The Credit Handbook

When Credit Goes Bad

One drawback to credit is that because it is readily available, it can be easy to get in over your head. Maybe an event in your life left you short of cash for a time. Or, maybe the debts just piled up, and now you’re not sure what to do about them.

When you experience a severe credit problem, the problem can compound itself. For example, if you are unable to pay your debts, debt collectors may start calling, your car may be repossessed, your wages may be garnished, and you may begin to worry about keeping your home.

This chapter will walk you through the various options you have when you need help dealing with debt. However you got to the spot you’re in, there is hope and there is help.

Are You in a Credit Crisis?

If you answer yes to two or more of these questions, you may need to scale back your use of credit and consider getting some help managing your money.

1. Are you borrowing money to pay for items you used to pay for with cash?
2. Is an increasing percentage of your income going to pay off debts?
3. Do you have savings to fall back on in an emergency?
4. Can you make only the minimum payments on your revolving charge accounts?
5. Are you at or near the credit limit on your cards?
6. Have circumstances forced you to take out a loan to make payments on a previous loan?
7. Are you unsure about how much you owe?
8. Are your monthly bills more than 20 percent of your take-home pay? (Excluding rent or mortgage payments).
9. If you lost your job, would you be in immediate financial difficulty?

I Can’t Pay My Bills

If you are having a hard time making payments to creditors, it is best to deal with the problem head-on.

1. Examine your situation.
List all of your debts and your income. See if you can figure out a debt payment plan that will work for you. Remember, you will also need the discipline to follow through with it.

2. Talk to your creditors.
Don’t wait until your payments are late—call right away. Creditors may be willing to work out a revised payment plan with you. But, they cannot help you if you don’t contact them. Never ignore your creditors. If you get mail from a creditor, open it and read it. Ignoring your credit problem for awhile will only make it much worse later.

3. Get Help.
If you feel you’re in over your head, or if you have a lot of different payments to juggle, you may want help. Nonprofit credit counseling services offer low-cost or free counseling. Many of these agencies will help you figure out a debt repayment plan and also work with you on budgeting and other money issues. They will also talk to creditors on your behalf.

4. Only as a last resort, you may need to consider bankruptcy to help settle your debts.

Taxes

If you owe money to the government, consider putting this debt toward the top of your list. Your first choice should be to file your tax returns and pay what you owe. If you cannot pay the full amount, the second best option is to pay as much as you can. If you must take this course, treat the Minnesota Department of Revenue and the Internal Revenue Service like any other creditor. Let them know you will be making a partial payment, and tell them when you plan to make payment in full.

If you are unable to pay what you owe, the interest and penalties can really add up. If you file your tax returns but don’t pay what you owe, you will be charged a late payment penalty in addition to owing interest. If you don’t file at all, you will pay the late payment penalty and a late filing penalty (these penalties are in addition to the interest that will accrue on the amount you owe). If you are unsure whether you owe the government a debt, obtain a copy of your credit report by contacting one of the three national credit reporting agencies. While the IRS does not currently report unpaid taxes to the credit reporting agencies, tax liens do show up on your credit report.

Student Loans

When you took out your student loan you agreed to be responsible to repay it. You signed a legally binding promissory note and agreed to repay the loan according to its terms. You are responsible for repaying the loan even if you quit school, can’t find a job, or didn’t like the education you received.

Ask for a Deferment or Forbearance
If you are having trouble paying a student loan, work with your lender before you default. Two options include deferment and forbearance. Deferment is a legal right you have to postpone payment if you meet the criteria for deferment. Examples might include going back to school or the birth of a child. Forbearance is when you ask the lender for a temporary break in payments or a reduction in payments. The lender may grant your request for a forbearance, but is not obligated to do so. Students usually use forbearance if they don’t qualify for a deferment. Either of these options buys you a little time to get back on your feet financially. However, you still owe the money you borrowed, and when the deferment or forbearance ends, you will again be making monthly student loan payments.

Work directly with your school or other lender to request a deferment or forbearance. Remember, you must continue to pay your loans until you receive notice that your request has been approved. If you stop paying when you apply for deferment or forbearance, you may end up in default, and then not qualify for the deferment or forbearance.

Defaulting on a Student Loan
If you default on your loan, the lender may take action to recover the money. The lender may garnish your wages, seize your tax refunds, garnish your social security in the future, and deny future requests for federal student aid. In addition, a default will probably be reported to credit reporting agencies and remain on your credit report for seven years. This will hurt your chances to obtain other credit.

If you have defaulted on your student loan, consider a couple of options. First, you may try to rehabilitate your loan. If you successfully rehabilitate your loan, the default notation will be removed from your credit report. To rehabilitate  a direct loan or a Federal Family Education Loan (FFEL) you will have to make 9 “affordable,” consecutive monthly payments on time. Your loan holder will determine what the payment will be, but will likely use 15 percent of your annual discretionary income divided by 12.

Second, you may consider consolidating a defaulted loan. In certain cases this is allowed. Consolidation helps you combine one or more loans into a new loan. To do this you must make a “satisfactory repayment agreement,” usually consisting of three consecutive monthly payments, with the prior lender.

