33
Chapter 4
Debt
Management
L
ike most college graduates,
you have a dream of life after
graduation that includes making
a lot of money and living the good life.
Unfortunately, for most college graduates
this dream is diminished by the large
amount of debt they have accrued during
their heydays at college.
The fact is, most college graduates have
large amounts of student loans, multiple
credit card balances, and a variety of other
forms of debt. And, as you know, all of
these need to be paid.
But don't give up on your dream of the
good life just yet. There is hope. However,
it's up to you to make it happen. So how
do you make it happen? By putting your
debt into perspective and developing a
plan to get yourself out of debt as soon as possible.
Debt Warning Signs
The first step to putting your debt into perspective is to recognize when
your debt is a problem. Monitor your debt every month and watch for any
of these red flags:
00Living from paycheck to paycheck with nothing leftover at the end of
each month.
00Impulse buying. Did you absolutely have to have those new shoes, that
52-inch HDTV, or that new computer?
00Making late or minimum monthly payments on your credit card(s), or
skipping payments altogether.
00Having credit cards that are at, or close to, your credit limit.
00Arguing with family members or friends over your spending habits.
00Being unsure of how much you really owe.
34
Y
o
ur
Financial
Future
00Using cash advances to pay your bills.
00Having more and more of your monthly income that must go to paying
off your debts.
00Having your credit card declined, or being turned down for additional
credit.
Do you recognize yourself in any of these scenarios? If so, it's time you
develop a plan to get out of debt.
Good Debt vs. Bad Debt
As you begin creating a get-out-of-debt game plan, you must first understand
what kind of debt you have. There are two types: good debt and bad debt.
Your goal is to rid yourself of your bad debts first.
So what is the difference between good and bad debt? It's pretty simple:
Good debt is debt that returns something of long term value to you, such
as higher education, or home improvements that increase the value of your
home. Bad debt can often be categorized as short-term "feel good" debt,
like unwise purchases you can't afford and don't really need.
How Much Debt Do You Have?
Now is the time for the reality check. Sit down with paper, pencil and a
calculator and start by making a list of all - and we mean all - of your debts.
By each of your debts, indicate whether the debt is a good or bad debt.
Next, rank them in descending order by their interest rates.
Now, organize your debts. Here is a form you can use:
Good Debts
Name of
Loan
Principal
Owed
Interest
Rate
Annual Interest
Payment (Est.)
Mortgage
$96,552
6.75%
$96,552 x 0.0675 = $6,517
Student
Loan
$27,000
4.50%
$27,000 x 0.0450 = $1,215
TOTAL
35
Name of
Loan
Principal
Owed
Interest
Rate
Annual Interest
Payment (Est.)
Visa
$5,522
15.75%
$5,522 x 0.1575 = $870
Gas Card
$648
11.25%
$648 x 1.1125 = $73
TOTAL
What Is An Acceptable Level Of Debt?
If your bad debt column is blank, and if you have been truthful, give yourself
a pat on the back and keep on doing what you've been doing. But if you've
got entries in the "bad" column, it's time to do some calculations.
Add up the total amount of interest paid on bad debt. Now, add up the
total principle you owe. Figure out your total annual income after taxes.
Now make a ratio out of these two numbers.
Using the previous example the ratio looks like this:
As a general rule, anything over 15 percent should sound an alarm and get
you motivated to lower it as soon as possible. The goal is to get your bad
debt as close to zero as you can, in as short a time as possible.
You may be wondering why good debt is not included in this equation. Good
debt helps your overall financial posture. Of course, if you've gone out on
a limb with your home purchase, or your student loans are staggering, you
may wish to include those numbers in your bad debt equation.
Total Bad Debt: $6,173
Total Annual Income, After Taxes:
$32,000
Bad Debt-to-Income Ratio: $6,173/$32,000 = 19.3%
Debt
Management
Bad Debts
36
Y
o
ur
Financial
Future
Paying Off Your Debt
Take a good look at your bad debt chart, focusing on the balance with the
highest interest rate. This is your starting point. Start your get out of debt
plan by paying that one off first. Once you've paid off your most costly debt,
don't stop there. Move on to the next one, and pay that off. Work your way
down the chart until you have eliminated all your bad debt.
Right now you are probably thinking, "sure, that seems simple enough, but
how on earth am I going to find the money to start paying down this bad
debt? Here's how:
00Lose the credit cards - Put them in a safe, hide them - or even better,
cut them up. Start spending cash or use a debit card. That way you
can't spend what you don't have.
