Start Dealing with Debt Issues Today
Debt is like an infection–the longer you put off taking action against it, the more it will grow. Unfortunately, you can’t just apply an ointment or take a pill to get rid of debt. The only way to get rid of it is to spend less than you earn.
You will not get ahead by borrowing money and paying interest. The average household pays 14.5% of their budget on debt payments. Among families with debt of any kind, including mortgages, other loans and credit cards, the median level of debt is $55,300.
Debt issues aren’t just a problem for people who make average or below-average incomes. Households with large incomes also get themselves into debt problems buying a lifestyle they can’t afford. As the paycheck increases, ways to spend it also increase. There are some who are living in the big house, but crossing their fingers to make the monthly payment.
Four signs that you have debt problems
1) You feel like you are living on the edge and losing a job would
create instant financial turmoil.
2) You can only afford to pay the minimum amount on loans and credit cards.
3) You use credit cards to pay for necessities or to get you through to the next paycheck.
4) Your total debt is over 35% of you total income
Examine Your Debt
If you are struggling to pay your bills, prioritize your debt and pay these off first: housting, utilities, food (stop eating out), transportation, child support, and health insurance. These are the bills that are a necessary to keep your family healthy and safe.
Next in importance are back taxes and student loans. If you owe back taxes, work out a payment plan with the IRS. Do not avoid paying taxes when they are due, this can result in steep penalties. If you are in trouble, contact both of these to work out a schedule of payments.
Get a Plan to Pay off Credit Cards and Auto Loans
Start reducing debts like credit cards and auto loans. Write down each loan with the balance, interest payments, and minimum payments. Paying down the monthly minimum (2% of your balance) will never pay off your card; pay as much as you can to pay it off as quickly as possible. Pay off your loans with the highest interest rates first since these are
costing you the most. After you pay off the highest rate card, move on to the next. However, if you have a credit card that is close to your cedit limit, pay off that one first.
Meanwhile, pay the minimum balances on the other cards until the first is paid off. If you have more than three credit cards, keep the oldest two accounts open, and close the most recent accounts. Keep your oldest accounts open because the account history looks good on your credit score.
If you are in a short-term situation, where you can’t pay all of your bills, contact each creditor (credit cards, auto loans, furniture loans, etc.) to work out a payment plan. It is in the creditors best interest to work out a payment plan for you to keep you paying something, rather than months of missed payments and a default on the loan. Tell them what you can realistically pay each month. Ask them to lower your interest rate or waive you fees if you have late payments or over-the-limit fees. If the first person you speak with says they can’t help you, ask to speak with a supervisor, or someone you can. This may take some persistance and multpile calls to get a payment plan that helps you. Keep a detailed log of the calls you make, the date and time of the call, the person you spoke with, and the decisions made.
Be Cautious with Debt
Avoid store credit cards. Even though discount offers are tempting, the APR is high–typically 20%-25% for cards from retailers such as Sears and Best Buy. Store credit cards also typically have low limits, so consumers easily spend it all on their first purchase. Being close to your credit limit with any card is a red flag increases your debt utilization ratio and could drag down your credit score.
Beware of no interest financing. You will be hit with a high interest payment if you don’t pay at least the minimum each month and pay off the balance by the end of the offer.
Be very cautious about using home equity loans to pay off credit card bills. DO NOT run up new debt. This will just steal the equity from your home and put your home at risk. If you do not have the discipline to stop spending, do not use a home equity loan.
If you are in danger of missing a payment, contact your creditors as soon as you realize you have a problem. They may be able to help you work out a payment plan, lower your rate, or lower your monthly payment. It is better business for them to keep you paying your debt and interest payments and avoiding bankruptcy and foreclosure.
Pay attention to the notices you receive from your lenders by mail. Credit card issuers and other lenders have the right to change the terms and conditions of your loan; they just have to mail you a notice. Credit card issuers can increase your interest rate or lower your credit limit. If you are unaware of the changes, you could have an expensive surprise in your monthly bill.
Avoid using your credit card for cash advances. This may be an easy way to get cash in a crunch, but it is extremely expensive. The rate is between 20-25%, and the fee is 3%. If you don’t pay attention, this can put you over your credit limit which will generate a $39 fee and can cause problems on your credit report. If you have a high balance from a cash advance, look at transferring this to a card with a lower rate.
