Debt Repayment Options Made Simple

As I see it, there are really only four options to getting out of debt. Here they are in my order of preference:

  1. Pay It off On our Own.
    -This is the best option for most people since there are no additional fees.
    -This option gets pretty tough for households that have interest rates in the 20% to 30% range or higher (late payment penalty rates, pawn loans, payday loans, title and vehicle equity loans, etc.).
    -While it’s not guaranteed or even a right to expect results, we can certainly call our creditors and attempt to negotiate lower interest rates, to get rid of penalty fees, and even move our payment due date back a few days in the month.
  2. Options for Paying Off DebtDebt Management Programs (DMP) through nonprofit credit counseling agencies. Disclaimer: I am employed by a nonprofit credit counseling agency, so take that into account. However, I always try to “keep it real.”
    -These programs offer full-balance pay offs within no more than five years by lowering interest rates and eliminating penalty fees.
    -This option is ideal for households with high interest rates and that have regular income to make monthly payments.
    -There is a capped enrollment fee (varies by state, but usually in the $50 to $75 range) and a monthly administrative fee (also capped by state, but no more than $50 for those with tens of thousands of dollars of debt).
    -Although we can negotiate better terms on our own directly with a creditor, creditors almost always prefer that we go through a credit counseling agency so that all of our creditors are providing concessions and not just one.
    -There is a temporary notation placed on our credit report to notify other potential lenders that we’re in a DMP and that we should probably not be getting into any more credit card debt until we complete the current DMP. The notation typically comes off at the end of the DMP.
    -Participation in a DMP has no direct impact on our FICO score.
  3. Debt Settlement or Debt Negotiations
    -These companies typically request that we stop paying our current creditors and, instead, send a monthly payment to them. Once they have a sufficient balance, they approach our creditors and attempt to negotiate a pay off of less-than-the-full-balance, usually at 50% or so.
    -If, in the minority of cases, we actually get to the point where the company succeeds in negotiating a settlement, we also owe them fees typically totaling 15% to 30% of the balance that was forgiven.
    -By the way, we can do all of this ourselves without involving a third-party or their fees.
    -Depending upon our income for the year, we may also have to pay taxes on the amount of debt forgiven.
    -Such settlements have a painful impact on our credit, with effects lasting for 7 years.
  4. Bankruptcybankruptcy process
    -This is a legal action filed in federal court, not with our creditors.
    -Bankruptcy’s purpose, from the filer’s point of view, is to protect our assets, up to a certain “exemption” value (home, personal property and income)
    -Bankruptcy, whether a Chapter 7 “Liquidation” or a Chapter 13 “Repayment”, stays on our credit reports for 10 years and is the single most damaging item on our credit (more so than foreclosures, short sales and collections).
    -To bust a myth, there is no such thing as a medical bankruptcy. For personal filings, it’s almost exclusively a Chapter 7 or a Chapter 13. Some creditors down the road might look at our bankruptcy with a little more leniency if it only includes debts to medical offices, labs and hospitals., but not if it includes any credit card debt that we may have gotten into in order to pay medical bills.
    -Most debts can be included in bankruptcy, such as collections, medical, store and credit cards, old or new, though the court and its appointed trustee have a lot to say as to what can be included. We can’t, for example, fund a whirlwind tour of Europe with a credit card and then turn around and expect the court to allow us to include that debt in bankruptcy.
    -I like to say that any debt that we owe to or through the government will likely still have to be paid, even after bankruptcy. This includes most student loans, child support and alimony, back taxes, fines and restitution, etc.
    -We can file for bankruptcy without an attorney’s help. However, I like what one attorney shared with me in a cab on the way to the airport after a conference we attended: “Yes, you can file for bankruptcy on your own, but you can also remove your own appendix. That doesn’t mean there won’t be a lot of pain and negative consequences down the road.”

All other options are either impractical, dangerous or ridiculously unlikely to succeed. These include:

  • Using home equity to pay off credit cards (this puts our home in jeopardy and likely does not address the cause of our credit card debt).
  • Playing the lottery in hopes of winning enough to pay off our debts (“the lottery is a tax on people who are bad at math”).
  • Cashing out a 401(k) or other retirement account comes with penalty fees AND it dramatically affects our future. Even if we end up in bankruptcy, most 401(k) and Individual Retirement Accounts are not impacted.
  • Borrowing against a cash-value life insurance policy may have some better repayment terms, but, again, if we don’t address the root cause of our debt, we can wind up with new credit card debt AND a loan against our insurance policy.
  • Ignoring our debt NEVER works. “But I haven’t heard from them in 4 months!” Trust me. Creditors don’t forget about debts owed. They will likely either sell it or sue us for  it (within the statute of limitations period, of course). One way or another, debts tends to stick around for life.

Todd Christensen
Everyday Money for Everyday People


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