2. Slay the Debt Dragon

Debt may be more American than either apple pie or baseball. After all, about three-quarters of U.S. families owe money to lenders. The median balance owed, including mortgage debt, is about $67,000.

Most families handle their debts pretty well, Federal Reserve statistics show. Fewer than half carry any credit card debt, more than 90% are current on their bills, and most keep their debt burdens manageable.

But about 15% of families are in trouble. Their debt payments exceed 40% of their incomes, indicating that they’re at great risk of financial distress. Millions have lost homes or are in the process of foreclosure, and more than a million people a year file for bankruptcy.

If you’re one of the 15%, you need help fast. If you’re not, you still need to know how to steer clear of trouble.

A: You should put retirement saving first now, even before you pay off your debt. If you don’t get a relatively early start putting away money for retirement, you likely won’t be able to catch up later. Those who start saving after age 35 have a very difficult time putting away enough money to comfortably retire, says Roger Ibbotson, founder of Ibbotson Associates financial research firm and a Yale School of Management professor. The ideal time to start saving for retirement is with your first job.

Prioritizing retirement means you’ll have less money for other goals, so paying down your debt and building up an emergency fund will take longer—but so be it. The tax breaks and investment gains you’ll make in the long run in your retirement accounts will overshadow the amount of extra interest you’ll pay on your debt.

When it comes to paying off your debts, you’re right to target your credit cards first. Credit card debt is “toxic” debt, since it offers no benefit to your financial future. Instead, it acts like a cancer, eating away at your financial stability with high interest charges. Payday advances, car title loans, and bounce fees at banks are other examples of toxic debt that need to be eliminated.

After paying off your credit card debt, your next goals depend on your individual situation. If all your education debt is federal student loans rather than private loans, you needn’t be in a rush to pay it off. That’s because federal student loans have relatively low, fixed rates and many flexible repayment options. You also may qualify for student loan forgiveness in 10 years if you work in public service, or 25 years if you don’t. An income-based repayment plan would allow you to minimize your payments so you can put money toward other goals. You can research your repayment options at FinAid.org, a financial aid and student loan education site.

On the other hand, if you have some private student loans, you’ll probably want to make paying them off a priority because the rates are variable and you don’t have as many repayment options. (You probably can’t make income-based payments, for example.)

When to prioritize a home purchase depends, again, on your individual situation. If you’re sure you’re where you want to be for the next ten years or so and are eager to own a home, you could start a down payment fund as soon as you finish paying off the credit card debt.

A: An emergency fund is a beautiful thing. The money in it can give you confidence that you can deal with job loss and other financial setbacks. An emergency fund can save you a small fortune in interest because you won’t have to borrow to pay unexpected bills.

But an emergency fund shouldn’t be your top priority if you have toxic debt, such as credit card debt. It’s smart to put at least a few hundred dollars in the bank before you begin to pay down your debts. That way, if you face a small financial setback, you can tap your emergency fund and not have to add to your debt. But it doesn’t make sense to wait until you have several months’ worth of expenses saved before you start to pay down expensive debt, because accumulating even a small emergency fund can take years to accomplish.

Let’s say that you currently spend about $50,000 a year. If you cut your expenses by 10%, you’d free up $5,000 a year for either repaying debt or building an emergency fund. Assuming that your monthly expenses are now $3,750, it would take you more than two years to build up even a three-month emergency fund. That’s way too long to pay usurious credit card interest rates if you don’t have to.

A: Paying off your adjustable-rate second mortgage may be a smart move. When rates start to head upward, as they inevitably will, that loan could get quite expensive. Eliminating that debt also frees up home equity that you could use in an emergency.

Paying off a fixed-rate mortgage is another issue. When deciding whether to pay off such a mortgage, many people focus on how much interest they could save or what their “return” on their money would be. (If you’re in a 35% tax bracket for federal and state income taxes, for example, your return on paying off a 7% mortgage would be 4.6%.)

In reality, though, most people have better things to do with their cash than pay off relatively low-rate, tax-deductible debt.

For example, are you on track with your retirement savings? Do you have a substantial emergency fund? Most families would be wise to set aside a cash reserve to cover three to six months’ worth of expenses. Someone who is self-employed with a nonworking wife might want to boost that emergency fund to 12 months’ worth of expenses.

Are you adequately insured? Your wife is financially dependent on you, so you probably should have a substantial life insurance policy. You may want to get one on her as well, if she cares for minor children and you’d have to hire a nanny if she died. You may also need disability coverage.

