January 2006
What if your debt has gotten out of control?
If you owe money, you've got plenty of company. So many people are borrowing these days that more than $2 trillion in consumer
debt is currently outstanding, up 23 percent since 2000. And that doesn't even include mortgages.
Getting into debt is easy, of course. Just open your mailbox, and you'll probably be greeted by a cascade of credit-card and mortgage-refinancing offers. But getting out is another story. These days the problem isn't only for slackers who charge too much without a thought of how to pay it back. For even the most financially conscientious among us, a descent into debt can be triggered by unexpected medical expenses, a job loss, or a costly divorce.
For anyone who has been coasting along, making minimum monthly payments on credit cards and taking on more and more debt just to pay the bills, the time for action is now. If you find yourself in that situation, here are five steps that can help:
1. Determine how bad it is
Take an unflinching look at your bills. Add up the total balances to get a grip on how much debt you currently have outstanding. You can find out what it will cost you to pay back that debt over various time periods, using the calculators at sites such as CardWeb.com or Bankrate.com. For each credit card, put in the current balance, the interest rate, and how much of the balance you pay each month. For example, if you've been paying the minimum 4 percent on a balance of $10,000 at an interest rate of 18 percent, it will take you 178 months and cost you $5,916 in interest to pay off the debt. Boost your payments to 5 percent, and the term drops to 134 months and total interest payments to $4,240.
2. Don't bet the house
It may seem tempting to take all that credit-card debt and pay it off with a home-equity loan. The rates are lower than those on credit cards, recently averaging 7.33 percent for home-equity loans and 7.04 percent for home-equity lines of credit, according to Bankrate.com. Plus the interest you pay is generally tax deductible. But using your home equity to fix a debt problem can be a big mistake, especially for people who have difficulty keeping their expenses under control.
For starters, you'd be turning an unsecured credit-card charge for last night's pizza into a 30-year debt secured by your home. Further, human nature being what it is, once those credit cards open up, you may be sorely tempted to hit the malls. Before you know it, you may have maxed out your cards again, and now you have a home-equity loan to pay off, too.
Another bad idea: transferring your credit-card balances to a new card that promises a low interest rate or none at all for a period of time on transfers. If you read the fine print, you'll find that if you're late with even one payment, that deal is finished and you're trapped with another high-interest card.
3. Put away the plastic
"Look in the mirror and say, 'The debt stops here,' " suggests Amelia Warren Tyagi, co-author with Elizabeth Warren of "All Your Worth" (Free Press, 2005). If you're carrying too much debt, she says, "you need to go to an all-cash diet." Take those cards out of your pocket, get everyone who charges under your name on board, and assign a percentage of your monthly income to pay down the balances over the long haul; Tyagi suggests shooting for 20 percent. You can keep one card active for emergencies, but leave it at home and preferably under lock and key. This takes some doing, of course, and may require you to postpone or forgo other purchases. But it's better to work things out on your own than under a court order.
If you cling to debt to support your lifestyle, "the stakes keep getting higher and higher," says Nancy Castleman, a founder of Good Advice Press. Whether you're used to using credit for the next-generation MP3 player or this season's silk blouse, ask yourself first, "Do I really need it?"
If your problems are the result of a financial catastrophe, such as huge medical bills, don't panic or be pressured into paying the noisiest bill collector first. Prioritize for the short-term and pay the bills that keep a roof over your head. Call the credit-card issuers to negotiate stretching out payments. One tactic is to say you'll take up another offer and stop using their card. "You're in a position of strength. You're paying them," says Scott Bilker, founder of DebtSmart.com and author of "Talk Your Way Out of Credit Card Debt" (Press One, 2003).
4. Choose your advisers wisely
Credit-counseling agencies are often touted as the place to go for advice and to set up a debt-management program. But in the past some disreputable ones have only dug consumers in deeper. A common ploy: taking your money with the promise of paying off bills, then simply pocketing the cash. The Federal Trade Commission has cracked down on some of the bad apples, but you still have to be careful. If an agency says it uses your first month's payment to creditors for its own fee or as a "voluntary contribution," run the other direction.
