This is a guest post from Michael Harr, Co-Founder and Chief Content Director at TodayForward. Michael worked as a collections agent for a major credit card issuer, and has more than a decade of experience as a comprehensive financial planner. You can read his personal blog at Wealth… Uncomplicated.
One of the great problems on the internet, in periodicals, and in books is the consistent lack of translation from principles to action. Today, we’re going to dispense with principles and focus solely on the specific actions needed to eliminate debt in what some might consider ‘unusual’ ways. Some of these tools aren’t for the faint of heart, and many of them will leave a nasty stain on your credit report. However, if you’re ready to get out of debt, let us begin.
Get it together
Before you embark on any task, you need to get a firm grip on your current situation. It’s not enough to simply say, “There’s too much month left at the end of the money.” You need to take a closer examination of your financial condition and this means you need to make a *GASP* budget.
A budget doesn’t need to be fancy; you don’t need to purchase some cutesy financial software; and you certainly don’t need to categorize every last dime of your expenses. What you need is a simple, high level listing of your income and expenses.
In this budget, you should start with your fixed and recurring expenses that you pay regularly. From there, you can get down to as much detail as you want. The point is to be able to recite exactly what goes where in a matter of minutes (more on this later).
Beyond this, you need to create a detailed list of your debts that includes each debt’s name, balance, minimum payment, APR, payment status and contact information. By having all of this information at hand, you will know exactly what you need to do to ‘get to zero’.
In keeping with our pledge to focus on action, here is a downloadable spreadsheet that is pre-formatted for your ease of use:
- Budget/Debt Spreadsheet (Excel)
- Budget/Debt Spreadsheet (OpenOffice)
Sizing up the problem
After you have your budget assembled and debts listed, it’s time to size up the situation. Best case, you have a positive cash flow and a mole hill of debt. Worst case, you have a negative cash flow and a mountain of debt. Regardless of where you are, we’ll detail out tools that can help you terminate your debt.
Note: If you have a massive negative cash flow because of a job loss or other income disruption, stop here. Until you have enough income to have a fighting chance of paying off your debts, no debt reduction tool or plan will work for you. Fix the income problem first, then tackle the debt later.
The tools of debt elimination
From here, we’ll go through the list of tools available to you that can help you in becoming debt free. We’ll begin with the small stuff like screwdrivers and hammers and move up to the wrecking ball and good old fashioned TNT. Regardless of where you are with your debt, there will be something that follows that you’ll be able to put to use that will save you money.
The screwdriver: Fee waivers
This is the simplest tool available to you. If you miss a payment or accidentally go over your credit line, you can simply call your credit card company and ask for a fee waiver. The odds of getting one depend on your standing with the company.
If you’ve been a long time cardholder or are a profitable customer, you’ll likely get a courtesy waiver. If you’re behind and constantly late or over the credit line, it’s unlikely you’ll get the fee waived. Either way, it doesn’t hurt to ask.
The wrench: Interest charge waivers
If you’re one of those people that typically pays the balance in full each month, you might be able to get an interest charge waived if you forgot to pay your bill in a given month. Such waivers are increasingly difficult to get, but if you’re a good customer (particularly if you have other accounts with the company or a subsidiary), it’s possible to have interest charges removed. Again, to find out, pick up the phone.
The hammer: Lower my rate or I’m gone
With the most recent credit card legislation having become law, it’s more difficult for credit card companies to unilaterally raise your interest rate. However, because of this legislation, many credit card issuers preemptively raised interest rates to try to squeeze as much money out of cardholders as possible. If you’re unhappy with your interest rate and you have good enough credit to go elsewhere, tell them about it.
When you call, start by being cordial and saying, “The interest rate on my account is much higher than I can get through ABC Credit Card Company. Can you reduce this interest rate for me, or should I move my business to ABC Credit Card Company?” At this point, the representative will see if the interest rate reduction is possible.
If they can’t change the rate or the rate isn’t competitive with what you can get elsewhere, take your business to the other company, but don’t close the account until the balance is paid in full. If the rate is reduced to your satisfaction, tell the representative thank you and get on with your day.
WARNING: The following tools have a very good chance of hurting your credit score (sometimes severely). If you need credit in the next five years, think carefully before using these tools. Also, most of the remaining tools are best utilized by those already struggling to keep up or are already behind on payments.
The Black & Decker: Temporary rate and/or payment reduction
These programs usually last anywhere from three to twelve months and feature a reduction in interest rate and/or minimum payments. They are primarily used to get an account that is one to four months past due up-to-date by suspending fees and reducing interest charges (sometimes to zero). If you have a temporary income disruption or a temporary spike in expenses, this tool can help you get back on top of your debt.