If you’ve covered all these bases and still want to pay off your mortgage, feel free. Otherwise, put the money to better use.

A: People can sometimes avoid bankruptcy if they seek help early enough. If they’re able to pay more than the minimums on their credit cards, for example, they may be able to use a legitimate credit counselor’s debt management plan to pay off their debt.

But debt management plans require that you have at least some disposable income. If you can’t keep up with your bills or find employment, that doesn’t describe your situation.

You still can contact a creditor counselor via the National Foundation for Credit Counseling at www.nfcc.org, but you also should contact an experienced bankruptcy attorney (you can get referrals from the National Association of Consumer Bankruptcy Attorneys at www.nacba.org). You may not want to file, but you may not have much choice, particularly if you want the collection calls to stop.

What’s especially sad is that you apparently drained your retirement to pay your bills. Your retirement money would have been protected from creditors, but you essentially threw good money after bad. Retirement money should be left alone for retirement so you can support yourself in your old age. Anyone who’s considering draining a retirement account or home equity to pay credit card debt or medical bills should first consult a bankruptcy attorney to understand the ramifications of this often-foolish act.

A: Use your grandfather’s generous gift to both help you retire most of your debt and get a start on an emergency fund.

After you sell the car, take $500 to $1,000 of the proceeds for your emergency fund. That will cover most minor emergencies and should keep you from adding to your credit card debt. Put the money in a safe account that’s accessible—but not too accessible. If it’s too easy to tap, you might be tempted to raid it for nonemergencies. A savings account at an online bank or a credit union are two good choices.

Take what’s left and pay down your credit card bills. Stop using your cards and figure out how much you need to put toward your debt to get the rest of it paid off in a few months. Then trim your expenses to come up with the money and set up an automatic transfer from your checking account to your cards.

Despite what you may have heard, credit card debt isn’t normal—a majority of U.S. households don’t carry credit card balances, according to Federal Reserve statistics—and it’s a real cancer on your finances. While you’re young, you should get out of the habit of carrying balances and into the habit of paying your cards in full every month. You’ll be richer for it and less likely to find yourself in the sad position of being old and in debt.

A: If you don’t owe this money, send the collector a letter by certified mail, return receipt requested, stating that the debt isn’t yours and that you don’t want to be contacted again. It’s not unusual for a collection agency to dun the wrong person, and this may not be the end of it. Often these poorly documented debts are resold, so you may have to tell the next collection agency the same thing.

If you did owe the money, you would want to tread more carefully. A collection agency would still have to honor a “do not contact me” letter, but sometimes these letters prompt the collectors to file lawsuits against debtors, says Gerri Detweiler, a credit expert with DebtCollectionAnswers.com. The collection agencies figure that if they can’t negotiate payments with a borrower directly, they’ll use the court system to get the debtor to pay.

A: Many families are facing your dilemma: flat incomes with rising costs. But your wage garnishments and 401(k) loans indicate that you have a history of mismanaging your money, which has led to even more pain.

You need the advice of an experienced bankruptcy attorney. By federal law, wage garnishments aren’t supposed to exceed 25% of your disposable income, and state laws often provide even lower limits. If you can get your garnishments adjusted or have them wiped out in a bankruptcy filing, you may be able to create more breathing room.

In the meantime, see whether you qualify for the federal government’s Supplemental Nutrition Assistance Program (formerly known as food stamps). If you make too much money or have too much in assets to qualify, you can still visit a food bank to supplement what you’re able to buy.

If you can’t find a way to lower your costs further, the only solution is more income—not an easy prospect, given the high unemployment rate, but you may be able to find a job at a competing business that pays more or start a business on the side.

Unfortunately, there are no miracles when it comes to money math. You can’t make two plus two equal five or have expenses that exceed your income without eventual disaster.

A: You don’t have a habit—you have an addiction. And it’s not clear that you’re dealing with it, since you refer to yourself in the present tense as a gambler. If you’re still gambling, all your efforts to pay off your debt and build a financially secure future for yourself will likely be pointless. Although $4,800 a month is more than most people have in retirement, you’re right that it won’t be enough to feed your addiction.

If you haven’t already, check out Gamblers Anonymous, a 12-step program based on the principles of Alcoholics Anonymous.