00Develop a budget - Do it with thorough charts, in writing. Study your
spending habits, your obligations, and the places where you are most
likely to get in trouble. Be sure that your written budget prioritizes
the paying down of your bad debt first, but also make sure you can pay
down your good debts on schedule, as required. Never let these slide.
00Live within your means - Stop all impulse buying, and don't lie to
yourself about this. Iron your own shirts. Brown bag your lunch. See
the movie when you can rent it for less than half what the theater
charges. Shop at thrift shops. Use coupons. Buy only sale items. Eat
in, not out. If you're feeling deprived, remind yourself that this is all
about your future, maybe even your survival.
00Pay more than the minimum due each month - This is a trap set by
the bank to own you for eternity. Pay as much as you can stand each
month, and then add a few dollars to that. Watch that debt dwindle
and congratulate yourself every month.
00Transfer credit card debt to a low interest card - If you have too much
debt to put onto that card, pay the minimum due on all cards but the
worst, and start making as large a monthly payment as you can on that
one. It gets easier and easier and feels better and better. Any debts that
you can roll into a single debt at a lower interest rate will put money back
in your pocket that you can then use to pay down the new, consolidated
debt. But be sure to pay very close attention to the fine print involved
with these cards, and familiarize yourself with the terms. Understand
both the introductory interest rate, as well as what it can grow to and
under what circumstances. Many Web sites offer information to help
you compare various credit cards to get the best deal. Start with www.
bankrate.com or www.cardtrak.com.
37
00Refinance your mortgage - If rates have gone down, consider refinancing.
See the Housing: Rent vs. Buy chapter for more information on how to
do this.
00Consolidate student loans - See the Student Loans chapter for more
information on how to do this.
00Use your savings - As painful as it is, it makes no sense to let savings
sit there and earn a piddling amount of interest ( which is taxable ) when
you're paying a much higher interest rate on debt. Paying down your
debt technically puts more money in your pocket in the form of interest
you no longer have to pay, untaxed, than you can earn on most any
savings account.
00Sell stuff you don't need - Have a yard sale or sell stuff online.
Likewise, if you are driving an expensive car, sell it and replace it with
an economy model or, better yet, if you live in an urban area with good
public transportation, go carless for a while and see what you save on
repairs, insurance and gasoline. Yes, your pride will suffer, but it will
suffer worse when you're in bankruptcy court.
00Use your home's equity - Review the Home Equity chapter to learn
how your home's equity can help you get out of debt.
00Get a part-time job - It'll give you a bit of cash to work with and, more
to the point, show you that you never want to get into this situation
again!
00Renegotiate with your lenders - Most lenders will work with you,
particularly if your next choice is bankruptcy. Ask for forgiveness on
fees, a lower interest rate, and/or a longer repayment schedule.
00Borrow from your retirement - "Borrowing" is the important word. And
notice that this is listed last. That's because this is not an ideal solution,
and should only be considered as a last resort. Before you proceed with
this option, consult a professional financial planner. Understand that
you are borrowing it from your future, and that you won't have much
of a future if you drown in debt before you get there. The terms usually
make this an attractive option, because as you pay back the 401(k) plan,
the interest you're paying on that loan is being paid to you. But be sure
you understand the consequences of this decision. For example, if you
decide to leave your job, you must repay the loan within 60 days or you
will be subject to various penalties and taxes.
If You Have Too Much Debt
If your situation is beyond the fixes described in the previous section, there
are resources to help you.
Debt
Management
38
Y
o
ur
Financial
Future
Financial Advisors
Contact your financial planner, if you have one. He or she can be an
excellent source of advice. After all, part of their job is to discuss any
financial problems you may have, and too much debt certainly qualifies.
Consumer Credit Counseling Service (CCCS )
If you want to re-negotiate terms with your creditors, you can get free
information from the CCCS. Call 800-388-2227 to find an office near you.
They will give you general budgeting advice for free, and specific counseling
for a low fee.
Keep in mind that CCCS, although marketed as a non-profit organization, is
funded in large part ( 85 percent ) by fees paid to it by credit card companies
in the form of commissions based on collections. This more or less makes
CCCS a glorified collection agency, which means it puts the creditor's
interest ahead of the debtor's. For example:
00CCCS is unlikely to recommend or even discuss bankruptcy, except to
highlight the drawbacks.
00They will put you on a "debt management program" which will require
you to pay them a certain sum every month that they, in turn, dole out
to your creditors.
00This program favors the repaying of credit card debt and ignores other
important debt, like your mortgage and medical bills, from which they
get no commission.
00They might suggest that you liquidate your retirement fund, and will not
tell you that if you declare bankruptcy, you get to keep your retirement
fund.
00CCCS has a cookie-cutter approach to debt management, and will not
do much as far as weighing individual circumstances.
