Thursday, 7 May 2015
If you are like many Americans, you have debts.
As of December 2014, the average American household owed more than $15,000 in credit card debt alone, according to NerdWallet. On top of that, there is student loan debt, averaging $32,264, and mortgage debt, averaging $155,192.
While overspending is sometimes the source of the debt problem, more often debt is the result of uncontrollable circumstances. NerdWallet Health crunched the numbers in 2014 and found medical bills were the number one cause of personal bankruptcies.
"While we are quick to blame debt on poor savings and bad spending habits, our study emphasizes the burden of health costs causing widespread indebtedness. Medical bills can completely overwhelm a family when illness strikes," Christina LaMontagne, VP of Health at NerdWallet, said in a release.
The number of personal bankruptcies has been declining the last four years, largely due to the improvement in the economy, according to Fitch Ratings (via Association of Credit and Collection Professionals). Still, some one million people filed for bankruptcy in 2014.
Given the serious consequences of bankruptcy, including loss of property and impact on your credit, it certainly should be treated as a last resort. Here are some tips to help you avoid bankruptcy.
"Your primary goal is to dedicate as much money as you can each month to paying down your debt," said Elizabeth Bauer-Simmons, a credit counselor for a non-profit organization in Atlanta. "This means cutting back dramatically on expenses and making serious sacrifices."
Eliminate virtually all discretionary spending immediately, she said. "Things like movies, dinners out, buying unnecessary clothing, expensive haircuts should be the first to go." After that, try reducing food and utility costs. Downsizing to a smaller house or cheaper car could be an option, providing your credit is good enough for you to get financing or approval for a lease.
If you need help prioritizing and trimming your budget, Bauer-Simmons said help is available from certified credit counselors at many non-profit agencies.These services are typically low cost, between $25 and $50, and free if you cannot afford to pay, she said.
You should contact your creditors as soon as you realize you are unable to meet your monthly payment obligations, Bauer-Simmons said. There is no guarantee, but in some cases creditors agree to reduce interest rates, change the payment terms, or reduce fees.
"Some money is better than no money to the credit card companies," Bauer-Simmons said. She added in her experience, credit card companies are the most willing to negotiate. "I have seen it make the difference between filing bankruptcy and being able to avoid it."
She cautioned that if you make an agreement with a creditor, you stick with it. "Most of them aren't willing to negotiate twice," she said.
One mistake many people make, Bauer-Simmons said, is not prioritizing how they will pay off their debt. "Don't approach paying off your debt randomly," she said. "You need to have a plan."
Budget to pay for "absolute necessities" first, she said, like housing, transportation, food, utilities, and any legal obligations like child support.
Next, focus on the debt with the highest interest rate. "Make minimum payments on the necessities and other debt, and pump as much money as you can into your highest rate credit card or loan," she said. "After you've paid off the highest, move on to the next highest, and so on."
She added in many cases student loan payments can be reduced or deferred if the borrower is in extreme financial distress. "Take advantage of this if you can," she added, "but make sure you don't forget about the loan." You need to be aware when the deferred payment period ends in order to avoid penalties or default.
A debt consolidation loan can sound like a quick and easy fix. You get one loan — with one monthly payment — and use the proceeds to pay off all your other debt. If you get a home equity loan for this purpose, your home is used as collateral.
"I typically don't advise my clients to get a debt consolidation loan," Bauer-Simmons said. "In my nearly 20 years of experience, I've never seen that be a viable solution."
Bauer-Simmons isn't the only one who is skeptical of such loans. According to U.S. News and World Report, debt consolidation is a poor choice primarily because consumers think they've addressed the issue and fail to solve the underlying problem, which is financial mismanagement. Also, debt consolidation can end up costing more in the long run when you factor in interest and fees. And if you borrow against your home to consolidate debts, you risk losing it.
Debt settlement services are mainly offered by for-profit companies that offer to negotiate a settlement with your creditors for a fee. According to Consumer Reports, these companies ask for the fees upfront, and they can be up to 15% of the total amount of the debt. And in most cases, also according to Consumer Reports, the companies do not provide their clients with any significant relief from their debt problem.
"There are absolutely no benefits to using these services. In fact, they can get you deeper into trouble" Bauer-Simmons said. "Remember, if it sounds too good to be true, it usually is."
If you decide you can't go it alone and need professional help, debt management services offered by non-profit organizations are a better option, according to CBS News.
Bauer-Simmons, whose agency offers debt management, explained these services include negotiating with your creditors, primarily to lower interest rates and reduce or remove fees. Once they have negotiated an agreement with the credit company, you pay the debt management service each month and they distribute your payments to your creditors.
Debt management is not free, but the fees are dramatically lower than debt settlement companies. In most cases, you'll pay around $25 a month for the service, Bauer-Simmons said. "And we never turn anyone away if they cannot pay the fee."
While you are in the debt management program, you are typically not allowed to open any new credit accounts and you receive financial counseling — such as learning to make a budget and start saving money.
As far as how it affects your credit score, Bauer-Simmons said, your creditors are aware of the situation, but they can use their discretion as to whether they report this to the credit bureaus. Typically, she said, participation does not have a negative impact on your overall credit score.
"No one got into debt the same way, and no one gets out of it the same way," Bauer-Simmons said. "Sometimes bankruptcy is the best option for a client. But it's important to carefully consider all the options before making that decision."
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