Debt Help Getting Rid of Debt

Which of These 4 Ways of Dealing with Debt is Right For You?

Written by John Ulzheimer

Making the decision to take control of an excessive debt problem is the first step toward a better financial future. Less debt equals less interest, which leads to more money in your pocket every month.

The challenge is figuring out which debt payment strategy is the best fit for your personal situation.

Here are four of the most common options, and how to weigh whether or not they’re right for you:

1. Debt Consolidation

No term in financial services is ripped off more often than “Debt Consolidation.” There are at least three different methods for getting out of credit card debt that are marketed as being some form of debt consolidation, but in reality there is only one that truly lives up to its name.

The real “Debt Consolidation” is when someone pays off several accounts with one account, consolidating all of his outstanding debt in multiple accounts into just one, newly opened account.

There are two common ways to consolidate credit card debt: a balance transfer credit card, or a personal loan.

Balance Transfers

Depending on your credit score, you may be able to qualify for an attractive new credit card that allows balance transfers. In a balance transfer, you move the debt from one or more credit cards to a new credit card that will not charge you any interest for an introductory period that can be 6, 12, or even 18 months. Balance transfers can help you better manage your debt by 1) simplifying your credit cards payments by combining them all under one account, and 2) giving you time to pay down the balance without accruing new interest.

Keep in mind that many credit cards will charge a transfer feeso be aware of this possibility and make sure that you will save enough in interest to offset the transfer fee. Otherwise, a balance transfer may not make financial sense.

Keep in mind that balance transfers just move debt from one or more credit cards to a new credit card. Therefore, your credit scores may not improve immediately because you will still have the same amount of credit card debt.

But, these offers can save you thousands of dollars in interest fees and buy you some time during the 0% introductory period, allowing you to aggressively pay down the balance without your debt growing.

Personal Loans

Another common method to consolidate excessive credit card debt involves taking out a personal loan to pay off your credit card accounts.

Like balance transfers, a personal loan allows you to use a new account with a lower interest rate to pay off your higher interest rate debt. While personal loans will offer a much lower interest rate than most credit card accounts, they won’t be able to compete with the extremely low introductory credit card balance transfer offers of 0%.

However, using a personal loan to consolidate credit card debt may be the smarter choice, even if the interest rate is a little higher. For starters, paying off revolving credit card debt with an installment loan will almost immediately help your credit scores. This is because installment loans are considered differently on your credit reports than credit card debt. A major factor used to calculate your credit score is your utilization ratio, which is the percentage of your available credit you are using.

If you have, say, a credit card with a $10,000 limit and you are carrying a balance of $8,000, then your utilization ratio is 80%, which isn’t so great for your credit score. If you pay off that balance with a personal loan, then your utilization ratio drops down to zero and your credit score jumps up.

The second reason that a personal loan may be a better option than a balance transfer is the issue of interest. While an introductory balance transfer offer of 0% interest is very attractive, you could find yourself right back in trouble if you aren’t able to pay off the full amount before the introductory period ends. Any remaining balance is going to be subject to a much higher interest rate once the introductory offer expires. You don’t have those issues with personal loans because the rate is fixed the entire time you’re using the account.

I actually like the personal loan option more than I like the balance transfer option, although both are better than doing nothing.

Finally, a personal loan is amortized over a shorter period of time than credit card debt which means that one way or the other you’re going to pay off the loan in a few years, normally less than five. And while the payments might sting during that time frame, it’s a far cry from making minimum payments on credit card debt that could take decades to pay off.

Click Below To See Option 2 on the Next Page

2. Debt Settlement

Debt settlement is relatively easy to understand. Here’s an example: if you owe a creditor $5,000 and convince them to accept $2,500 to pay off the debt, then the debt has been settled.

Some consumers hire debt settlement companies to negotiate settlements, but doing so isn’t necessary.

You are completely within your rights and capabilities to negotiate settlements on your own, and some creditors refuse to negotiate with debt settlement companies as a rule.

Beware of Resurrecting the Dead Debt

Every state has a statute of limitations that determines when an old debt will become “time barred.”

Time barred debt is debt which has aged to the point where a creditor can no longer sue you in an effort to collect the debt. To determine whether a debt should be time barred a you can contact your State Attorney General’s Office or do a little online research.

Time barred debt can still remain on your credit reports if the debt has not yet reached its “purge date.” Accounts are not purged from your credit reports until the time limit for credit reporting, which is typically seven years from when it first went into default. This is sometimes called the “7 Year Rule.”

Because of this, you might be motivated to settle a time barred debt if, for instance, the account was preventing you from qualifying for a mortgage loan. You might even decide to settle a time barred debt because your financial situation has improved and you feel that paying off the debt is the right thing to do.

If you are thinking about settling a time barred debt, keep in mind that it is only a good idea if they plan to do so in a single, lump sum payment.

Negotiating a payment plan on time barred debt is a bad idea because once the first payment is received, the door is legally re-opened for the creditor or collection agency to sue you for the remaining balance.

However, if a settlement on a time barred debt is is negotiated and paid in full, then the creditor or collection agency would not be able to sue you because the debt has been fully exhausted.

When Debt Settlement Doesn’t Make Sense

Debt settlement may or may not be the right option for you, depending on the type of debt you are dealing with. Debt settlement is usually not a good option for consumers who are current on their bills. First, the act of settling a debt can have a very negative impact on a your credit scores. Settlement is considered to be a major derogatory item in both the FICO and VantageScore credit scoring systems.

Also, if you are current on your bills, the creditor may not truly believe that you are in financial distress. If you’ve always made your payments on time, and continue to do so, why would I accept half of what you actually owe me, unless there’s some compelling reason for me to do so?