You can check credentials at The Association of Independent Consumer Credit Counseling Agencies (www.aiccca.org) and the National Foundation for Credit Counseling (www.nfcc.org), whose members are supposed to adhere to certain standards. Also ask your state attorney general's office or local Better Business Bureau about complaints. And don't hesitate to shop around, which you can do by phone. In particular, ask about fees, which can vary from agency to agency.
Be aware that even the best credit-counseling agency is limited in what it can do for you. It can't do anything about secured loans, that is, your mortgage or a car loan, nor can it reduce interest on student loans. It can negotiate with credit-card companies, hospitals, department stores, and lawyers, but many aren't yielding as much as they once did. In a study of people who've used credit counseling, Jinhee Kim of the University of Maryland found the best results came about when people sought counseling early on and, most important, stayed with it.
It generally takes about five years to pay off debts with a debt-management plan. Agencies get most of their funds from the creditors they negotiate with, but you may also have to pay fees, often about $75 to start and $50 a month after that.
5. Consider the last resort
Bankruptcy has always been the worst-case scenario, and now it's even more so. Because of federal laws that became effective in October 2005, "someone earning above the median income for their state has a much more difficult time liquidating debts," says Todd E. Duffy, a bankruptcy lawyer in New York City. And that's true even if you have extraordinary expenses. The $50,000 heart surgery that put you over the financial brink may move a judge to tears, but it's no guarantee that he or she will discharge your debts if you'd have even $100 left in your pocket each month after paying eligible living expenses. What's more, that amount is set by the Internal Revenue Service, not by what you actually spend. For example, a single person earning $4,167 to $5,833 a month is assumed to be able to get by on $691 a month for food, clothing, and incidentals.
To add insult to financial injury, if you file for a Chapter 7 bankruptcy and don't qualify, you could be accused of abuse of process. What you're left with is Chapter 13, a more stringent bankruptcy plan that requires repaying debts over three to five years and using all of your disposable income toward that end. Attorney's fees for a bankruptcy can range from about $600 to $3,500. And you have to pay that bill up front.
Getting into debt is easy, of course. Just open your mailbox, and you'll probably be greeted by a cascade of credit-card and mortgage-refinancing offers. But getting out is another story. These days the problem isn't only for slackers who charge too much without a thought of how to pay it back. For even the most financially conscientious among us, a descent into debt can be triggered by unexpected medical expenses, a job loss, or a costly divorce.
For anyone who has been coasting along, making minimum monthly payments on credit cards and taking on more and more debt just to pay the bills, the time for action is now. If you find yourself in that situation, here are five steps that can help:
1. Determine how bad it is
Take an unflinching look at your bills. Add up the total balances to get a grip on how much debt you currently have outstanding. You can find out what it will cost you to pay back that debt over various time periods, using the calculators at sites such as CardWeb.com or Bankrate.com. For each credit card, put in the current balance, the interest rate, and how much of the balance you pay each month. For example, if you've been paying the minimum 4 percent on a balance of $10,000 at an interest rate of 18 percent, it will take you 178 months and cost you $5,916 in interest to pay off the debt. Boost your payments to 5 percent, and the term drops to 134 months and total interest payments to $4,240.
2. Don't bet the house
It may seem tempting to take all that credit-card debt and pay it off with a home-equity loan. The rates are lower than those on credit cards, recently averaging 7.33 percent for home-equity loans and 7.04 percent for home-equity lines of credit, according to Bankrate.com. Plus the interest you pay is generally tax deductible. But using your home equity to fix a debt problem can be a big mistake, especially for people who have difficulty keeping their expenses under control.
For starters, you'd be turning an unsecured credit-card charge for last night's pizza into a 30-year debt secured by your home. Further, human nature being what it is, once those credit cards open up, you may be sorely tempted to hit the malls. Before you know it, you may have maxed out your cards again, and now you have a home-equity loan to pay off, too.
