Five-Step Plan for Dealing With Deep Debt

 

Five-Step Plan for Dealing With Deep Debt Intense panic accompanied by stifled screams and helpless flailing is a monthly ritual for people drowning in debt. As a cliché, it is, unfortunately, all too familiar. The Federal Reserve announced that as of June 2006, Americans are carrying more than $810 billion in revolving debt. That does not include mortgages and loans for such things as autos, mobile homes, education, boats, trailers or vacations. But it's never too late to turn things around. First and foremost, be committed, says Howard Dvorkin, founder of Consolidated Credit Counseling Services Inc. and author of "Credit Hell: How to Dig Out of Debt." "People have to want to get out of debt. They aren't going to get out of debt just to get out of debt, they have to want it." 1. Establish your bearings. Once you're absolutely, unconditionally prepared to do whatever it takes to pull your credit rating out of a nosedive, you're ready for stage one. "Take a step back and evaluate the situation," says Emily Davidson, corporate communications director for Credit.com. "It's very common for people to skip over this and go straight into crisis mode. It's really difficult for people to face the problems that they might be having." The best way to assess the condition of your finances is by pulling your credit reports. This can be accomplished three ways. Go to Annualcreditreport.com, which is the only authorized source for consumers to access their annual credit report online for free. Call (877) 322-8228. Complete the form on the back of the Annual Credit Report Request brochure, and mail it to: Annual Credit Report Request Service, P.O. Box 105281, Atlanta, GA 30348-5281. You are entitled to one free credit report a year from each credit bureau -- Equifax, TransUnion and Experian. As long as the reports are ordered from the centralized agency, they can be ordered all at once or at different times of the year. Learn how to read your report. It can be illuminating. According to Dvorkin, "People tend to underestimate rather than overestimate -- probably about 20 percent lower than what they actually owe. The average debt is $9,000: 20 percent of $9,000 is $1,800 -- so that is a pretty significant fluctuation for most of us."

2. Chart your path. How far behind in your payments you are can drastically alter your plan of action. "If you're just in the beginning of having this financial crisis and beginning to fall behind, it's really best to work on your own to try to recover," Davidson says. On the other hand, your options are going to be different with one or two 120-day-late payments on your credit report. "If you let something go all the way to a charge-off -- where it's placed with a collection agency -- that will be seriously negative for the full seven years. It is known as 'seriously derogatory,'" says Maxine Sweet, vice president of public affairs for Experian and author of the consumer credit advice column "Ask Max." A severely damaged report does buy you some wiggle room. "You can negotiate with creditors, or work with a debt-negotiation company or debt-counseling company," Davidson says. "The potential downside is that there could be some damage associated with those programs -- as far as how the lenders choose to report your repayments. But if you're already at that stage, there's not a whole lot that can happen." Obviously, the hope is that you've caught yourself before that point. Even if you haven't, you will be able to recover with some work and the passage of time. "People have a lot of options," Dvorkin says. "Unfortunately, they don't realize all their options. Bankruptcy isn't the first option; it's the last option. The first is to juggle the household budget." 3. Put the plan into action -- the dreaded "B" word. Call it a budget, spending plan or resource allocation; it all comes down to the same thing: "Stop spending," says Sweet. "You can't say 'I'm in over my head' and keep living the same lifestyle. You have got to figure out what you can cut out of your life." This is the mantra of credit experts. "Stop spending; use cash instead of a credit card," Dvorkin says. "Most people's budgets are 15 to 20 percent fat. You don't need a $4 latte at Starbucks every day. People can do without certain things -- do you need 200 satellite channels? Can you get away with 100?" 4. Pay your bills. So your budget is whippet-lean, yet there's still not enough money to stretch across all your obligations. You do have options. "If you're unable to pay small bills, it's a good idea to contact the business to see if you can work out an agreement," Davidson says. In the case of an extreme emergency, "If it's a utility bill, or something that doesn't report to the credit bureaus, it's sometimes OK to skip it -- if it's a one-time situation where you're in a financial crisis -- if you have to in order to pay bills that are reported to the credit bureaus, you can avoid damage," she explains. Payments should be prioritized. After paying your rent or mortgage, the loan or credit card with the highest interest rate comes first, while paying the minimum on the rest of your debts. "By far the most expensive kind of debt you can have is payday-loan debt," Davidson says. "Consumers should really do anything they can to pay that off first." Similarly, collection accounts should hold high priority. Unpaid collections are worse than paid collections. You can negotiate a payoff settlement that reduces your bill, and when you do, demand that all derogatory remarks be removed from your credit report or at least reported as paid in full. Be sure to get agreements in writing before sending off your payment. Be proactive when you're struggling with payments. Call your creditors and negotiate to keep your accounts current and from being reported as delinquent or "bad debt." You can ask for reduced monthly payments, or even change due dates to balance out your monthly bills. "Most lenders want to help you find a solution," says Davidson. The same strategy can be used for fixed-loan payments. Remember, though, that this is a short-term strategy. You'll pay more interest to extend the repayment schedule, but it allows you to stay current and save your credit rating. Use the extra money to pay off debts one at a time, gradually increasing payments to other debts. You may be surprised at the help that is available. "Obviously, with student loans there are forbearance programs, there are mortgage programs for people who are having hardships," Davidson says. The important thing is to work with your creditors throughout your struggle. Worst-case scenario: When you just can't even come close to paying your debts, declaring bankruptcy is an option. The long and costly process will, if successfully completed, discharge most of your debts and let you build up your credit again. "Chapter 7 stays on your credit report for 10 years and Chapter 13 for seven years. It's a long, long time of impact," says Sweet. Generally, most people are surprised at how easy it is to regain their credit in the aftermath, but it can be an uphill battle. 5. Add stability to your credit file. If you have really bad credit -- perhaps even filed bankruptcy -- don't let your credit status go dormant. "The faster you begin to re-establish good credit, where you pay on time, every time," says Craig Watts, public affairs manager at Fair Isaac Corp., "the faster you'll improve your credit score." "After you've gotten out of the real danger zone, check your credit reports," Davidson says. "See what's happened; don't just assume that you destroyed your credit. Once you do that, you'll have a better idea of how you can continue your recovery. "For example," she says, "if you've filed for bankruptcy, you can see exactly what your credit score is and then evaluate what kind of products you can apply for that will help you re-establish your credit." A secured credit card is one option for consumers seeking to build a solid credit history. One caveat: Make sure your credit grantor reports to the credit bureaus, not all do. Last, open a savings account at your bank. This shows creditors that you are working to save and that you have reserves to repay debts.