Options and Strategies for Managing Debt

When it comes to working through financial difficulties, there is no one-size-fits-all program or solution. Each individual’s situation and financial hardship is unique, therefore requiring that the appropriate option or solution meet their individual needs. AAA Fair Credit Foundation’s Certified Financial Counselors will help you explore your options so you can resolve your debt problems in a way that’s best for your own personal situation. AAA Fair Credit Foundation is not allowed by law to provide legal advice or representation.

Listed below are various options and strategies for getting your debt situation under control.

Option 1: Self Help - Do It Yourself

Spending Management
Managing debt and spending is a constant challenge for many people. While most people have the intent to be financially fit, they simply just do not have the right tools to reach financial independence. Becoming financially fit is a realistic goal, and one that everyone – regardless of income – can attain.

The first step in reaching this goal is to stop overspending. This sounds simple, but for most, it’s quite the opposite. The fact is, if you don’t have the right tools, you will continue struggling with overspending and debt accumulation.

One excellent way to control your finances is by using a spending plan. The amount of money wasted each month on unnecessary purchases can be surprising - $5 here, $10 there – it adds up quick if you’re not paying attention. A spending plan combats poor spending habits by identifying where you will spend and save your money so all your money is accounted for. By tracking ALL your spending, you can identify the areas where money is wasted and redirect that spending to bill payment, saving for retirement, or some other savings goal.

Follow the steps below to create a balanced monthly spending plan:

• List your income and create a list of all your assets.
• Complete a list of your debt obligations.
• Compare income vs. expenses.
• Set priorities and make changes so your income will be greater than your expenses.
• Track every purchase and monetary transaction.
• Compare your actual performance with your plan.
• Make adjustments as necessary.

Contact Your Creditors
If you can't make ends meet because of temporary emergency (job loss, illness, divorce, death or a loved one, or an other compelling reason), contact each of your creditors and ask them to reduce their monthly bill until you get on your feet again. Explain why you are falling behind and try to work out a modified payment plan that reduces your payments to a more manageable level. Some creditors may offer some type of in-house assistance program. These programs typically reduce payments for brief periods, generally up to 6 months. Unfortunately, not all creditors will agree to a modified payment structure, so you may find your overall debt load is still too heavy for your budget, even after contacting all your creditors. If you find this is the case, you should consider the next option – Credit Counseling / Debt Management Plan.

Option 2: Consumer Credit Counseling / Debt Management Plan

Consumer Credit Counseling
Credit counseling is a combination of financial education, budgeting assistance and debt counseling. A good Credit Counselor will listen to your story and encourage you to talk about your financial challenges. A Certified Counselor will review your whole financial situation including both your budget and debt, and will educate you on the merits of options available to you. AAA Fair Credit Foundation is licensed as a non-profit consumer credit counseling agency.

Debt Management Plan (DMP)
In a DMP, participating creditors will typically offer special concessions like lower monthly payments and lower interest rates. Many creditors will also “re-age” (bring current) your account and report it to credit reporting agencies as current instead of past-due. A DMP isn’t for everyone. For example, it won’t lower your secured debts, like mortgage or car payments. Also, if your debts are completely unaffordable or you are in danger of losing your home or car, a DMP is probably not your best option. It is also good to know that while creditors may report an account is being administered through a credit counseling agency (this notation does not affect your credit score). However, accounts enrolled in a DMP must be closed and your participation may also limit your ability to obtain new credit while you participate in the program. DMP services are available as part of the suite of financial services offered by AAA Fair Credit Foundation.

Option 3: Obtain a Debt Consolidation Loan

Certainly not the worst thing you could do, but you must own a home, have some property or have some assets to pledge as collateral for the loan...otherwise a loan isn't even an option at all. In addition, you cannot borrow your way out of debt. You're still going to have to pay back the money to someone.

You may be in a position to lower your cost of credit by consolidating these debts into a second mortgage or a home equity line of credit (HELOC). Remember, these loans require that you put up your home as collateral on the loan. If you can’t make the payments, or if your payments are ever late, you could lose your home.

Also be sure to calculate the total cost of a debt consolidation loan. Like all other options, there are pros and cons to consolidating debts through a home loan. In addition to the interest on the loan, you may have to pay “points,” with one point equal to one percent of the amount you borrow. On the other hand, these loans can provide certain tax advantages not available with other kinds of credit.

Option 4: Negotiate Settlements for Less Than Full Balance

Debt negotiation differs greatly from credit counseling and DMPs. It can be very risky, and have a long term negative impact on your credit report and, in turn, your ability to get credit. That’s why many states have laws regulating debt negotiation companies and the services they offer. Contact your state Attorney General for more information.

Debt negotiation firms may claim they’re nonprofit. They also may claim that they can arrange for your unsecured debt — typically credit card debt — to be paid off for anywhere from 10 to 50 percent of the balance owed. For example, if you owe $10,000 on a credit card, a debt negotiation firm may claim it can arrange for you to pay it off with a lesser amount, say $4,000. The firms often pitch their services as an alternative to bankruptcy. They may claim that using their services will have little or no negative impact on your ability to get credit in the future, or that any negative information can be removed from your credit report when you complete their debt negotiation program. The firms usually tell you to stop making payments to your creditors, and instead, send payments to the debt negotiation company. The firm may promise to hold your funds in a special account and pay your creditors on your behalf.

