Debt Reduction Strategies

Four Ways to Deal with Debt

Since it’s so easy to get into debt, it should come as no surprise that so many people are quickly drowning it in. The old adage -” Act in haste, repent in leisure” is especially apt when it comes to debt.

Just a few quick signatures can get you deep enough in debt that will still be around decades later.

Everyone is looking for a quick for just about every problem in the world, so why should overwhelming debt be any different? But is there such as thing as a quick fix when it comes to debt?

Debt Consolidation

The first alleged quick fix is debt consolidation. By this I refer to the kind of work done by some credit counseling firms.

There are many kinds of counseling firms around, all with varying degrees of effectiveness and ethics. You best bet is a firm associated with the National Foundation for Credit Counseling. This association has set up a network of local Consumer Credit Counseling Services. These are non-profit firms, partially funded by the credit industry.

At one point, chances were good that you could work out a plan through one of these agencies that effectively reduced your debt and payments, because of the industry affiliation. However, lenders felt they were being taken advantage of, and have drastically tightened up their standards for helping overwhelmed lenders. Read Credit Counseling to learn more about the problems consumers are now facing.

Other credit counseling firms, some calling themselves non-profits, got into the business and advertised heavily. While some were legitimate, there were many con artists that abused their customers badly.

They would keep the money the customer sent in to pay off debt, they would pay late and run up fees for you, their own fees were exorbitant and many were just shills trying to get their customers into high cost debt consolidation loans.

A good credit counselor will make you gather all your bills and income stubs before even meeting with you. He will go over your financial situation and come up with a plan. He will then try to negotiate with your creditors to reduce your debt or your interest rate or both.

However there is only so much a credit counselor can do. Some lenders refuse to negotiate at all. Others will actually raise your rates if they find out you are in counseling.

The best you can hope for is a plan that gets you out of debt in 5 years or so and that reduces your overall balances by 40 – 60%. All in all this is not a quick fix.

Another approach some counselors will take is to offer you a debt consolidation loan, either secured by a mortgage or unsecured, if you don't own a home. Since you are already in financial distress, don’t expect such a loan to be cheap.

I would not consider such as loan unless you have destroyed all your credit cards and closed the accounts. Make sure that you not only have enough money to pay back the loan, but also to cover your ordinary living expenses, such as your rent or mortgage, car payment, food, utilities, health insurance, etc.

If you think you can swing it, shop around. If the credit counselor can arrange for a loan, chances are you can find other lenders on your own who will give you a loan. Compare terms, especially upfront fees and the interest rate.

Make sure that your loan payments – and interest rate - are considerably less than the combined bills you were paying before. Otherwise, why bother?

Now this is not really a quick solution to your debt problem – you have a big loan to repay, but can also be the beginning of the end of your debt nightmare if you have the discipline to control your spending.

Credit counseling will probably have some affect on your credit score and might invoke the universal default clause in some of your credit contracts, kicking up your interest rates substantially on a few of your accounts.

A debt consolidation loan will probably affect your score less. It might even help it. That doesn’t mean you should go out and run up new debt.

Home Equity Loan

If you have a home with some equity in it, you can either refinance or get a second mortgage. Everything I have said about destroying credit cards and imposing self-discipline applies doubly, since you will lose your home if you screw up.

The attractiveness of this type of loan is its tax deductibility and the relative ease with which you can qualify for one with a reasonably low interest rate.

It should also have little impact on your credit rating.

This is superficially at least one of the more attractive – although not really quick – fixes to your debt problems. But do you want you use the equity in your home to pay for last year’s Christmas presents?

Also do you want to convert short term debt, something that can be paid off in five years or so, into a 15 – 30 year commitment?

Debt Settlement

If you’re really close to bankruptcy, debt settlement (or negotiation) might be for you.

There are many firms that do this type of work. They negotiate your debt down, usually in return for a quick pay-off of the remaining debt.

These firms make many big promises. If you use one, it is up to you to see that they’re kept.

Watch out for fees and expenses. Try to cut a deal where you only pay a percentage of the money the firm saves you.

Double or triple check the firm. Get references and check them out. Go on the internet and search on the firm name to see if anything comes up. Check with the Better Business Bureau.

If the firm successfully gets your debts reduced, be aware that the IRS, and some states, will consider the forgiven debt as taxable income. Also lenders don’t like this technique and your credit score will plunge. This will be a negative item on your credit report for seven years or so.

The big advantage is that a large chunk of debt is immediately wiped out, increasing your ability to meet your other debts and hopefully giving you a chance to rebuild your credit score.

This is one of the true quick fixes to overwhelming debt.

Bankruptcy

The second true quick fix is bankruptcy. Bankruptcy has lost most of its negative connotations. It will wipe out all dischargeable debts - read Bankruptcy to see which debts are not dischargeable.

The procedure is relatively painless, in spite of bankruptcy reform that came into effect in late 2005. Lenders are trying to clamp down on what they consider unnecessary bankruptcies, so they are throwing up more obstacles in the potential bankrupt’s path, but if you don’t have a lot of assets to protect, things are pretty much as they were before.

You have to go through a mandatory 90 minute counseling session, which will cost you $50. The counselor will tell you which chapter you can file under, Chapter 7 or Chapter 13. Be aware that if you are forced into Chapter 13, you might want to consider other options, because of the draconian budget that will be forced on you.

Bankruptcy remains on your credit report for ten years, but because of anomalies in the credit scoring system, your score might go up, you will likely get immediate offers of new credit and within two years, you will be able to get a mortgage at a rate very near to what prime borrowers will qualify. That is, if you behave yourself from a financial standpoint.

Bankruptcy is truly a fresh start and should be used if you have no other options.

What to Do? Credit Counseling?

When people get so far into debt that they have to consider these measures, they usually don’t know where to turn or what to do. The psychological pressure is enormous. They are harassed day and night by bill collectors.

In other words they need expert help. So ask around and find a well regarded credit counselor, bankruptcy attorney or consumer debt advocate. Ask questions and discuss your options. At least you will have a good idea what your next step should be.

At this point credit counseling is required before you can file for bankruptcy, so you really have nothing to lose by giving it a try.

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