There’s no denying that it’s been a rough couple of years. In my practice I’ve assisted more clients with bankruptcies and foreclosures since the downturn started about three years ago than I have in my entire career. I’ve worked with people who’ve been hit with everything except the proverbial kitchen sink, and they’ve got the lumps to prove it.
So let’s talk about debt and how to deal with it, because even though the economy is showing some signs of life, I think we’re far from out of the woods, and many people are still struggling from the loss of income.
Financial burdens can suck the joy out of life. Massive debt is emotionally oppressive and casts a shadow over just about everything else in your life. So it’s not surprising that many people deal with debt issues by ignoring the mound of unpaid bills and hoping that somehow it will all just go away.
But that’s just about the worst thing you can do.
Looking at all the financial horror stories I’ve witnessed over the past three years, they all have one common element, and that’s time. The fact is that when you’re investing your money, time and compound interest can work wonders. But when you owe money, time and compound interest can wreak havoc. So that’s my first bit of advice for dealing with your debt burden: Don’t procrastinate. Start doing something to get your debt under control, and start doing it today.
The next thing you should do is understand the types of debt that you have, because not all debts are equal. Secured Debt is any debt that is backed by collateral, something of value the creditor can seize if you default on your debt. We’re talking mostly about mortgages and car loans. Unsecured Debt is any debt that is not backed by collateral, so your creditor is taking a much bigger risk when loaning you money. Bigger risk means higher interest rates. That would be your credit card or the line of credit so generously offered by your bank.
So all other things being equal, the debts that you want to pay off first are your unsecured debts, starting with the one with the highest interest rates – and don’t forget to factor in the late fees that creditor may charge when you get behind. Whichever one is costing you the most is the one you want to attack first. Save your mortgage or other secured debts for later.
To deal with unsecured debt, the best place to start is by negotiating with your creditors. Banks don’t want you to declare bankruptcy and they don’t want you taking your balance to somebody else (especially if it means closing your old account). To prevent losing business, creditors are sometimes willing to offer lower rates or even settle debts for a lump sum payment less than what you currently owe.
Creditors know perfectly well that a host of competitors offer cards with low introductory rates and that their customers are not going to pay 20% (or more) indefinitely. Call the customer service desk of your current high-interest credit card and simply inform them that you’d like a lower rate – and it doesn’t hurt to tell them about the great offer you just received in the mail from the other guys.
If they’re not willing to bring the rate down, fill out the paperwork and transfer your balance. But be warned, these low rates can get pretty steep once the introductory period expires, so be disciplined in making payments on the balance regularly to eliminate the debt as quickly as possible. This is a “grace period” where you can eliminate one of your debts, so use the opportunity wisely.
Lump sum settlements are a little harder to find, but it’s not impossible. In this case, you contact the credit card company offer to pay $5,000 cash to settle your $10,000 debt. Now it’s highly unlikely that the creditor will accept an offer like that, but just as with any other negotiation, you start low and meet somewhere in the middle. If the creditor is willing to play ball, you could take thousands off the balance and thousands more off the interest you’d be paying over time.
But now the question becomes, where can you scratch together the money to pay the lump sum?
Now if you have a large, high-interest credit card balance and some semi-liquid assets like an IRA, it might actually make good financial sense to take the tax hit for cashing out a portion of the IRA in order to pay off the debt. Now this is not something I recommend lightly, so make sure you run the numbers to make sure it’s to your advantage.
To make this determination, figure the tax consequences of taking money out of your IRA – and don’t forget the 10% penalty in addition to the tax liability based on your tax bracket. Then compare the tax consequences to the interest that will be paid on the credit card debt – the website bankrate.com has a handy calculator that can help make this calculation.
If you’re just making the minimum payment required by the credit card company, you’ll likely find that the interest you’re paying on the debt could be two or three times what you actually owed in the first place – and far less that the tax liability you’ll incur from the one-time raid on your retirement savings.
But here’s the thing. Don’t do this until you’re certain that your cash-flow situation is under control. If every month shows you sinking deeper into debt, don’t resort to tapping a retirement account because the result could be that six months from now, you’re back in debt but with a smaller retirement nest egg. Make sure your current income can cover your current liabilities.
Creditors know perfectly well that a host of competitors offer cards with low introductory rates and that their customers are not going to pay 20% (or more) indefinitely. Call the customer service desk of your current high-interest credit card and simply inform them that you’d like a lower rate – and it doesn’t hurt to tell them about the great offer you just received in the mail from the other guys.
If they’re not willing to bring the rate down, fill out the paperwork and transfer your balance. But be warned, these low rates can get pretty steep once the introductory period expires, so be disciplined in making payments on the balance regularly to eliminate the debt as quickly as possible. This is a “grace period” where you can eliminate one of your debts, so use the opportunity wisely.
Lump sum settlements are a little harder to find, but it’s not impossible. In this case, you contact the credit card company offer to pay $5,000 cash to settle your $10,000 debt. Now it’s highly unlikely that the creditor will accept an offer like that, but just as with any other negotiation, you start low and meet somewhere in the middle. If the creditor is willing to play ball, you could take thousands off the balance and thousands more off the interest you’d be paying over time.
But now the question becomes, where can you scratch together the money to pay the lump sum?
Now if you have a large, high-interest credit card balance and some semi-liquid assets like an IRA, it might actually make good financial sense to take the tax hit for cashing out a portion of the IRA in order to pay off the debt. Now this is not something I recommend lightly, so make sure you run the numbers to make sure it’s to your advantage.
To make this determination, figure the tax consequences of taking money out of your IRA – and don’t forget the 10% penalty in addition to the tax liability based on your tax bracket. Then compare the tax consequences to the interest that will be paid on the credit card debt – the website bankrate.com has a handy calculator that can help make this calculation.
If you’re just making the minimum payment required by the credit card company, you’ll likely find that the interest you’re paying on the debt could be two or three times what you actually owed in the first place – and far less that the tax liability you’ll incur from the one-time raid on your retirement savings.
But here’s the thing. Don’t do this until you’re certain that your cash-flow situation is under control. If every month shows you sinking deeper into debt, don’t resort to tapping a retirement account because the result could be that six months from now, you’re back in debt but with a smaller retirement nest egg. Make sure your current income can cover your current liabilities.
Now you might be thinking that you can’t just do this by yourself. Negotiate with a multi-billion dollar credit card company?! Sure you can, but if you want help, there are a couple of things to consider. The first is that you can find any number of for-profit entities who say they specialize in debt reduction and have some vague but miraculous way of eliminating your debt. At best, this is an exaggeration and at worst, it could be an invitation to fraud.
There are non-profit organizations out there who assist consumers with getting their debt under control. But let’s be clear in understanding that just because an organization is non-profit doesn’t mean that their services are free. You will have to pay for their assistance. To find an approved consumer credit counselor in your state, go to this website.
Only twelve days until the tax filing deadline! Many happy returns!
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