Another bad idea: transferring your credit-card balances to a new card that promises a low interest rate or none at all for a period of time on transfers. If you read the fine print, you'll find that if you're late with even one payment, that deal is finished and you're trapped with another high-interest card.
3. Put away the plastic
"Look in the mirror and say, 'The debt stops here,' " suggests Amelia Warren Tyagi, co-author with Elizabeth Warren of "All Your Worth" (Free Press, 2005). If you're carrying too much debt, she says, "you need to go to an all-cash diet." Take those cards out of your pocket, get everyone who charges under your name on board, and assign a percentage of your monthly income to pay down the balances over the long haul; Tyagi suggests shooting for 20 percent. You can keep one card active for emergencies, but leave it at home and preferably under lock and key. This takes some doing, of course, and may require you to postpone or forgo other purchases. But it's better to work things out on your own than under a court order.
If you cling to debt to support your lifestyle, "the stakes keep getting higher and higher," says Nancy Castleman, a founder of Good Advice Press. Whether you're used to using credit for the next-generation MP3 player or this season's silk blouse, ask yourself first, "Do I really need it?"
If your problems are the result of a financial catastrophe, such as huge medical bills, don't panic or be pressured into paying the noisiest bill collector first. Prioritize for the short-term and pay the bills that keep a roof over your head. Call the credit-card issuers to negotiate stretching out payments. One tactic is to say you'll take up another offer and stop using their card. "You're in a position of strength. You're paying them," says Scott Bilker, founder of DebtSmart.com and author of "Talk Your Way Out of Credit Card Debt" (Press One, 2003).
4. Choose your advisers wisely
Credit-counseling agencies are often touted as the place to go for advice and to set up a debt-management program. But in the past some disreputable ones have only dug consumers in deeper. A common ploy: taking your money with the promise of paying off bills, then simply pocketing the cash. The Federal Trade Commission has cracked down on some of the bad apples, but you still have to be careful. If an agency says it uses your first month's payment to creditors for its own fee or as a "voluntary contribution," run the other direction.
You can check credentials at The Association of Independent Consumer Credit Counseling Agencies (www.aiccca.org) and the National Foundation for Credit Counseling (www.nfcc.org), whose members are supposed to adhere to certain standards. Also ask your state attorney general's office or local Better Business Bureau about complaints. And don't hesitate to shop around, which you can do by phone. In particular, ask about fees, which can vary from agency to agency.
Be aware that even the best credit-counseling agency is limited in what it can do for you. It can't do anything about secured loans, that is, your mortgage or a car loan, nor can it reduce interest on student loans. It can negotiate with credit-card companies, hospitals, department stores, and lawyers, but many aren't yielding as much as they once did. In a study of people who've used credit counseling, Jinhee Kim of the University of Maryland found the best results came about when people sought counseling early on and, most important, stayed with it.
It generally takes about five years to pay off debts with a debt-management plan. Agencies get most of their funds from the creditors they negotiate with, but you may also have to pay fees, often about $75 to start and $50 a month after that.
5. Consider the last resort
Bankruptcy has always been the worst-case scenario, and now it's even more so. Because of federal laws that became effective in October 2005, "someone earning above the median income for their state has a much more difficult time liquidating debts," says Todd E. Duffy, a bankruptcy lawyer in New York City. And that's true even if you have extraordinary expenses. The $50,000 heart surgery that put you over the financial brink may move a judge to tears, but it's no guarantee that he or she will discharge your debts if you'd have even $100 left in your pocket each month after paying eligible living expenses. What's more, that amount is set by the Internal Revenue Service, not by what you actually spend. For example, a single person earning $4,167 to $5,833 a month is assumed to be able to get by on $691 a month for food, clothing, and incidentals.
To add insult to financial injury, if you file for a Chapter 7 bankruptcy and don't qualify, you could be accused of abuse of process. What you're left with is Chapter 13, a more stringent bankruptcy plan that requires repaying debts over three to five years and using all of your disposable income toward that end. Attorney's fees for a bankruptcy can range from about $600 to $3,500. And you have to pay that bill up front.
