5 tips for managing your debt

Consumer Reports News: May 02, 2013 07:08 AM

Recently we asked debt-management experts for their best tips on handling debt. Several are certified credit counselors in agencies connected with the nonprofit National Foundation for Credit Counseling (NFCC), a group that offers free or low-cost help. Our tips will help you pare down what you owe.

Tip 1: After budgeting, negotiate
Tip 2: Consolidate your obligations
Tip 3: Prioritize payments
Tip 4: Use a credit counselor
Tip 5: Consider the last resort

Tip 1: After budgeting, negotiate

A first step for clients of InCharge Debt Solutions in Orlando, Fla., is an analysis of income, expenses, and assets, says Mike Leon, manager of credit-counseling operations. He then helps them prepare a scaled-back spending plan.

Leon will also contact a client's credit-card company to request a lower interest rate. He says he's often able to negotiate reductions for clients in the single digits. Recently he had an interest rate on a $4,900 balance cut to 7 percent from 16 percent, and another balance of $2,550 was cut to 6 percent from 24 percent.

But you can do that yourself. "You'd be surprised at how many people don't call their creditors before things get to a point where they're falling behind," says Bruce McClary, a spokesman for ClearPoint Credit Counseling Solutions in Seattle. You'll get more cooperation if you're still current with payments.

Tip 2: Consolidate your obligations

Folding multiple credit-card and loan bills into one loan with one monthly payment can help you manage what you owe. There are two types of debt consolidation worth considering:

Combine student loans. The average college graduate with a bachelor's degree in 2011 holds $27,000 in debt among 8 to 12 student loans, says Mark Kantrowitz, publisher of FastWeb.com and FinAid.org, college-finance resource hubs. Borrowers can make their lives much easier by seeking a Federal Direct Consolidation Loan. The federal student-aid website has details.

In consolidation, a weighted average of all the student's loan interest rates determines a new rate and monthly payment, which can't exceed 8.25 percent. Students typically are offered several repayment options. The minimum monthly payment on a consolidation loan may in fact be lower than the combined payments for a borrower's federal loans.

Parents who have borrowed for their children's college education can consolidate their Direct PLUS loans--fixed-rate education loans borrowed from the federal government--but they can't group them with their children's loans.

The system can help identify those who are eligible for new debt-forgiveness and income-based repayment plans. Loans that originated from private lenders can't be consolidated under this program. Read "Student Loan Borrowers Shouldn't Get a Degree in Debt" for more information on paying for college.

Transfer debt to a lower-rate card. Some credit cards offer a zero-percent teaser interest rate on balance transfers for a limited time. You'll typically pay a transfer fee of 3 to 4 percent of the balance. If you don't pay off the entire balance by the time the teaser rate expires--usually 12 to 18 months--you'll owe at a much higher rate, generally between 12 and 22 percent. (Read about the best travel credit cards.)

If you don't think you can pay the balance within the introductory period, opt for a card with a low fixed rate. One with a relatively low rate for the life of the balance transfer--4.99 percent--is the PenFed Promise Visa Card from Pentagon Federal Credit Union. People who are not federal employees or connected to the military or qualifying organizations can join PenFed for a nominal amount.

Tip 3: Prioritize payments

If you can't pay all your debts each month, Deanne Loonin, a staff attorney at the National Consumer Law Center in Boston and author of the center's "Guide to Surviving Debt," recommends focusing on keeping current on secured debt--obligations like auto loans and mortgages that are backed by property. Give high priority to debts related to necessities such as utilities and debts you can't discharge, including student loans and unpaid federal taxes.

Have a plan for dealing with unsecured credit-card debt. If you made only the minimum 2 percent payment on a $2,000 balance accruing interest at 18 percent, it would take you 24 years to pay it off. Increasing payments to 5 percent would cut your repayment period to six and a half years. Boost it to 10 percent, and you'd be free in about three and a half years.

When the Consumer Reports Money Lab analyzed different ways of prioritizing credit-card payments, we found that paying off the card with the highest interest rate first resulted in the lowest amount of interest paid. But if that balance is large, you won't feel the liberating results as fast. With the "snowball approach," you budget a total monthly amount to pay your credit-card bills. You pay the minimum on the larger balances, and work on paying off the smallest balance first. You may end up paying more in interest, but you'll get a psychological lift from erasing each card's debt. And having open accounts with a zero balance might help your credit score.

Tip 4: Use a credit counselor

Sometimes doing it yourself is just too hard.

With a debt-management plan (DMP), a counselor can negotiate with most creditors to lower rates and eliminate late fees and other penalties. Then the agency will act as a consolidator, collecting one monthly payment from the debtor and disbursing funds to creditors. Nonprofit agencies that are members of the National Foundation for Credit Counseling charge a one-time DMP setup fee of about $30. Most also require DMP maintenance fees averaging $20 a month. Before you work with an agency, research it with a local Better Business Bureau.

Avoid for-profit debt-settlement companies, which claim they will settle all your debt for a fee without counseling or a DMP. The Consumer Financial Protection Bureau says those arrangements usually can't get you better terms than what you could negotiate yourself.

Tip 5: Consider the last resort

Personal bankruptcy
--under Chapters 7 and 13 of the U.S. Bankruptcy Code--can seem like the financial version of a nuclear option, but experts say it can be a useful tool for some people. "You have the same right as General Motors to discharge your unsecured debt," says Georgette Miller, an attorney in Lawnside, N.J., with additional offices in Delaware, New York, and Pennsylvania.

In Chapter 13 bankruptcy, credit-card balances can revert to zero. You can keep your home and car. You'll still owe on first mortgages, auto loans, and usually student debt. Student-debt interest continues to accrue during the bankruptcy period, but those creditors can't pursue you for payment. You can stretch out or catch up on other debt for up to five years. After that, your student loans revert to your original loan terms or to new negotiated terms.

Chapter 7 bankruptcy requires you to liquidate assets to pay your debts, but it also discharges your liability for certain debt (student loans are an exception). You're eligible for Chapter 7 when your income is below a certain dollar threshold. Federal and state bankruptcy laws offer exemptions to protect you from having to sell some assets. Florida exempts primary residences; Nevada exempts primary-home equity of up to $550,000 per couple. Federal law exempts equity in a vehicle worth up to $3,675, among other exemptions. Social Security, pension benefits, and retirement-account assets are exempt as well.

This article is adapted from the May 2013 issue of Consumer Reports Money Adviser.

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