Search:

Debt Settlement, Bankruptcy and Credit Ratings

By: Eric Jilson. Debt is often one of the largest expenses people may have. Paying off a debt should always be of a higher priority than savings and investments. It makes perfect sense that reducing debt quickly will result in a better return to consumers than putting savings into a money market account or into shares whilst still retaining that debt.
The best way to deal with debt is to choose a strategy that you can maintain.
Investing in debt
Q: Increasing debt is a growing problem for consumers in our country. Is it then better to pay off the debt or to place the money into savings?
A: It is by far the best strategy to pay off high-rate debt, particularly credit card debt where the interest rates are quite high. Your best strategy is to pay all you can towards that debt and only use your credit card in emergencies.
There are caveats; it's also a good idea to establish a savings habit even whilst you are fighting debt. This may be something as small as placing all your change at the end of each day into a special jar and when the jar is full, putting the contents into a bank account.
If you haven't established a retirement plan at work, you may decide to put aside a small amount from your paycheck each month so that you get in the habit of setting aside that money, rather than spending it. If, however, you have a high-rate debt, you should focus on clearing that first, as once that debt is gone you will have more money to place into savings or investments.
One size doesn't necessarily fit all
Q: Many people manage to claw their way out of debt, only to fall back in again. Would it be the right thing for some people to cancel their credit cards, even if this may result in credit score implications?
A: It would make sense for those people who find that having the credit card is too much of a temptation to spend. If you find yourself in debt, you have to work out why in order to stay out of it.
Everyone's situation is different, therefore there is no "one size fits all" solution to this problem. If your debt is a result of an unusual one-off incident eg a car accident, then you may not have problems with a credit card, because the temptation is not the problem. If, however, you find that you are constantly using the cards, spending more than you can really afford, you may need to cancel them.
Expensive credit booster
Q: What credit implications would there be for a person who decides to cancel their cards? For someone with a credit card problem, what would be more damaging: the overuse and late payments of the cards or getting rid of the cards?
A: When I speak to upset consumers, most of them say, "I don't want to damage my credit rating." This is interesting, because they may already have a very high level of debt but they avoid seeking help thinking that this may affect their rating. Almost a third of a credit score is based on the level of debt, so their rating is most probably already adversely affected.
Most people don't see that - they think that paying the bills on time is an indication of financial responsibility.
Often, the problem is how much it will cost to maintain your credit score, rather than the degree of affect. An example of this is a person who is constantly running up debt, therefore paying high interest rates, or someone who has a high level of debt but does not seek advice from a debt settlement company or credit counselling service will end up paying a great deal in order to maintain their credit rating. This can sometimes be thousands of dollars once they have paid the interest.
If they choose to deal with the problem, initially their credit rating may be affected, but in the long run their costs will be reduced because their debt has been negated and they can start afresh. Both sides have to be considered: what costs there are in damaging your credit rating and what are the expenses in maintaining your rating if you keep the debt.
The average consumer should pay attention to their credit rating as it affects other things as well as credit card costs. It will affect your mortgage, auto insurance etc, but this is commonly less than what you would be paying in interest.
Getting back on track
Q: You speak about dealing with the problem and putting up with the affect on the credit score to get back on track. Are you referring to bankruptcy? Or is bankruptcy only for the most desperate scenarios in these times?
A: Bankruptcy can be a result, but it doesn't have to be. This is where my opinion differs from other consumer advocates - there is more than one way to handle the situation.
In the first instance, if you have the ability to get yourself out of the situation in three years or less, then that is what you should do. If that is not possible, you should speak to someone from a credit counseling agency. There are a number of people who would like to do this but are prevented from doing so because of the expense of the monthly payment on the credit counseling program.
Bankruptcy can sometimes be the appropriate solution. I always try to encourage people with a lot of debt to talk with a bankruptcy attorney. This is confidential, it won't damage your credit, it doesn't cost anything to talk and it will help you overcome the fear of what will happen if you file.
People think that they'll lose everything and that their furniture will be taken away. This doesn't automatically happen. Speaking with an attorney will help give a person the correct information for their situation.
Between bankruptcy and credit counseling there is an option of debt settlement. This solution has a bad reputation because of the number of companies in that area who are less than reputable. It can be an option and you can decide whether to do it yourself or hire a company to help you. It may be possible to settle your debts for less than what you owe now, enabling you to work on rebuilding your credit and your financial life.
Debt settlement option
Q: How can you decide whether debt settlement is a good option?