To qualify, you’ll need to be in the collections queue of the card company in question. This doesn’t necessarily mean that you have to be behind on payments with them as credit card companies continuously scan your credit report to see if you’re falling behind elsewhere. In addition to being in collections, you’ll typically need to provide some information that often includes why you’re falling behind, your monthly income and expenses, and an overview of your total debt picture.
If a collector calls and you want to try this tool, say, “I’m really struggling financially right now because of X, Y, and Z. Is it possible that you could reduce my monthly payments temporarily until I can get back on track?” The collector will then check your account and possibly even your credit report to see if you qualify. If you do, they’ll ask for some additional information and you’ll have your budget and debt worksheet at your fingertips to answer their questions.
For accounts where you’re not yet in the collections queue, but you are with other creditors, call the customer service line and ask for the collections department phone number. Call the collections group, tell them your story, and go on from there.
The table saw: Debt consolidation
Each year, thousands of people lose parts of their limbs to the fearsome teeth of the table saw. Each year, many times that number use a debt consolidation loan with similar results. We list debt consolidation as an option, but the vast majority of people who use this will end up in just as much (or more) debt five years later.
If you want to consolidate your debt (and the odds of this tool succeeding in reducing your debt are worse than betting on black on the roulette wheel), go online to shop rates and try to find a loan. You can consolidate your debt using a secured or unsecured loan, with rates being lower for secured loans and higher for the unsecured variety.
Debt consolidation loans were easy to obtain before the credit crisis, but they are still available to some today. We could walk you through the process, but we generally dislike these loans because they’re an invitation to more debt.
The chainsaw: Permanent pay down
For anyone that’s been in and out of the collections queue for a period of time, a permanent pay down might be available to you. These programs are usually set up to be completed over a four to six year time period and feature a reduced, fixed rate and a slightly higher minimum payment. Credit card companies offer these on a more limited basis because the terms of the pay down are very favorable for customers.
To qualify, you’ll need to explain the reason you fell behind with payments and give a somewhat detailed accounting of your budget. Card issuers view these programs as a way to increase the probability that you will repay them, even if it means that you’re going to stop paying someone else. The bottom line is that if you can qualify for a program like this and you believe you can maintain the required payments, it’s a great deal.
A word of caution on this: Do not agree to this program if you don’t think you’ll be able to keep up the payments. These are often one-time only offers, and you don’t want to waste the opportunity.
To get set up on a program like this, talk to the collections group and say, “I’ve been in and out of collections for some time now, but I eventually get caught up. Do you have something where I can just pay a fixed amount and have this account paid in full over the next few years? It seems like I keep making payments to all of these different companies and never really see any results. Anything you can do to help would be great.”
The agent will check to see if you qualify and may even need a manager’s approval, but if it’s available and you’re confident you can maintain the payments, do it.
The wrecking ball: Debt settlement
Ah, the much talked about debt settlement. There are countless advertisements and infomercials from companies that say you can settle your debt for ‘pennies on the dollar’. While they’re right, they definitely oversell this debt reduction tool.
Before you can qualify for a settlement, you need to be in some serious financial pain, otherwise, you’ll never get one. If a collector sees that you’re struggling, but you’re going to come into some cash or have assets that can be sold (retirement investments, real estate, etc.), he or she may offer you a settlement. A typical initial settlement offer will be for 80 to 85 percent of your current balance (lower if you’re in horrific financial shape) which can save you a lot of cheddar.
While the savings is a major benefit, there’s also a catch. Whatever the unpaid balance amounts to, you will receive a 1099-C that will be added to your taxable income. This means that if you’re in the 25 percent marginal tax bracket and have $1, 000 left unpaid, your tax bill will increase by $250. As an example, if the balance was $5, 000, you paid $4, 000 to settle it, and paid $250 in taxes, your net savings is still $750.
Settlements are usually structured as a lump sum or a series of payments over 90 days or less, and it’s usually not wise to pursue a settlement unless you have the money to make it happen.
If you find yourself in a position to do a settlement and don’t care about your credit score, you can initiate the conversation by calling the collections department and saying, “I’m struggling with my debt for X, Y, and Z reasons. However, I have some money available and I’m trying to work a settlement with at least one of my creditors so my total payments are more manageable. Would you be able to work something out with me?” Start the conversation there and don’t be afraid to negotiate, because that’s a normal part of the process.
Also, don’t be unreasonable or upset during any stage of your settlement negotiation. You have a limited amount of resources and the card company has a minimum amount they need to collect. To get the best results, always be friendly, courteous, and honest about your situation.
The last tool available is like taking a load of TNT to your financial life and setting it off. There are a lot of consequences to this action, and it’s definitely not something to do without a great deal of consideration. With that said, sometimes bankruptcy is the last best option for you if you’re facing truly insurmountable odds.