Just because a debt negotiation company describes itself as a “nonprofit” organization, there’s no guarantee that the services they offer are legitimate. There also is no guarantee that a creditor will accept partial payment of a legitimate debt. In fact, if you stop making payments on a credit card, late fees and interest usually are added to the debt each month. If you exceed your credit limit, additional fees and charges also can be added. This can cause your original debt to double or triple. What’s more, most debt negotiation companies charge consumers substantial fees for their services, including a fee to establish the account with the debt negotiator, a monthly service fee, and a final fee of a percentage of the money you’ve supposedly saved.

While creditors have no obligation to agree to negotiate the amount a consumer owes, they have a legal obligation to provide accurate information to the credit reporting agencies, including your failure to make monthly payments. That can result in a negative entry on your credit report and your credit score will be adversely affected. And in certain situations, creditors may have the right to sue you to recover the money you owe. In some instances, when creditors win a lawsuit, they have the right to garnish your wages or put a lien on your home.

Even if your creditor reduces the amount you owe, it doesn't mean you're free and clear. The Internal Revenue Service considers the amount forgiven as income (reffered to as Discharge of Indebtedness) and the creditor will probably send you a 1099-C form to report it on your annual tax return at year end).

Option 5: Bankruptcy

Bankruptcy generally is considered the debt management option of last resort because the results are long-lasting and far reaching due to the fact that it can appear on their credit report for up to 10 years. Bankruptcy is also a matter of public record for anyone that wants to know. Filing bankruptcy requires you to appear in Federal Court for at least one hearing, possibly more. In addition, certain types of bankruptcy require a court-appointed trustee to control and oversee your estate.

People who follow the bankruptcy rules receive a discharge — a court order that says they don’t have to repay certain debts. However, bankruptcy information (both the date of your filing and the later date of discharge) stay on your credit report for up to 10 years, and can make it difficult to obtain credit, buy a home, get life insurance, or sometimes get a job. Still, bankruptcy is a legal procedure that offers a fresh start for people who have gotten into financial difficulty and can’t satisfy their debts.

There are two primary types of personal bankruptcy: Chapter 13 (Reorganization) and Chapter 7 (Liquidation). Each must be filed in federal bankruptcy court. As of April 2006, the required filing fees run about $275 for Chapter 13 and $300 for Chapter 7. Attorney fees are additional and can vary.

In October 2005, Congress made sweeping changes to the bankruptcy laws. The net effect of these changes is to give consumers more incentive to seek bankruptcy relief under Chapter 13 rather than Chapter 7. Chapter 13 allows people with a steady income to keep property, like a mortgaged house or a car, which they might otherwise lose through the bankruptcy process. In Chapter 13, the court approves a repayment plan that allows you to use your future income to pay off your debts during a three-to-five-year period, rather than surrender any property. After you have made all the payments under the plan, you receive a discharge of your debts.

Chapter 7 is known as straight bankruptcy, and involves liquidation of all assets that are not exempt. Exempt property may include automobiles, work-related tools, and basic household furnishings. Some of your property may be sold by a court-appointed official — a trustee — or turned over to your creditors. The new bankruptcy laws have changed the time period during which you can receive a discharge through Chapter 7. You now must wait 8 years after receiving a discharge in Chapter 7 before you can file again under that chapter. The Chapter 13 waiting period is much shorter and can be as little as two years between filings.

Both types of bankruptcy may get rid of unsecured debts and stop foreclosures, repossessions, garnishments and utility shut-offs, and debt collection activities. Both also provide exemptions that allow people to keep certain assets, although exemption amounts vary by state. Note that personal bankruptcy usually does not erase child support, alimony, fines, taxes, and some student loan obligations. And, unless you have an acceptable plan to catch up on your debt under Chapter 13, bankruptcy usually does not allow you to keep property when your creditor has an unpaid mortgage or security lien on it.

Under the Bankruptcy Abuse Prevention and Consumer Protection Act (“BAPCA”), which took effect on October 17, 2005, all individual debtors who file bankruptcy on or after must undergo credit counseling from an approved nonprofit credit counseling agency that is approved by the U.S. Trustee Program within six months before they file bankruptcy, and must complete a U.S Trustee-approved financial management instructional course after they file bankruptcy. With certain exceptions, an individual is not eligible to file bankruptcy without completing credit counseling, and is not eligible to receive a bankruptcy discharge without completing a financial management instructional course.

To obtain a state-by-state list of approved credit counseling agencies visit www.usdoj.gov/ust, or contact a Federal Bankruptcy Court. Before you file a Chapter 7 bankruptcy case, you must satisfy a financial “means test.” This test requires you to confirm that your income does not exceed a certain amount. The amount varies by state and is publicized by the U.S. Trustee Program at www.usdoj.gov/ust.

Individuals considering filing bankruptcy should seek the services of a licensed Attorney in their state of residence specializing in this field.

Option 6: Do Nothing

For most people this is not a practical solution, but technically it is still an option. An example where doing nothing might work for you would be if you were unemployed and had no assets a creditor could pursue to repay the debt owed. Essentially you would be judgment proof and your creditors would (at least temporarily) hit a roadblock. However, this does not mean that they can’t come after you at a later date when you least expect it.