Modest Debt

When you are in too deep what are your options? Say your “bad” debt-credit card balances plus any excessive house and car debt-is relatively modest, between 5% and 15% of your income. In that case, some belt-tightening is in order. Start by exhuming your financial records for the past three months to trace where your money is going. Then list your fixed expenses (mortgage, car payment, utility bills, etc.) and variable expenses (food, clothing, entertainment, etc.) Once you identify items on which you splurge, either purge them from the budget or set strict limits on how much you’ll spend.

“Bad” Debt Between 15% and 25% of Yearly Income

“Bad” debt between 15% and 25% of your yearly income calls for a more systematic debt-repayment plan. Like millions of Americans have done in the past decade of declining mortgage interest rates, you may be tempted to fold those debts into a home-equity loan or a new mortgage to reduce your monthly payments. Such a move can save you money, but for many borrowers it generally ends up costing more in the long run. Worse, the debt elimination may be only temporary. 70% of households who consolidate their credit card bills have run up new credit card balances within in a year. Those that run up credit card debt again will have little or no home equity to draw on for a long time and their total debt will be increased.

People who have fallen into debt should make a commitment to pay it off in three to five years. One step is to move credit card balances to a new card that has a low interest rate. Preferably paying off the balance while the low introductory rate applies. You could also try calling a present card issuer and ask them if they would lower your rate if you transfer some balances to that card. (You have to have some line of credit available, of course.)

You should start thinking of paying off your debts as an investment. If the credit card rate is 17%, every time you pay $100 you’ll earn $17 compounded annually over the life of the loan. Pretax, that’s the equivalent of a 25% return. Few investments are that safe and that profitable.

“Bad” Debt Between 25% and 50% of Yearly Income

If your “bad” debt is between 25% and 5o% of your yearly income, you should consider enlisting professional help to pull out. You can turn to a financial planner or one of the nonprofit debt-counseling services. Help with your debts these days is no further than a mouse click or a flick through the yellow pages, but choose carefully. A reputable debt counselor will help design a budget, negotiate with creditors for easier payment terms, and teach you to live within your means. Most will ask for a donation when you can make one or impose modest monthly charges of $2 to $3 per creditor. There are no shortcuts for getting out of debt. The process may take three to five years, so avoid companies offering overnight credit repair, a switch to another credit identity, or other quick fixes.

These are some of the better-known credit counseling services: National Foundation for Consumer Credit; American Consumer Credit Counseling; and Money Management International.


“Bad” Debt Over 50% of Yearly Income

If your “bad” debt makes up more than 50% of your income, the best course may be to seek bankruptcy protection. Borrowers plunged in debt have had two options to extricate themselves: Seek the protection of Chapter 7 bankruptcy, which erases most of their bills (though not taxes or child support), or enter credit counseling as discussed above to develop a repayment plan.

Finally, as you pay off your old debt, try to save something, however, modest – even if it prolongs your indebtedness. That way, when you’re done, you’ll have something to show for your sacrifices and a healthy new money discipline that will keep you out of the debt trap for years to come.

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