00They won't mention that restructuring your credit card debt under
their program will have a negative impact on your credit report.
Credit Counselors
Another option is credit counseling groups or credit repair clinics that will
work with you for a fee. Be wary of the crooks out there that will take your
money and do nothing for you. Be particularly leery of those that promise
to "fix your problem fast," get you a "new credit identity," or want their
fee up front. Also, beware if they promise to get the bad info off your
credit report. Bankruptcies, tax liens, judgments and delinquent payments
cannot be removed by anyone for any reason.
39
Investigate any credit counselor you are considering using with the Better
Business Bureau www.bbb.org and any other consumer watchdog group.
Other useful websites include:
00www.debtproofliving.com
00The Motley Fool www.Fool.com
00The National Foundation for Consumer Credit www.nfcc.org
or 800-388-2227
00Federal Trade Commission www.ftc.gov or 877-FTC-HELP
Collection Agencies
If one or more of your creditors has turned a collection agency on you,
know your rights.
00A collection agency may contact you by phone, e-mail, fax, mail, or in
person.
00They cannot call you before 8:00 a.m. or after 9:00 p.m.
00They cannot call your boss or members of your family.
00No one else can be forced to pay a debt that is yours alone.
00You can get them to stop calling you by sending them a letter. They are
then only allowed to contact you regarding plans to bring legal action
against you.
You do not need to tolerate rude or belittling remarks. But by the same
token, do not take that same attitude with the collection agency. After all,
you do owe the money.
Collection agencies are not empowered to work out payment terms. They
make money by collecting a percentage of the amount owed, so they will
not cut deals on anything other than, perhaps, payment timetables. If you
think you are being treated unfairly, contact the FTC at 877-FTC-HELP and
ask for information on the Fair Debt Collection Practices Act, or visit their
Web site at www.ftc.gov.
Bankruptcy
Filing for bankruptcy should only be done as a last resort. No one loves it,
and you should not go into it casually. However, sometimes it's the only
course of action left. There are two forms of personal bankruptcy:
00Chapter 7 Bankruptcy - will permit you to discharge certain debts.
00Chapter 13 Bankruptcy - will give you a debt repayment schedule.
It does not discharge debts, but it does make creditors back off.
Debt
Management
40
Y
o
ur
Financial
Future
There are some drawbacks to filing bankruptcy, and you should clearly
understand these before taking such a drastic step:
00Bankruptcy will appear prominently on your credit reports for 10 years
after you file for it. This means getting more credit will be difficult,
particularly for the first few years.
00You are unlikely to be allowed to make a major purchase, such as a
home, in the first five to seven years following the filing. Use that time
to build up a down payment for a home purchase. Seven years isn't
forever. And as a renter, you won't be paying property taxes or spending
your money on home maintenance.
00Filing for bankruptcy costs money. It will probably run you some $1,000
or even more in filing and legal fees.
00Although there is a great emotional benefit to cleaning your slate and
starting over, there is stress and some embarrassment that surrounds
filing for bankruptcy. It is also unpleasant to have to bare your personal
affairs to court personnel, lawyers and creditors, and to have your
personal finances placed under court control.
00When you walk out of bankruptcy court after signing the final papers,
you will still have shoes on. Most states allow you to protect a certain
amount of home equity. In some states ( Florida, Iowa, Kansas, Minnesota
and Oklahoma ) you may even be able to keep your home, no matter
what it's worth. Most states will allow you to keep home furnishings,
clothing, household goods, pensions and retirement accounts, so don't
sell these off or empty out these accounts to pay off your debts unless
you are certain you will never file for bankruptcy.
00Don't expect to be allowed to keep expensive luxury items like jewelry,
boats, multiple cars or other big-ticket items.
While there are significant negatives to declaring bankruptcy, there are
some benefits, even beyond having a chance to start over:
00Certain kinds of debts can be wiped away completely, or discharged.
Typically, these are:
00redit card debts
00uto loans
00ent payments
00edical bills
00tility bills
41
00By the same token, certain kinds of debt cannot be discharged. These
are:
00hild support
00limony
00axes (both state and federal)
00ourt-ordered fines or damages
A final note about bankruptcy: With your slate wiped clean of the worst of
your debts, you are getting a do-over. This means you can breathe easily
for the first time in a long while. You can answer the phone again and
stop cringing whenever you open your mail. This does not mean that you
can go right out and spend like there's no tomorrow. One bankruptcy
experience should be enough for anyone. Get credit counseling and resolve
to learn from your past mistakes. Now is the time to start working toward a
reasonable financial future and retirement.
Debt
Management
search