A: Ninety percent of the people I speak to have no desire to file for bankruptcy and will do anything they can to pay their bills. This is where debt settlement will work. There are a number of criteria in choosing the best company. The most important things to keep in mind are that, should the company appear to be pushing you towards debt settlement without considering your circumstances or explaining things to you, or if they indicate that it is an "easy" way out - do not stay with them. Whilst debt settlement can be painful, like any other solution (not just a fix it pill), with all its negative and positive aspects, it can be a good option. If you choose to do it yourself, I would recommend Zipdebt.com. It was founded by Charles Phelan, who was originally in the industry and it's very, very good.
His program costs nearly $400, so it can be out of reach for many people who are deeply in debt.
My opinion is that it is worth that amount because it goes into a great amount of detail about how debt settlement works, things to avoid, dealing with different types of collection tactics, etc and someone who purchases this will save much more than the cost of the package.
There is a basic program available at $197 -- the more expensive $397 program includes some coaching from Charles and this can be very helpful for consumers who need one-on-one help. You should also remember that the average consumer will pay more than that in fees for a credit counseling program and it is also costs much less than the hiring of a consumer law attorney (although that is sometimes the best option for some people).
Bankruptcy
Q: Is debt settlement considered a lesser credit offense than bankruptcy?
A: To be able to go through debt settlement, your accounts have to go delinquent. There is no way out of that as you can't settle if your accounts are current. Creditors do not will allow it, so your credit is going to be temporarily damaged. This is a solution for someone who will not or cannot file for bankruptcy.
Both debt settlement and bankruptcy negatively affect your credit report. Chapter 7 bankruptcy will remain on your report for 10 years and with debt settlement, the collection reports will remain on your report for seven and a half years from the date you first fell behind on the original debt. If you take two years to pay off the debt settlement then the effect would be about the same.
Whether you are dealing with bankruptcy or debt settlement, once it is completed you can start rebuilding your credit.
Best strategies
Q: You had mentioned that it's best to try to pay off as much of the debt as possible. What would you say is the best debt pay-down strategy to follow?
A: You should view reducing debt as a marathon, rather than a sprint, because that is what is the reality for most people.The strategy that is the best for getting out of debt is one that works for you. Remember that everyone's situation is different. There are many reasons as to why consumers end up in debt. The idea that a solution is to just "spend less, save more" can be misleading and frustrating for those who have run into medical debt or those who have done everything by the book for 20 years and then have to leave the workforce in order to care for an aging parent. For everyone it's different. So I encourage people to find the approach that suits them best.
If one program or strategy doesn't seem to be working for you, try another one. If you feel that you need some support, choose the coach, class or group that's going to work for you. Examples of these include Debtor's Anonymous, going to Dave Ramsey's class at your church or an online support group.
Remember that we are all different and don't become discouraged if the first option doesn't seem to be working. Look to others who have been successful, examine what they've done and find the way that works for you.
Staying out of trouble
Q: How can we as consumers avoid debt problems in the first instance?
A: The most important thing to do is to build a back up reserve in your finances. Also, if you are keeping an old Visa credit card you may request for a balance transfer to your mostly-used card from the issuer with 0% interest; this will mean more available balance for you in your new card. For when things go wrong because inevitably a challenge will happen to everyone. Buy the smallest, least expensive house that you will be comfortable in.
The biggest pitfall for most people (I've done it too!) is taking on debt based on where we currently are financially or where we think we're going, then realizing for whatever reason that we can't follow through.
An example of this is you get the big car payment based on the job you have now, but then a year later you no longer have the job but you still have the car and the repayments. Many people are going through the same problem with houses right now. They bought the house based on where they were economically at that time; the interest rate has changed, taxes have gone up, the value of the house is reduced etc and the debt is no longer affordable.
Every day we are faced with the pressure to spend, spend, spend. It's very difficult to go against that tide and to try to live and save more for the future than for today. This trap is a common one and it is not easy to get out of.
For most of us, debt is something we must take on if we are to buy a car or a house - it cannot be avoided. But we should be careful that we don't find ourselves in a situation that is impossible to get out of. When you lose money in the stock market, that can be difficult, but if you cannot sell your house and have to endure a foreclosure, that is something else.
Getting help
Q: What would you like to leave our readers with?
A: Debt is very stressful, isolating and very scary. If you find yourself in that situation, don't try to do it all on your own. Don't be scared to ask for help, whether this is talking to an attorney, a counseling agency or someone you trust. It's very difficult and you need someone to encourage and motivate you.