Defaulted loans, even those that have been consolidated, will remain on your credit report for seven years and may still raise a red flag with future creditors.

Home Loans

If you fall behind on your mortgage payments, contact your lender right away to avoid foreclosure. Most lenders will work with you if they believe you’re acting in good faith and the situation is temporary. Some lenders may reduce or suspend your payments for a short time. Other lenders may agree to change the terms of the mortgage by extending the repayment period to reduce the monthly debt. If you and your lender are unable to work out a plan, contact a housing counseling agency for help.

Warning: Think Twice About Using Your Home as Collateral
If you need a loan, think twice about using your home as collateral. What you’re really doing is putting your home on the line. If you are thinking about refinancing your mortgage loan or getting a second mortgage or a home equity loan, remember that if you can’t make the required payments, you could lose your house and the equity you’ve gained.

Debt Payment Plan

If you feel that you’re losing ground and not managing your debts as well as you’d like to, set up a debt payment plan. Completing this plan will take patience. You will have to stick to the plan until your debts are repaid. But remember—paying back a little is better than doing nothing or just worrying about the problem. Paying back a little will give you a sense of control. It will also let you begin to resolve your problem.

To set up your plan, take these steps:

1. Figure out who you owe and how much you owe.
2. Decide how much you can pay back and when you can pay it back.
3. Set up a plan for repaying your debts.
4. Discuss your plan with your creditors.
5. Implement some tough belt-tightening measures for a time. Stick to your plan to help you control your spending.
6. Occasionally revisit your plan to make sure it is keeping pace with your debts, your daily living expenses, and any pay increases or other new resources.

If you want to attack your debts, there are a few options to increase the money available to repay them.

• First, you may want to examine your daily living expenses and find places you can cut back.
• Second, you may consider selling assets.
• Third, you may wish to get a second job, or have a family member earn additional money that can be used to repay debts.
• Fourth, loan consolidation, home equity loans, or refinancing your home might be options to consider (though the cost of borrowing money this way is generally high, and putting your home on the line is a risky trade-off).

If there is not enough money to repay all of your debts, you’ll have to prioritize them. If you are balancing a car payment, a house payment, and credit card payments, common consensus is to pay the secured debt first. This means your priority will be your house and car payments. You may also want to stay current on utilities and insurance payments. This is so you will not lose these goods or services. For example, if you are even one day late in making a car payment, the lender who financed your car may repossess it. Most utility service and insurance coverage stops when you stop paying for them. House foreclosures don’t move as quickly, but if you get behind in your mortgage payments, you will probably pay penalties and you may lose your house.

Talk to Your Creditors

If you don’t have the money to cover other debts such as credit card and medical bills, inform these creditors of your current situation and your plans to repay the debts. While most creditors will try to work with you, not paying your bills on time can still result in a negative credit rating, garnishment, or bankruptcy.

Contact a Credit Counseling Service

Consumer credit counseling agencies help individuals or families with financial problems. These nonprofit groups help with budgets, money management, and debt repayment plans. Certified counselors will help you examine ways to solve your current financial problems. They will also help educate you so that you can prevent future difficulties. The counselor will review your financial situation and provide possible solutions. The counselor will also help you develop a spending plan that covers both your living expenses and payments to your creditors.

If you have severe debt, the counselor may help you set up a debt management plan. This is a systematic way to pay down your outstanding debt. You pay money to the consumer credit counseling agency and it sends the money to your creditors. Benefits to you include making just one monthly payment, possibly seeing finance charges reduced or waived, and receiving fewer collection calls. You may find credit counseling agencies listed in the phone book or online. Or, if your employer offers it, contact your employee assistance plan for help. These services are also available through some military bases, universities, credit unions, and housing authorities.

In considering a credit counseling service, get the details about what “counseling” services the company will actually provide. Read the contract carefully before you sign up for a debt management plan offered by such companies to make sure you understand what is being offered. Sometimes, these companies work with for-profit companies in consolidating your loans. Before you pay or “contribute” to any organization, check it out by contacting the National Foundation for Consumer Credit, the Better Business Bureau, or the Attorney General’s Office.

A Note About Debt Settlement Companies

Debt settlement or negotiation companies promise you quick results to get out of debt, but often don’t deliver on their promises. They typically tell you to stop paying your bills altogether and instead save the monthly payments you are making in a savings account. Once you have sufficient funds, the company will supposedly contact your creditors to negotiate a lump-sum payoff of your debt. Debt settlement or negotiation companies often promise you that they can cut your bills in half or more.

Debt settlement companies must register with the Department of Commerce. Under Minnesota law, debt settlement companies cannot:

• Tell consumers to stop paying their creditors;
• Advise consumers that entering a debt settlement plan will shield them from interest, fees, collection activity, garnishment, or lawsuits;
• Represent to consumers that entering a debt settlement plan will improve their credit score; or
• Falsely represent that the debt settler can negotiate better settlement terms than a debtor could on his or her own.