Avoid subprime credit card offers. These target families trying to get out of debt and young people with no credit. Subprime cards have extremely high rates and fees; since these are prepaid and don’t charge interest, the issuer makes money from the fees. The annual fee can also use up much of your available credit. They also do not help you credit history because they do not report your activity to credit agencies. Secured cards are a better option to build credit.
Avoid loans from pawnbrokers, bill-paying services, finance companies, check-cashing outlets and payday lenders. These all charge high rates and fees. They also charge low minimum payments so it may take forever to pay off the debt. Finance companies can also be a negative reference on your credit report.
Do Not Borrow More than You Can Afford
If you can’t afford to pay for an item, don’t put it on your credit card. Save and pay with cash. Credit cards are not additional income. If you currently carry a balance, do not use your credit card for everyday items such as meals, clothes, gas and groceries. There is no sense in paying $90 for a $30 meal with nothing to show for it.
If your home is more than you can afford, sell your home and downsize into one that fits into your budget. Mortgage payments, property taxes and homeowners insurance should be less than 25% of your gross income. If you can’t afford the monthly payment for a fixed, 30-year mortgage, you can’t afford the house.
If your auto loan is a larger part of your budget than you can afford, sell the car and get a car with a lower payment. Also, limit your loan to 24 months. You will pay too much interest with a longer loan. Don’t buy into 0% down. The more you put down on your car, the more money you will save in interest payments. A goal is to eventually pay cash for a car since it is an asset that depreciates as soon as you drive off the dealer’s lot.
Will Debt Consolidation Help?
Your first step is to honestly assess your situation by asking yourself these questions:
- Do you have a serious problem or situation that has gotten you into debt? And, is it over so that now you can begin to dig yourself out?
- If you get a lower rate loan and consolidate your bills, will you be able to stop buying on credit and only buy what you can pay for with cash?
- Will you be able to eliminate or drastically reduce your debt with a new loan?
Here are several options for consolidating debt:
1. Transfer Balances to a Lower Rate Credit Card
Start by contacting your credit card issuers and other lenders and ask for lower rates. If that doesn’t work consider transferring your balances or small loans (like auto or student loans) to a lower rate credit card. However, only do this if you can pay off all or most of the card during the intro period. For many cards, this is now 6-12 months.
Many cards will allow you to apply for the card first to see what your offer will actually be and transfer your balance within a few months to a year. Keep in mind that the median credit limit is $13,500. You may not be able to transfer your total balance, so start with the highest rates. Balance transfer fees are now 3% of your total balance.
2. Home Equity Line of Credit
Do this only if you are absolutely committed to paying off your debt and 100% certain you will not run up new debt. You are offering your house as security that you will pay the debt. Since this reduces the risk to the lender, these loans have lower rates. If you do not pay back this loan, losing your home is a possible consequence. Beware that the payment terms are lenient and it is easy to just pay minimums. If you want to make this work, pay as much as you did before on your monthly bills- don’t use this as a way to pay less on your debt and use your money for something else. The mortgage crisis has made it more difficult to get a home equity line of credit.
3. Personal Loan
You may be able to get an unsecured loan at a bank or credit union for a lower rate than the average credit card rate. Start with your own bank where you have a relationship. However, the bank will look at your credit report and may not give a loan if you already have too much available credit already.
What happens if you Don’t Pay Off Your Debt?
If you don’t pay off your credit card bills, after sixty days they can classify your account as defaulted and will turn your account over to collections. A defaulted account is costly for credit issuers, they would rather work out a payment plan and keep you paying something toward your debt.
If you are in financial distress without a plan, contact a credit counselor. They advise about general budgeting, foreclosure, bankruptcy, and credit card repayment. They can help you walk through your household spending budget, suggest ways to cut expenses and pay down your debt. To find a legitimate counselor, contact the National Foundation for Credit Counseling, at www.nfcc.org or call 1-800-388-2227.
Consider Credit Unions
Consider joining a credit union, they typically have the lowest rates and fees for credit cards, auto, mortgage, and personal loans. They also look at your total credit picture, not just your credit score, which may help you get lower rates. You can find a credit union through National Credit Union Administration,http://www.ncua.gov/.
Mortgage Rates and Student Loans
There are some situations where borrowing is beneficial. Your home is an asset that appreciates and the interest on your mortgage is tax deductible. On college loans, the interest rates are reasonable and the education is an investment in your future.
Once you have paid your other debts, tackle your mortgage. Save interest by making one additional payment each year. Send the lender a letter in writing that the extra payment should be applied to principal, not interest. Keep a copy of the check and letter to make sure the payment has been applied correctly.