You Might Get Sued

If you think your credit card company is going to sit idly by and wait for you to call them to negotiate a settlement, you’re mistaken. The minute you default on a credit obligation, the creditor is hard at work trying to figure out the best way to compel you to pay them.

If you’ve defaulted on a large debt then you can bet the farm that the creditor is going to seek counsel and weigh a lawsuit as an option.

While you can ignore your credit card bills, you can’t ignore that guy banging on your door who hands you a summons notifying you that you’ve just been sued. That friendly guy, formally referred to as a “process server,” just put you on notice that you have 30 days to find a lawyer, hire him or her at $400 per hour, and respond to a creditor that you didn’t pay.

Click Below To See Option 3 on the Next Page

3. Credit Counseling

Credit counseling can be a great option for consumers who find themselves overwhelmed with credit card debt but still have both a consistent income and the ability to make monthly payments of a lesser amount. And, it’s a fantastic option for those who care about their credit scores.

When you sign up to work with a credit counseling organization you enter into what is known as a Debt Management Plan, or DMP.

First, you will be assigned a debt management provider who will assess how much you owe, earn, and how much you can realistically afford to pay out on a monthly basis.

Next, the debt management provider will attempt to renegotiate your debt by contacting your creditors and trying to lower monthly payments, fees, and interest rates on your behalf.

If the negotiations are successful (which is not always guaranteed) then you will begin making a single, monthly payment to the credit counseling organization. It in turn will subtract its fees from your monthly payment (if applicable) and then will distribute the remaining funds to all of the creditors included in the DMP, sort of like a Chapter 13 bankruptcy trustee.

The credit counseling organization usually receives a monthly fee from each of the creditors involved in the consumer’s DMP. Typically a DMP takes three to five years to complete, but if it’s completed according to terms then you can actually pay off your debt without causing any further damage to your credit reports and scores.

Choose Wisely

As with any industry, consumers need to be aware that there are some bad apples in the credit counseling space. Scammers operating under the credit counseling umbrella have been known to take advantage of financially desperate consumers by charging high fees and failing to deliver what was promised.

Credit counseling services can be offered by for-profit and non-profit organizations. If you want to ensure that you’re dealing with a reputable organization then you’re going to want to choose one of the members of the National Foundation for Credit Counseling.

When credit counseling doesn’t make sense

DMPs can certainly be very effective but they are not always the best solution for dealing with all excessive debt scenarios.

If you have recently experienced an income reduction but can still afford to pay something on your credit obligations each month then a DMP is likely going to be a good fit. However, for consumers who have experienced a financial hardship from which they are not likely to recover in the near future then it might more sense to consider speaking with a bankruptcy attorney.

A DMP is a good idea if you can realistically afford to keep up with the newly renegotiated monthly payments and if you are committed to three to five years of making those payments.

If a you enter into a DMP and default on the new payments, then it’s possible that the fees will be reapplied to your accounts.

Click Below To See Option 4 on the Next Page

4. Bankruptcy

Filing for bankruptcy has been compared to rolling a hand grenade into you credit report. It’s the equivalent of bringing out the “big guns” because it’s the most extreme measure you can take when dealing with debt problems.

What is bankruptcy?

Bankruptcy is a legal protection from creditors. Depending on the type of bankruptcy and your individual scenario, it may completely eliminate your debt or allow you to repay it at a rate that is more in line with your financial capabilities.

Once a bankruptcy has been filed your creditors cannot continue to attempt to collect debts from you. That means no lawsuits, no more late payments reported to the credit bureaus and no more harassing phone calls.

Chapter 7 vs. Chapter 13 bankruptcy

The two primary options available to consumers who are considering filing bankruptcy are a Chapter 7 and Chapter 13 bankruptcy.

Chapter 7 is also referred to as a “straight” bankruptcy and results in the liquidation of all consumer debts, as long as they can legally be eliminated. When a financially distressed consumer files for Chapter 7 he must pass a test to verify that he does not make too much money. If he passes the test then the consumer is eligible to file a Chapter 7.

Chapter 13 is often referred to as “reorganization” or a “Wage Earner Program.” A consumer typically files for a Chapter 13 when he either (a) earns too much money to pass the Chapter 7 test or (b) wants to keep assets like cars and houses.

Consumers who file for a Chapter 13 will be appointed a trustee who will examine their “repayment plan” which restructures the consumer’s debts and forces some creditors to accept a lesser amount than is owed and possibly forcing other creditors to wipe out the debts entirely. The consumer will make a new monthly payment to his trustee typically for three to five years before the bankruptcy is complete.

The Downside

Bankruptcy is going to have a very negative impact on your credit scores, not once but twice.

First, when the bankruptcy itself finds its way onto the public records section of your credit reports there is likely going to be a negative score impact. Second, each account that was included in the bankruptcy is going to have a bankruptcy notation added and thus compound the damage.

Thankfully the idea that a bankruptcy will forever destroy someone’s credit is false. Bankruptcy filings can only remain on your credit report for up to 10 years. And yes, there are ways to begin rebuilding credit after filing bankruptcy and as the bankruptcy ages it will become less and less problematic.

The Upside

Despite the fact that you’ve just filed for bankruptcy, you’d be surprised how many creditors will roll the dice and take a chance on extending credit.

For example, if you filed a Chapter 7 you may be 100% debt free. If you’ve got a job and no debt then you’re in a pretty enviable position and many creditors will take a chance on you well in advance of the bankruptcy dropping off of your credit reports.

You shouldn’t be surprised when you start getting firm offers of credit in the mail within 24 months of your filing.

About the author

John Ulzheimer

Leave a Comment