Anyone who wants to build a retirement fund can contribute to an individual retirement account (IRA) or Roth IRA, as long as the person or the spouse has earned income. You can contribute up to $5,000 a year if you’re younger than 50, or $6,000 if you’re older.

A: When a lender charges off a bad debt, the debt itself doesn’t disappear. The lender is simply declaring that it doesn’t think it will be able to collect. The debt can be sold to collection agencies, which can post the collection account on your credit reports. Debts disappear only when you pay them or have them legally erased in U.S. Bankruptcy Court.

The collection agencies are checking your credit reports to see if there’s evidence your financial situation is improving. If they find such evidence, they’re likely to step up their collection efforts and may even file a lawsuit against you. You need to respond immediately to any notice that you’re being sued, since there are limits to how long creditors are supposed to be able to pursue you in court over debts. The limits vary according to each state’s statute of limitations, but range from 3 to 15 years. If the debt has aged beyond that limit, you’ll need to show up in court to point that out. (These state statutes of limitations are different from the federal limit on how long bad debts can show up on your credit reports, by the way. The federal limit on reporting negative credit report information is typically 7 years and 180 days from when the account first went delinquent.)

One of the lessons you should learn from this experience is not to trust a lender to tell you how much you can afford to borrow. The other is that you should always arrange financing in advance before you venture onto a car dealership lot. If the dealership can beat the deal you get from your bank or credit union, great. Otherwise, you’ve got financing that you know you can afford.

A: The clock on reporting most negative marks begins when the account first goes delinquent and isn’t reset when a creditor or collection agency updates or sells the debt. If the collection agency continues to report the debt after seven years and 180 days passes, you should be able to dispute the entry with the credit bureaus and get it removed from your credit reports.

You also may need to be concerned about your state’s statute of limitations for this debt. This statute affects how long you can be sued over a debt, which can vary from 3 to 15 years. In some states, the statute can be extended if you make a payment on the debt or even acknowledge it as your own.

If you’re at risk of being sued, you may want an attorney’s advice about how to proceed and whether you should try to settle this account. You can get a referral from the National Association of Consumer Advocates at www.naca.net. Even if you aren’t at risk of a lawsuit, it could pay to get this debt resolved. As you’ve learned, mortgage lenders typically aren’t willing to lend money to people with open collection accounts on their reports.

A: Clearly, you can’t afford your life. The fact that you incurred debt to switch to a career field that you now hate indicates that you’re prone to making rash decisions. So the most important lesson is that you must thoroughly research your options before making your next step.

Contact a housing counselor approved by the Housing and Urban Development Department to discuss your loan modification options. You can get referrals from www.hud.gov. The modification process is so torturous and complex that it can really pay to have an experienced hand guide you, but you shouldn’t pay thousands of dollars to an attorney or other “expert” when you can get low-cost or even free advice from a HUD-approved housing counselor.

If you can’t get a modification and your home costs are eating up more than 30% of your monthly income, seriously consider a short sale so that you can move to a more affordable place. Here you will want an attorney’s help because short-sale negotiations can be tough and the lender can keep you on the hook for the remaining debt if your agreement isn’t worded properly.

You’ll need to have a talk with your children as well. This will be difficult, but if you aren’t saving sufficiently for retirement, you can’t afford to help them with education costs. Your kids can get a college education on their own by working and using federal student loans, but they may need to switch to cheaper schools.

Think long and hard before you borrow any more money, for job training or anything else. A session with a career counselor could help you define other jobs you could get with your existing credentials. If you do need more training, get it the most cost-effective way possible. Nonprofit community colleges offer inexpensive courses at night that would allow you to keep your day job.

Although you don’t think you’ll ever be able to retire, at some point, you won’t be able to continue working. Your priority should be to pay off your debt and build up your retirement savings so that you have more to live on than Social Security checks. Everything that doesn’t serve those goals has to be discarded, as difficult and painful as that may be.

A: Widows and widowers are often advised not to make any big decisions in the first year of their bereavement. Unfortunately, bill collectors aren’t willing to wait that long.

You need to determine your liability for your late husband’s debts. Don’t rely on what collection agents tell you. They may insist that you have a legal or moral obligation to pay a bill when you don’t. An experienced probate or bankruptcy attorney can help you sort through the debts to see which ones need to be paid from your husband’s estate, which you may be responsible for, and which can go unpaid. Student loan obligations, for example, typically end at death unless you or someone else cosigned the loans.

