Filing for bankruptcy can trash your financial life in so many ways. Even if you are successful in the courts, your old debts still can resurface as “unpaid” on credit reports.
A better strategy is to pay off debt over time, using bankruptcy only as a last resort. In July 2011, about 1,217 businesses and individuals sought Chapter 11 protection, a 24.2 percent increase over June, according to data from Automated Access To Court Electronic Records (AACER).
“There’s no quality to debt. Years ago it was tax deductible, but it hasn’t been for decades,” says John F. Harrison, CFP with Aspire Financial Advisors in Newtown, Mass. “The interest added to items purchased on credit doubles, and even triples, their cost and creates emotional stress.”
Whatever the size of your debt load, there almost always is a way out without claiming bankruptcy.
One way to get serious debt under control is to merge credit-card balances on high-interest rate accounts onto one new credit card with a lower interest rate. Companies such as Pro-Card Services will help you do this for a one-time fee that you may be able to recoup in your first couple of months of interest savings.
“It immediately reduces the amount of interest on a debt so that less of what you are paying is on interest and more on principal,” says Harrison. “But don’t use more than 35 percent of a credit line on any given card because it will negatively impact your credit score.”
Another danger is the temptation to go into more debt again once the consolidation is complete.
“What happens is that you start charging a little on the new card since the rate is so low. Then, when the introductory period expires and the rate goes up, you are left with more debt than when you began. You have to be very disciplined to make a balance transfer work,” says Gail Cunningham, spokesperson with the National Foundation for Credit Counseling (NFCC) whose member agencies counsel more than 3 million consumers each year. The average client who comes to an NFCC member agency for help with their debt has 6 credit cards to their name.
Think Before Canceling Credit Cards
It’s natural to want to cut up credit cards once they are paid off or consolidated but doing so actually can hurt your credit score. The idea is to pay off serious debt while rebuilding a damaged credit report.
“By closing a card you’ve paid off, you remove available credit so that your debt relative to your line of credit increases and negatively impacts the credit-utilization factor of the credit-scoring model,” says Cunningham. “Credit is a privilege. If you have it, treat it respectfully. Close [accounts] with caution because credit is hard to come by these days.”
Pay More Than the Minimum Each Month
Interest rates and the method by which finance charges are calculated vary from one credit card company to another. By law, issuers must disclose the interest rate they charge as well as the method they use to calculate the charges on monthly credit-card statements. In addition, the Credit CARD Act of 2009 requires issuers to provide cardholders with a snapshot chart or table of how long it will take to get out of debt.
“Create a list, rank your credit cards according to interest rate then use any extra money coming in or discretionary income to put toward the balances with the highest interest rate, and most importantly: Stop using the card,” says John Ulzheimer, president of consumer education at SmartCredit.com, a credit-monitoring website based in Costa Mesa, Calif. “If you only pay the minimum payment, you take longer to pay off the debt—especially on cards with very high interest rates because you’re not attacking the principal.”
Create a Spending Plan
A spending plan or family budget involves accurately tracking all of your expenses—cash, checks and credit cards—so they don’t exceed your income.
“The easiest way to reduce expenses is to have a budget so that you know where your money is going,” says Harrison. “When you work with a monthly spending plan, it’s easier to see where you can cut back and find money to put toward debt repayment.”
To create a spending plan with customized categories, track spending for 30 days with a notebook carried at all times in a coat pocket, purse or gym bag.
“Everyone in the household must agree to track spending so that the head of the household can figure out where the money is going,” says Cunningham.” It’s the little money spent casually that adds up. You can’t know where you are going financially until you know where you are.”
Consider reducing or suspending investments. But don’t cut back on retirement savings, says Harrison. “If you don’t put money in your IRA this year, that opportunity is forever lost,” he says.
The average APR on credit cards with a balance on it was 14.67 percent in 2010, according to the Federal Reserve’s G.19 report on consumer credit.
“Name one investment that guarantees a return rate of 14 percent. Therefore, if you are paying 14 percent interest on credit card debt while earning 3 percent on a bond, you’re not getting ahead,” says Ulzheimer. “Instead, you are losing every single month while you are investing.”
Harrison suggests continuing to make contributions to retirement plans, such as IRAs and 401(k) plans. “Saving 15 percent interest on credit is not like earning 15 percent on your money because compounding interest on a decreasing balance is not equivalent to the compounding interest on an increasing balance,” he says.
Generate New Income
About 19.3 percent of Americans in the workforce are underemployed this year—down only slightly from 19.8 percent in 2010, according to the Gallup Healthways Well-Being Index, which defines being underemployed as either unemployed or working part time but wanting full-time employment.
“Pay off serious debt faster by earning more money. Look into overtime and take side projects,” says Ulzheimer who also favors money-related 12-step programs, such as Debtors Anonymous, fashioned after Alcoholics Anonymous. “I love Debtors Anonymous. If the Underearners Anonymous near you is structured in the same way, then it’s a fantastic way to earn more income.”
Juliette Fairley is a frequent commentator on Grab Networks’ Better TV Show. She previously hosted Cha Ching Money Makers TV show for the Discovery Channel and is the author of Cash in the City (John Wiley & Sons). Her work has appeared in The Wall Street Journal, The New York Times, TIME magazine and other publications. Follow her on Twitter @JulietteFairley and visit www.juliettefairley.com.