While the bankruptcy legislation that went through in 2005 made it tougher to file and even more difficult to have debts discharged, it remains a viable option if things are simply too much to handle. There is a very important reason that bankruptcy exists: it essentially recognizes that people can sometimes find themselves in a financial predicament that cannot be overcome without intervention from a third party – the courts.
By granting the power to courts to discharge or restructure debts, the burden of debt can be lessened or completely removed, allowing filers to get on with the rest of their lives.
To file for bankruptcy, you’ll need an attorney to help you sort out the details. Having your budget and a comprehensive list of your debts will be necessary in helping to decide which chapter to file. Shop around for an attorney that handles a good number of bankruptcies each year and one that charges a reasonable rate. Ideally, you’ll be able to give them a 30 second overview of your financial woes and they’ll give you an estimate of the cost.
Once you’ve engaged an attorney, follow the process to the letter and you should have things sorted in short order.
What this post is really about
While the title and the content makes this post seem like it’s about eliminating debt through action, it’s actually about the fundamental problem that economists call ‘asymmetric information.’ These programs aren’t a secret, and they’re available through just about every credit issuer in some shape or form. However, the creditor knows what they can do and it’s up to debtors to figure out how to navigate their way to being debt free.
Consider this: Two families in serious debt have the goal of being debt free, and each is exactly the same with one exception. The first family knows the information above. The second family does not. Who will be debt free faster?
A challenge for readers
The information presented in this post is a great start to solving the problem of asymmetric information as it relates to getting out of credit card debt. However, as a reader of FiveCentNickel, you can take this to the next level.
If you have a story about using one or more of the above tools, please share your experiences by posting a comment. Detail out which tool you used, with which company, when this occurred, and what the net result was. You can remain anonymous if you wish.
If you read this post and use any of the information presented, please post updates on your experiences with specific details. That way others can monitor the comments and gain even more.
That reminds me… Wasn’t there a famous guy who said something like ‘knowledge is power’? This can be some powerful stuff… If you participate.
6 Responses to “How to Get Out of Debt: Hardcore Tools for Getting to Zero”
In another blog that I have read earlier, the blogger was surprised when his credit score got significantly lower after he has paid off the remaining balance of his car loan. It seems that eliminating debt is bad for your credit rating.
@Dan – You are correct with the exception for insolvency. In addition to that, there are exceptions for bankruptcy, qualified farm debt, and qualified real property business debt. Always consult an accountant or the appropriate IRS publication (for most this is publication 908).
With respect to your other point about most who settle are insolvent, this isn’t always the case and while I haven’t seen any statistics on this, I would wager that the overwhelming majority of balances settled are with debtors that hold other assets – primarily retirement assets. Since retirement accounts are protected from creditors (with few exceptions), it often makes sense for a debtor to avoid liquidating these types of accounts that would trigger penalties and taxes. They are better off settling the debt without the use of such assets.
While this brings ethics to center stage, I always think of this issue as (1) if we force people to liquidate retirement assets to repay debts, then (2) they will wind up being less able to care for themselves later, leading to more dependence on entitlement programs. As it stands the creditor writes off the unpaid balance to receive a deduction, the debtor reports the unpaid balance as income, and the debtor maintains their retirement balances. In short, it’s better to have the lender take an affordable hit (they are supposed to monitor their risk levels and settlements are part of the analysis) than to completely sap an individual’s retirement savings.
Re: Debt Settlement.
The author was correct when he said settled debt becomes taxable income. But what he doesn’t mention (and very few who discuss this option ever do) is that those taxes are waived in certain circumstances. One of those circumstances is insolvency — where someone has a negative net worth. It seems to me that anybody who is in a position to settle debt is also in the negative net worth position.
@Anthony – You’re exactly right about the lifestyle change. One of the most important aspects of debt elimination is in the way we perceive it. When looking at those that have successfully eliminated their debt, you see a common attribute which is a fundamental paradigm shift. Those that make it to zero view debt differently than others.
This is a big part of why so many people that follow Dave Ramsey are able to become debt free. They listen to his program, read his books, attend Financial Peace University, and even use his software tools along the way. This immersion into a philosophy that teaches sound principles has the effect of permanently changing the way people think about debt.
In the follow on post to this one (http://bit.ly/d8rDCS), I touch on this a little bit in the three core habits of becoming debt free.
Thanks for the comment, and good luck the rest of the way to zero.
Good post. Currently, I am doing things the old-fashioned way: I’m spending less than I earn and making debt payments, month by month.
My personal opinion is that the best “tool” to eliminate debt is a lifestyle change. My mother-in-law is in a terrible situation, but is able to live off of $600/month for rent, electricity, and food. If you slim down to necessities, anyone can eliminate debt, regardless of how deep the hole is.
“knowledge is power” – Raiden from Mortal Kombat