You also need to make sure that you get all the money and property to which you’re entitled. You and your children probably qualify for Social Security survivor benefits. (You can find out more at www.ssa.gov.) You also may inherit retirement funds and life insurance policies that are protected from creditors. Life insurance policies that name you as a beneficiary, for instance, pass outside your husband’s estate and don’t have to be shared with creditors—again, regardless of what collection agencies may tell you.

After you’ve sorted out his estate, you can begin rebuilding your financial life for yourself and your children. A fee-only planner can help you get started. You can get referrals from the Garrett Planning Network at www.garrettplanningnetwork.com, which represents planners who charge by the hour, or the National Association of Personal Financial Advisors, at www.napfa.org, which represents planners who charge retainer fees or a percentage of assets they manage for you.

A: Your brother’s bills are the responsibility of his estate, not your parents. His creditors would have to be paid if he had any assets, but in this case, they’re out of luck.

That doesn’t mean they won’t keep trying, however. Your parents could opt to ignore the calls, letters, and guilt trips the collectors try to inflict. Or they could talk to a probate attorney who is familiar with the laws of the state where your brother died. The state probably has some kind of simplified probate that would allow your parents to legally resolve these bills and put an end to collection activities.

A: So you’re surprised that a “very aggressive and threatening” collector suddenly changed the rules on you? It’s time to wise up and realize that you’re not dealing with an ethical company.

You need to make an appointment immediately with an attorney who is familiar with the credit and collection laws of your state. You can find a referral through the National Association of Consumer Bankruptcy Attorneys at www.nacba.org. Many of these attorneys offer free or discounted initial sessions.

All too often, rogue collection agents violate federal and state fair debt collection practices by threatening to sue when they have no intention of doing so or when they are legally barred from filing lawsuits. Your state’s statute of limitations limits how long a creditor can sue over a debt. In some states, people who lose homes to foreclosure also are protected against lawsuits over any remaining mortgage debt.

But your payments may well have extended the statute of limitations under which the collector would be allowed to sue you. That’s why you need an attorney to advise you. You also might want to consult DebtCollection Answers.com, a site run by debt expert and consumer advocate Gerri Detweiler, for more help in dealing with collectors.

You were smart not to send the financial information the collector demanded, because none of that is necessary for a settlement discussion and the data could easily be used against you. If the agency is unethical enough, it could use the bank account information to raid your accounts.

A: You’re already in trouble. You have an unaffordable mortgage, you have a whopping pile of debt, and you’ve defaulted on your credit cards and student loans. Your desire to pay your bills is irrelevant at this point: You’re in too deep.

You may be able to avoid bankruptcy if you find a job after graduation that substantially boosts your income. In the meantime, you could give yourself some wiggle room by getting a roommate to help pay the mortgage and talking to your lenders about economic hardship options. (You can learn more about these at the financial aid site FinAid.org; search for “Trouble Paying Debt.”)

Before you make deals with any lenders, though, you should talk to an experienced bankruptcy attorney (check the National Association of Consumer Bankruptcy Attorneys, at www.nacba.org for referrals) about your situation. You don’t say how much you owe on credit cards, but if the minimum payments are eating up that much of your income, it’s probably tens of thousands of dollars. If your job prospects when you graduate aren’t sterling, you may never be able to pay off that debt. You won’t be able to erase the student loans in bankruptcy, but you might be able to get rid of the credit card debt.

In the future, you need to understand two things. One is that carrying any credit card balance is a recipe for disaster. You shouldn’t have charged more than you could afford to pay each month, since that allowed you to keep living a lifestyle that wasn’t sustainable. Anyone who can’t pay more than the minimum on a credit card is in serious trouble, and using one card to pay another is insane.

The other point to remember is that mortgages aren’t good debt if you can’t afford the payments—and a payment that eats up half your take-home pay is the very definition of unaffordable. Another clue that you bought too much house is the interest-only mortgage. If you can’t afford to buy a house using a 30-year, fixed-rate mortgage, you can’t afford the house.

Your credit scores should be the least of your worries at this point. Go get some good counsel, consider your options, and make a plan to deal with this mess. When you’re on the other side, you can start rebuilding your finances and your credit.

After I spent the night in a hospital, we got a bill for just under $20,000. I don’t have health insurance (big mistake, I know). Because our combined income is more than $24,000, we were told we were not eligible for any discount. The woman I spoke with about the bill told me my options were to pay off the bill at $550 a month for the next three years, which is more than we pay for rent; pay the bill in full and get a 10% discount, which I do not have the money for; or file for bankruptcy.

