Are you facing a financial crisis due to an unexpected event? An illness, job loss, or a life event such as a divorce can gradually erode funds. You may face difficulty making ends meet, leading to a financial crisis.
Borrowing to get out of debt will worsen your situation and affect your credit rating. Do you spend more than 40% of your income settling unsecured debt such as medical bills or credit cards? If you expect this situation to continue for a while, it is better to resolve this issue sooner rather than later.
Table of Contents:
- Take stock of your finances
- Debt settlement options
Take stock of your finances
Assess your cash inflows and outflows to decide on what action to take. How much do you have by way of income and savings? Note how much you must pay monthly to settle your mortgage, credit cards, utilities, and other bills.
Do you have a lot of unsecured debt, such as credit cards and lines of credit? If you don’t settle promptly, this debt can balloon with the addition of late fees and increased interest.
When do you expect your circumstances to change? Is there a possibility of getting any compensation, insurance, or other payment to mitigate your loss?
Debt settlement options
Once you know the severity of your problem, you can decide how best to get your finances in order. When considering options, keep the following in mind.
The solution you work out should be doable. You will lose credibility if you commit to a payment plan you cannot afford. Focus on a solution that will get you out of debt, keep debt manageable, and put you in a position to rebuild your credit rating and financial health.
Here are some solutions to consider:
Use your emergency fund
If you have an emergency fund, ideally about three to six months of living expenses, this is the time to tap into those funds. Use this resource to keep current on your debt and other payments. Only use your credit cards if you have a way of settling them. If not, your money woes will worsen.
Look for ways to raise extra cash
Can you sell some items you don’t need to meet your debt and other expenses? How about finding another job or a side hustle to pay your bills? Are there subscriptions for magazines, cable TV, or other services you can cancel to increase savings?
Review your insurance policies. Check whether it is possible to negotiate a lower premium or move to another insurer whose rates are lower.
Talk to your creditors
Before you default on any payments, inform your creditors of your situation. Inquire about payment concessions from unsecured creditors. Check whether your mortgage lender can defer payments for a short period or offer an easier repayment plan.
Consolidating your debt is advantageous if you can get a loan at a favorable interest rate to pay off your outstanding bills and credit card payments. Aim for a loan where the monthly payment and the overall interest are less than what you now pay on your loans.
Note that the terms a lender offers to consolidate a debt depend on your credit rating and debt-to-income (DTI) ratio. Lenders tend to look for a credit rating in the mid-600s and a DTI of less than 36% when evaluating a loan application. Qualifying for a loan will be easier if you meet these criteria.
While a loan secured with your home can help lower interest, you risk losing this asset if you default on payments.
Seek out a credit counselor
If you feel overwhelmed about approaching creditors, get help from an accredited credit counselor.
A credit counselor will examine your income, debt, and expenses and help create a budget to manage your finances. Such an advisor may provide resources and offer to negotiate more affordable terms with creditors.
Credit counselors, whether from for-profit or non-profit agencies, charge fees for their services. The National Foundation for Credit Counseling (nfcc.org/how-we-help) is a useful resource for finding a certified credit counselor who can help you.
Look for reviews with the Better Business Bureau (bbb.org) or Consumer Affairs (consumeraffairs.com) before hiring a counselor.
Enroll in a debt management program
Depending on your financial situation, a credit counselor may offer a debt management program to help ease your payments. Enrolling in such a program is beneficial if you can afford the monthly payment required.
Here the credit counselor will negotiate with unsecured creditors to reduce payment by lowering interest rates, waiving fees, or reducing the amount you owe. Instead of making payments to different creditors at various times, you make a single, lower payment to the credit counseling agency that distributes this payment to the various creditors.
Enrolling in a debt management program eases payment and gives peace of mind as there is a plan to settle your debts in about three to five years. Moreover, the impact of such a program on your credit report is less than if you were to sign up for a debt settlement program or file for bankruptcy.
Note that your credit counseling agency will charge a set-up fee and monthly fees that vary by state. You may qualify for concessions based on your income.
Signing on to a debt management program also has some drawbacks. You may be asked to close your credit cards to stop incurring further debt. This action can hurt your credit rating while limiting your access to credit.
There will be a note on your credit history that you are in a debt management program. This indicates to lenders that you should not get any new credit during this period. However, it will not affect your credit rating.
Note that you are still liable to pay unpaid taxes, secured loans such as mortgage and car payments, student loans, and child support or alimony payments.
File for bankruptcy protection
There are pros and cons to filing for Chapter 7 or Chapter 13 personal bankruptcy protection. Since this action can affect you for seven to ten years, consult a bankruptcy lawyer before proceeding (through referrals or nacba.org).
On the plus side, creditors will stop calling once you file for bankruptcy protection. Your debt is frozen, and no further interest or late fees gets added.
Suppose you are eligible to file for Chapter 7 bankruptcy protection. In that case, settling or writing off your unsecured debt may take 4-6 months. If not, you must file under Chapter 13, where you arrange to pay your debt within three to five years.
If you adhere to the court-designated plan, any debt remaining after three to five years of payment is erased. Your case is then discharged. If not, your file is dismissed, meaning you will return to square one.
There are also disadvantages to declaring bankruptcy. The fact that you applied for bankruptcy protection will show in your credit reports for 7-10 years. Applying for new credit, insurance, or a job becomes more difficult.
Although your credit rating will drop due to the filing, it will improve after the court approves the erasure of your debt or you commit to a consistent payment plan. Any changes to a payment plan require court review and approval. Make sure you are aware of these facts before taking the bankruptcy route.
Debt Settlement Programs
Another way to settle your unsecured debts, such as medical bills and credit card debt, is to seek the help of a company specializing in debt settlement programs. Like a debt management program, the company negotiates on your behalf to get concessions on the amount you owe. You will deposit amounts to a specific account from which the company will pay your creditors.
It is vital to get the services of a company with accreditation from the American Fair Credit Council. Check how long the company has been in service and reviews and complaints made about the company to ensure you get good service.
Beware of scammers
When considering options to settle your outstanding debt, be wary of persons and organizations offering to help. Some debt settlement companies can charge fees and offer high-interest loans that can further set you back.
Check reviews of such companies with the Better Business Bureau and follow the recommendations of the Consumer Financial Protection Bureau (consumerfinance.gov/consumer tools/) regarding debt settlement options available.
Plan for financial recovery
Irrespective of how long it takes to settle all your debt, keep moving forward to rebuild your credit. Use a budget to track your income and expenses. You will then spend within your means and control your debt.
While you will have to wait about two years after the discharging of your debt to apply for a mortgage, you can apply for a secured credit card, a card issued against a balance you deposit as collateral, to re-establish your credit record. The fact that you kept current on your payment plan also helps to build your credit rating. Arrange with your bank to transfer a certain percentage of money from your after-tax income to a savings account on your payday.
Each small action you take to reduce spending can add to your emergency, retirement, and other funds to ensure a future free of financial woes.
Stay committed to settling your debts
How you plan you get out of debt depends on the severity of your problem and its emotional toll. For example, it is necessary to allow for the time you will take to get another job, recover from an illness, or feel comfortable after a life event.
Whether you work out a solution by talking to creditors or channeling external help, it’s possible to get through this impasse. Aim to maintain a budget and look for new ways to earn and save. Above all, stay committed to settling your debt. Getting out of debt is challenging but doable and rewarding.