I Can’t Pay My Bills… Now What?
Most borrowers have good enough intentions when they take out a loan. But for some the unexpected happens. Whether it’s a health crisis, divorce or job loss, before they know it they are far behind in debt and they feel buried. What happens next depends on how much they know, how quickly they ask for help and how clearly they can see the information. When we feel buried we tend to hide and no longer open the mail, answer the phone or pay attention to the information being shared. If you find yourself saying that you don’t need this article, keep reading. The perfect time to learn about this subject is before you need it. Or, maybe you can use the information to help a friend or family member.
It is good to know that there are many ways to get either temporary or permanent debt relief. The first and most important step is to organize your finances. There are various free and easy to use budgeting tools (including our own Money Management tool inside our online banking or to contact our Certified Financial Counselors) that may help you organize your income and expenses. Once you know exactly where your money stands and what you are able to pay, the next step is to contact your creditors and when you do it’s always helpful to know your options.
So, what are the options?
Debt Restructure: Some lenders will entertain a request to provide some relief during a financial hardship. Temporary modifications of payment may be possible to help a borrower through a difficult time. Permanent restructuring of debt, which may include interest rate and/or payment reduction that extends the payoff term of the loan may also be an option in extreme cases with proper justification.
- Pro: Less costly than other options as you avoid collection fees and get back on track faster. Working with your creditor means you may be able to avoid repossession of collateral.
- Con: If you become delinquent because you are paying less than the payment initially scheduled, your credit score may decline even though you have permission to pay a lower payment.
Debt Consolidation Loan: A debt consolidation loan is different from a debt settlement plan. With a debt consolidation loan you will use one loan to pay off all or some of your creditors and then only have one payment to one lender, usually a credit union or a bank. A debt consolidation loan may have stringent requirements such as a minimum debt-to-income ratio. You may also need to provide collateral or agree to have payments made directly to your creditors.
- Pro: You will pay less interest over time, and making one payment (as opposed to many) may be easier to keep up with. You will probably pay the loan off over a period of time up to 60 months (unless you use a real estate loan for consolidation) and that means you will be out of debt much faster than making the minimum payments on credit cards.
- Con: You may be more inclined to charge up your credit cards once they have a $0 balance and find yourself back in debt. If you chose to go this route you must remain disciplined!
Credit Counseling: Different than debt settlement, a non-profit credit counseling agency may provide guidance on budgeting or enroll you in a debt management plan. In a debt management plan the credit counselors may attempt to work with your creditors to negotiate a reduction on interest rates and fees.
- Pro: Non-profit companies provide this service at no charge and working with one may provide your creditors with “good faith” that you really want to pay your debt. Plus you may learn something about budgeting and keeping yourself out of debt from the credit counselors.
- Con: It takes a while and can be detrimental to your credit score as creditors may require you to pay for several months before they mark you “paid as agreed”.
FYI – The Partnership FCU has two Certified Financial Counselors who will work with you to identify different solutions for your situation. Unfortunately we cannot contact your creditors.
Debt Settlement: There are many advertisements for debt settlement companies. In our experience consumers don’t always completely understand how debt settlement actually works so let me explain. A debt settlement company will negotiate with creditors on your behalf. As part of this program, you will stop making payments to your creditors and begin making one monthly payment into an account set up by the debt settlement company. After a certain amount of time has passed and you have accumulated at least 50% of at least one of your debts, the settlement company will begin negotiating with your creditors on your behalf, one creditor at a time. They will ask your creditors to “settle” the debt. If the creditor says yes, then you pay less than what you actually owe, and the debt settlement company takes their fee as a percentage of the settlement amount. There is no magic to this, you could contact your creditors and ask them for the same break, but you should have that amount ready to pay immediately because creditors will likely expect any settlement amount in a lump sum.
- Pro: It can lower the amount you owe: This is the main motivation for debt settlement. If you’ve amassed a large amount of debt, entering a settlement program has the potential to cut that amount by 40 percent or more. For example, if you have $30,000 in debt, a successful settlement program can cut the amount you owe to as little as $16,000 before fees.
- Con: The biggest drawback to entering debt settlement is the impact on your credit. Because you stop making payments to your creditors, your accounts will go delinquent, which shows up on your credit report and can remain for up to seven years after. After settling, the creditor will update that debt’s status as being “settled.” Depending on your credit score at the beginning of the process, your score can fall 45 to 150 points. Your forgiven debt is taxable at your normal tax rate, which varies depending on how much income you’ve earned. Once a creditor has settled a debt, you’ll receive a 1099-C cancellation of debt tax notice. You’ll put this into your return as other income.
(The FTC regulates debt settlement companies and restricts certain actions. For example, debt settlement companies cannot charge fees in advance. All fees must be taken as a percentage of the settled debt. Additional rules stipulate that any dedicated accounts created as part of a settlement plan must be owned by you, and you can withdraw funds from that account anytime. If you want to learn more about these regulations, the FTC provides information on its website.)
Bankruptcy: Bankruptcy should be the final resort for managing your debt. Bankruptcy is a legal process that can allow you to eliminate debt. Chapter 7 Bankruptcy, which has strict income requirements, can liquidate all your debt though some of your assets will be sold to pay it off. A Chapter 13 Bankruptcy requires you to work with your creditors to create a payment plan where you will pay a percentage of the debt actually owed.
- Pro: Bankruptcy wipes out almost all debt; some people find it less stressful than working with creditors especially if the hardship is permanent and you will not be able to pay.
- Con: Bankruptcy is very damaging to your credit score and can impact your future eligibility for loans and lines of credit as well as the price you pay for it. A bankruptcy will stay on your credit report for seven to ten years and can reduce your score by up to 200 points.
How much does my credit score matter?
Your credit score is the primary way that financial institutions determine if, how much and at what price you qualify for credit cards, personal loans, cars, homes and home equity loans. From an early age it is important to maintain a healthy credit score and that means paying your bills on time, maintaining a healthy mix of credit and not keeping credit card balances at their limit. Small mistakes like paying one bill 30 days late can cause your score to decline and it can take a long time to rebuild. We recommend obtaining a copy of your credit report each year and checking it for accuracy. You can go to www.annualcreditreport.com for your free copy.
Don’t be afraid to ask for help! Our representatives are waiting to help you walk through your options. Contact Us today!