We’re going to look at getting me on my wife’s insurance plan and see if we might be able to get them to retroactively cover some of the cost, but that doesn’t seem too likely, even though the incident happened less than a week after we got married. What is the best course of action?

A: Don’t hold your breath about getting covered retroactively—that’s not going to happen. But get added to your wife’s insurance as soon as possible anyway. As you’ve seen, even the healthiest person is just one accident or illness away from potentially catastrophic bills, and having insurance will help you the next time.

Call the hospital and ask to speak directly to a financial counselor. Most hospitals have them, and they can help you review your situation to see if you might indeed qualify for discounts. A typical charity program would erase bills for people whose incomes equal 200% or less of federal poverty limits and would offer discounts for those with incomes up to 400% of those limits. The poverty line for a family of two was $15,130 in 2012, meaning that you could earn up to $60,520 and still get some kind of discount at many hospitals.

Even if you don’t qualify for a charitable discount, you still might be able to reduce the bill if you can persuade the hospital to charge you what it would have charged an insurer for the same stay. Insurers negotiate significant discounts with providers, and you could end up paying quite a bit less if the hospital gives you the same discount. We’re not talking minor discounts, either: The “sticker price” for hospital care for an uninsured person can be two or three times the price paid by insurers, according to the National Consumer Law Center.

You also should review your bill for errors, since those are common and can dramatically increase your costs.

If you can get the total bill reduced, you may be able to work out a payment plan with the hospital that you can afford. Whatever you do, try to avoid taking out a loan or using credit cards to cover this bill. A payment plan with the hospital typically won’t carry any interest, whereas the rates you would pay to a lender would probably be sky high. Also, the hospital won’t have any incentive to work with you to lower your bill after you charge it to a card.

If the hospital won’t cooperate and you can’t pay the bill, bankruptcy might be the best of bad options. Otherwise, the debt probably would be turned over to collection agencies that could hound you for years.

For more tips and strategies on how to negotiate your debt, pick up The Medical Bill Survival Guide (Westminster Cambridge Conglomerate, 2010), by Nicholas Newsad.

A: Bankruptcy is sometimes the best of bad options, particularly when you’re facing unsecured debts such as credit card bills that equal more than your annual income or that would take you five or more years to repay. Five years is typically how long you’d be required to chip away at your unsecured debt in a Chapter 13 bankruptcy repayment plan, although, given your lack of employment, you may qualify for a Chapter 7 liquidation bankruptcy, which would erase your credit card debt.

Bankruptcy typically can’t wipe out students loans or a mortgage. But you probably qualify for economic hardship options that would allow you to reduce or suspend payments on any federal student loans. Private student loans don’t have similar provisions, but you may be able to work out a payment plan with your lenders, or you may have enough financial room to pay them if your other debt is wiped out.

By federal law, a bankruptcy can’t be used against you in employment decisions. However, employers may hold against you the late payments, charge-offs, and collection accounts that frequently precede bankruptcy, so the protection offered by the federal law may not be of much help.

It’s a tough call to make, and you’d benefit from some advice. Consider contacting a legitimate credit counselor, such as one affiliated with the National Foundation for Credit Counseling, to see if a debt management plan could help you. But you also should talk to an experienced bankruptcy attorney so that you understand all your options and the possible consequences of each.

A: Not everyone can qualify for a Chapter 7 liquidation bankruptcy, which typically erases credit card debt. If your income is above the median for your area, or if you’re trying to protect assets that would be taken in a Chapter 7 case, you could wind up in Chapter 13 bankruptcy, which requires a repayment plan.

The best way out of your situation may be to buckle down and pay off the debt as quickly as you can, even if it means your daughter has to take a sabbatical from school for awhile. You also could sell or cash in some non-retirement assets, if you have them, to pay off your debt.

If you really can’t afford these bills, you could contact a legitimate credit counselor, such as one affiliated with the National Foundation for Credit Counseling, at www.nfcc.org, to see if you could swing a debt management plan that would allow you to pay off these bills at a lower interest rate.

If that won’t work, another option is to try to negotiate a settlement with your creditors. Settlements trash your credit scores, and your creditors could sue you if you stop paying your bills, so this solution isn’t for the faint of heart. You may want to return to that attorney and ask for guidance before you take such a drastic step.