Five Steps for Getting Out of Debt Without Declaring Bankruptcy
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Despite studies that report monthly drops in credit card usage and defaults, some Americans are having difficulty paying off excess debt even as the economy improves. There were 133,459 U.S. bankruptcy petitions filed in May 2011, which is 10% more than in 2010, according to Automated Access to Court Electronic Records (AACER).
“There’s no redeeming quality to debt. Years ago debt was tax deductible but it hasn’t been for decades,” says John F. Harrison, CFP with Aspire Financial Advisors in Newtown, Massachusetts. “The interest added to items purchased on credit doubles and even triples their cost and creates emotional stress.”
While 33% of Americans carry credit card balances up to $10,000 and 13% carry more than a $10,000 balance, according to a Consumer Reports survey, eliminating $10,000 in debt is manageable for most households without claiming bankruptcy. Here’s how:
1) Consolidate Debt
One way to get serious debt under control is to merge credit card balances on multiple high interest rate accounts onto one credit card with a lower interest rate. A 0% loan gives you time to pay off credit card balances without interest charges draining away your payment. The longer the introductory period, the more debt you can pay down. The Citi Simplicity card currently offers 0% for 21 months. Many balance transfer offers with 0% APR are only available to consumers with good credit scores.
There are some red flags consumers should be aware of when transferring a balance from one credit card to another. One is the balance transfer fee, usually 3% to 4% of whatever amount is transferred. This fee is added in to your balance, so you can also end up paying interest on the fee if the balance isn’t entirely paid off when the 0% period ends.
Another danger is the temptation to run up debt again once the consolidation is complete.
“You start charging a little on the new card since the rate is so low. Then, when the introductory period expires and the rate goes up, you can be left with more debt than when you began. You have to be very disciplined to make a balance transfer work,” says Gail Cunningham, spokesperson with the National Foundation for Credit Counseling (NFCC) whose member agencies counsel more than three million consumers each year. The average client that comes to an NFCC member agency for help with their debt has six credit cards to their name.
2) Create a Spending Plan
About 40% of American families spend more than they earn, according to the Federal Reserve.
A spending plan or budget involves accurately tracking all of your expenses–cash, checks, credit cards–so that outflow doesn’t exceed income.
“The easiest way to reduce expenses is to have a budget so that you know where your money is going,” says Harrison. “When you work with a monthly spending plan, it’s easier to see where you can cut back and find money to put toward debt repayment.”
To create a spending plan with customized categories, track spending for 30 days with a notebook carried at all times in a coat pocket or purse. “Everyone in the household must agree to track spending so that the head of the household can figure out where the money is going,” says Cunningham. “It’s the little money spent casually that adds up. You can’t know where you are going financially until you know where you are.”
3) Properly Manage Your Credit Cards
It is natural to want to cut up credit cards once they are paid off or consolidated, but doing so can affect your credit score. The idea is to pay off serious debt while rebuilding a damaged credit report.
“By closing a card you’ve paid off, you remove available credit so that your debt relative to your line of credit increases and this negatively impacts the credit utilization factor of the credit scoring model,” says Cunningham. “Credit is a privilege. If you have it, treat it respectfully. Close with caution because credit is hard to come by these days.”
Pay more than the minimum each month in order to reduce overall finance charges. Interest rates and the method by which finance charges are calculated vary from one credit card company to another. By law, issuers must disclose the interest rate they charge as well as the method which they use to calculate the charges on monthly credit card statements. The Card Act of 2009 requires issuers to provide cardholders with a snapshot chart or table of how long it will take to get out of debt.
According to Americans’ Financial Capability Study by the National Bureau of Economic Research, the borrowing habits of 41% of credit card users resulted in either substantial interest payments, fees or both. 54% always pay their credit card bill in full. Of the 46% who don’t pay their credit card payment in full, 12% don’t know the interest rate on their card with the largest balance.
Paying just the minimum takes longer to pay off debt, especially on cards with high interest rates because the principal remains untouched. If you can only afford the minimum payment on your card, stop using it. Do not add more debt that you can’t afford. If you have more than one credit card, prioritize them by interest rate and pay off your debt with the highest rate first.
4) Generate New Income
About 19.3% of Americans in the workforce are underemployed in 2011 according to Gallup Healthways Well-Being Index, which defines the underemployed as either unemployed or working part time but wanting full-time employment.
Look into overtime and additional projects. Use this money to pay down debt. For those in salaried positions, asking the boss for a raise may help. Projections for 2011 salary increase budgets are up at 3% compared to 2.5% in 2010, according to The Conference Board, a global, independent business membership and research association. Salary increase budgets refer to the money that companies earmark for salary increases in the coming year and are represented as a percentage of current payroll.
5) Suspend Investing
Consider reducing or suspending investing, but continue to put money into retirement accounts. If you get behind and quit investing in retirement accounts, it is hard to make that up.
The average APR on credit cards with a balance on it was 14.67% in 2010, according to the Federal Reserve’s G.19 report on consumer credit. Paying down debt at 15% is a better return than many investments.