any consumer credit counseling agency or debt-management program.” |
• | Will I continue to receive monthly statements from my creditors? If not, what types of reports do you send and how often? It’s your credit history on the line so make sure the program offers ways to keep track of your interest rate, payments, and balances. |
• | Will you work to get my creditors to lower or eliminate interest charges and fees? If they say yes, it’s a good idea to verify it personally with your creditors. |
• | What debts are not included in the plan? This is especially important information. You must continue making payments to creditors that are not included in the DMP. |
• | Do I have to make upfront payments with any creditors before they will accept me? If a counselor tells you yes, call the creditor personally to verify. |
• | Will my past-due accounts be “re-aged” (meaning brought current)? If so, how long will it take? Note that re-aging accounts does not delete past delinquencies or late payments from your credit report. Also, according to federal law, re-aging can only take place if the account has not been re-aged in the past year and no more than twice in last five years. |
As the DMP is being established, it’s important to keep paying your creditors so you aren’t charged late fees and penalties. This will also keep negative information from appearing on your credit history. After you’ve enrolled, contact each creditor to confirm that it has accepted the terms of the proposed plan.
Ads for debt settlement companies are rampant and many claim to be able to settle your debt for a fraction of what you currently owe. While these ads may sound very tempting, don’t confuse a DMP with debt settlement or negotiation. Consumer advocates generally don’t promote debt settlement or negotiation plans, but these can be a viable alternative for consumers who owe a lot of money and are considering bankruptcy.
As with credit counseling agencies, debt settlement companies normally have you send monthly payments to them instead of your creditors. They promise to hold the funds until all parties have agreed upon a negotiated balance, and they typically claim to have the power to reduce the full amount you owe by 50% or more.
Beware!
Creditors are not required to negotiate with debt settlement companies, so whatever you’re told or read, know that there are no guarantees.
To enroll in a debt settlement program, your accounts must normally be in default or past due by 90 days or more. This means that you’ve stopped paying creditors, who are now charging you interest at a high default or penalty rate. You’re racking up late fees as well, and if your credit line is exceeded in the process, even more fees will be added. Your credit score has already likely plummeted or will soon do so, and your debts are typically growing at an astronomical rate.
Debt settlement companies often require you to pay separate fees, such as a setup fee, a monthly service fee, and even a percentage of the amount you save. Finally, the IRS can step in and tax as income any amount of debt that has been forgiven above $600, so it’s important to consult a tax advisor before you pursue any type of debt settlement plan.
Although many negative aspects are involved, if you owe a lot of money, are 90 days or more behind on your accounts, and can’t afford to pay the minimum requirements of a DMP, you should consider both debt settlement and bankruptcy.
If you decide to try a debt settlement firm, make sure you contact the state Attorney General to see if debt settlement companies are required to be licensed in your state. They can also tell you whether a particular company is licensed. Additionally, it’s always a good idea to check with the local Better Business Bureau to see if any complaints have been filed against the company.
One final piece of advice: If you’re serious about this option, explore the possibility of taking a do-it-yourself approach to debt settlement first. You can do anything that a debt settlement firm can do and avoid all the steep fees in the process. (Unfortunately, you will still be subject to taxes on any amount settled.)
Several members of the CardRatings.com forum have successfully settled their own debts. Visit our forum for pointers on doing so. If you need some limited guidance, consider the services provided by ZipDebt (follow the link at CardRatings.com/Book), which offers an impressive one-year money-back guarantee on any of its three Do-It-Yourself Debt Negotiation Training & Coaching Programs, which are much less expensive than what a traditional debt settlement firm would charge.
Tip
Go to CardRatings.com/Book for a list of companies offering these services that I know are reputable.
Most of us see bankruptcy as the ultimate sign of failure or chronic overspending, when it’s often nothing of the sort. The overwhelming debts that often drive people into bankruptcy today are more often than not related to illness, job loss, and divorce.
The doctor and hospital bills might be piling up from an accident you had a few years ago. You might have lost your job and health insurance, gone through your emergency fund, and are using credit cards to keep food on the table and fill prescriptions. You might have tried at least some of the ideas I’ve shared here, and you’ve spoken to a credit counselor. But the bill collectors keep calling, the stress is unbelievable, and you feel as though you’ve run out of cash and options.
In a situation like this, depending on the type of debts you have and how long it would take you to pay them off, bankruptcy should be considered. As MSN’s Personal Finance Columnist Liz Pulliam Weston puts it,
If, despite your best efforts, it would take more than five years to pay off your credit cards and medical bills, or you would need to use assets that would otherwise be protected in bankruptcy—like retirement accounts and home equity—then you should at least consult with a bankruptcy attorney about your options.
Student loans, child support, and alimony are types of debt that generally cannot be discharged through bankruptcy.
One thing to consider is that you must be willing to withstand a major blow to your credit report, the effects of which can last for up to a decade. It will be harder to obtain credit, your credit lines will be limited, and you’ll usually have to pay much higher interest rates on the credit you do manage to get, as well as higher premiums on insurance policies. (Visit the CardRatings.com forum for tips on how to rebuild your credit following bankruptcy.)
If you’ve weighed all the other methods of resolving debt and really see no clear way out, I agree with Weston: The best person to speak with about your options is a bankruptcy attorney. Visit NACBA.org to find one. Probably the most significant sign that it’s time to approach a lawyer is if you’ve tapped out all your resources, and your home or car is on the line. (Bankruptcy laws can generally protect these items.)
If you’re contemplating bankruptcy, you’re not alone. The number of personal bankruptcies filed throughout the years has seemingly climbed right along with the popularity and increased use of credit cards. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 was touted as a solution to the problem.
Many consumer advocates and personal finance experts would argue, though, that this legislation has actually worsened the consumer debt situation because it has become harder and more expensive to file. The same advocates contend that the legislation was enacted only to appease creditors, including those in the card industry.
“Though the law cracked down on debtors, it did nothing to rein in the credit card issuers and other lenders whose practices helped fuel the bankruptcy boom,” explains Weston, also the author of Deal with Your Debt: The Right Way to Manage Your Bills and Pay Off What You Owe (Prentice Hall, 2005).
Even though it is harder to file now than it was before 2005, the number of U.S. bankruptcies continues to surge. Filings in February 2008, for example, were up 28% over the same period in 2007.
Even if bankruptcy is your only option, and although it might seem impossible at times, I want you to know that you can conquer your debt. There’s even life after bankruptcy! With the information and resources I’ve provided, along with your determination and persistence, you will be able to manage your finances and control your debt instead of allowing your debt to control you. Good luck on becoming debt-free—and please let me know of you progress by dropping me a note or by posting in the CardRatings.com forums.