Debt is an ongoing problem that plagues consumers around the world. Heavy debt is caused by various factors. Loss of job, divorce, and over extending one’s financial abilities are just a few ways debt sneaks up on hard-working people. If you are having a problem with debt, you are most likely wondering how to get out of it. Here are five common solutions.
1. Bankruptcy
Many people get scared and naturally want to solve debt by filing for bankruptcy. Bankruptcy is a legal status that clearly defines one’s inability to pay creditors. Depending on the chapter the debtor files, he or she may be excused from making any payments.
The downside to choosing bankruptcy as an option is the resulting credit status. A bankruptcy will remain on the consumer’s credit report for a period of seven to ten years. This status will make it difficult for that person to obtain any credit during that time. Bankruptcy should be used as a last resort when no other options seem feasible.
Debt consolidation is another common method to solving the problem of overwhelming creditor bills. The process involves merging all open accounts into one account. A consolidation can be done in several ways. One way is for the debtor to apply for a consolidation loan. The lender will write out a check big enough to cover all of the debtor’s open accounts. The debtor will then make payment to this single creditor.
A debtor could also perform a self-initiated consolidation by applying for a high limit credit card that would cover payment for all existing accounts. This is also a great method because some high limit credit cards offer excellent APRs. The down side is availability. If the debtor has already experienced several negative notations on his or her credit report, lenders may be reluctant to help. In addition, if that individual’s income is not enough to cover the debt payments, a consolidation will not be very beneficial.
Credit counseling services can provide consumers with advice on how to manage their bills. They offer a wide range of solutions from financial planning, to payment tips, to writing letters to creditors. Credit counseling services are not a bad idea. However, they are not free. So, the customer risks paying for something that may not work.
A debt management company is a company that also offers a wide range of services to consumers in need of assistance. One thing they can do is negotiate with the lenders. They will attempt to convince lenders to lower interest rates and finance charges on the debtor’s behalf. Another service that these companies offer is a third party debt consolidation. In this situation, the debtor makes a lump sum payment to the debt management company and they pay of his or her creditors. DMC companies can possibly help to lower an individual’s debt. However, the bill can get costly and not every DMC is trustworthy.
5. Nada
Some people actually opt to do nothing to fix credit. They let the debt rack up in hopes that the seven-year period will pass before legal action wipes them clean. This is definitely not an intelligent idea. A smart debtor needs to be proactive for effective debt repair. With the right attitude and the will to make the situation better, a debtor can get from under the heavy weight.
This has been a guest post from Leah Fields. Leah likes to write about home improvement, personal finance; she writes for creditreport.org.
This is a common question, as well as a common misconception. The short answer is “no”, paying off old debt does not hurt your credit score. It also doesn’t improve your credit score that much either. Here’s why..
Once a debt hits the 180 days past due mark, it is recorded on your credit history and carries forward as a negative mark for 7 years. Nothing you can do will remove this prior to that 7 year expiration, so in effect the damage has already been done. Paying off that debt is the responsible thing to do, but you won’t be rewarded with a higher score for doing so. It does look better to lenders that you paid it off however, no matter how long it took.
So for debts 180 days past due, it’s better to pay them than not but don’t expect a big bump in your score for doing so.
The underlying reason for this is that creditors weigh your ability to remain current with your bills more than your ability to pay them back eventually. The better way to improve your credit score is to remain current on your debt and pay your bills on time. If you’re just focusing on paying off debt and some of it is past 180 late, then start at the most recent or current debt and work your way back, paying off the 180+ days late debt last.
Here’s an accompanying video clip in which Farnoosh Torabi, Jean Chatzky and David Bach field this question and more. (feed readers may need to view the complete post to see the embedded video)
A big topic in the personal finance blogging world is often credit cards vs. debit cards. Another, somewhat related topic is how many credit cards should a person have? This is not a one-answer-fits-all sort of question, but I feel pretty certain that most people would agree that 25 credit cards is a bit much.
Meet Pete D’Arruda, not only does he have 25 credit cards with a total available credit limit of $300,000, but he’s proud of it!
The crazy thing is he’s a personal finance consultant!
Why would anyone, much less a finance consult, think so many credit cards is a good thing? Well, it’s about the almighty credit score. See, one of the major factors in determining your credit score is what’s known as your debt-to-available-credit ratio (or “utilization rate“). This is simply a ratio of how much you currently owe to your total available credit. In D’Arruda’s case, his total available is a mighty $300,000.
So you would expect his debt to available credit ratio to be quite low, and his score to be quite high since he never carries a balance from one month to the next. In fact, he does boast of a 810-815 FICO score.
He also claims to have piles and piles of rewards in the form of cash back, airline miles, freebies and more.
But here’s the problem: You can get a very good credit score and low utilization rate with far less than 25 credit cards. This is just extreme.
Most finance experts recommend keeping your debt to available credit ratio below 30%. This means that D’Arruda has to keep the total of his current balance to under $90,000 to get the maximum benefit to his credit score. $90,000! Most people with $90,000 in credit card balances is likely to have bigger problems than a less than perfect credit score. This is just overkill.
You can achieve the same benefit by having one or two credit cards, and charging less that 30% on them. If that’s less than you spend per month, then use cash for the difference. (Here are 5 more ways to improve your credit score)
Besides having far too much available credit, he’s also opening himself up to 25 different potential points of identity theft.
And I for one wouldn’t want to have to keep track of all those accounts, various balances and rewards programs! And all for a high credit score which may not be all that important anyway.
I will give him credit for having self control. How many people in his situation would simply find themselves six figures in debt?
Credit repair is a hot topic these days – largely because it is a crucial element of overall financial health. Without maintaining good credit, you are not only likely at the mercy of lenders should you ever need financing, you are also guaranteed to spend more money than a consumer who maintains a good credit record and solid credit scores.
Why Credit Should Matter Now
Many consumers make the mistake of waiting until the last moment to do something about their credit scores and only make the attempts when they need to secure financing. But waiting until the last minute these days is a measure in ‘too little, too late’. It is important to do something about your credit score now regardless of your timeline or need for financing.
Here is an overview of situations where a bad credit score will cost you big bucks:
Mortgage lenders are scrutinizing credit histories and scores harder than ever thanks to the near-meltdown of the industry a few years ago. There are now stricter lending laws being imposed and borrowers need to come to the table with really good credit in order to have the most opportunities for an affordable home loan. Those without good credit scores will have a tougher time getting lender approval and for loans that are approved the interest rate of the loan will be higher, meaning you’ll spend a lot more money over the life of the loan than if you were eligible for a lower interest rate. Your loan terms and conditions may also be stricter such as requiring more than the typical 20% down payment on your loan.
Auto Loans
Like mortgage lenders, auto loan financing may be impossible for those with bad credit or the interest rate you pay on the loan may be much higher than for other buyers. As a result, you will pay more for the vehicle over the life of the loan, which is essentially a price you can’t make up in the value of the vehicle since most vehicles depreciate as soon as you drive them off of the sales lot.
It is not just financing companies that are looking closely at credit scores. Insurance providers are pulling credit scores on customers in order to gauge their potential for claims being filed. Insurance providers use a theory that credit history is relative to claim potential, meaning that those with lower scores are more apt to file an insurance claim. If you have a low score, you will have to pay a higher premium on your auto and home insurance than consumers who have better credit backgrounds.
Utilities/Consumer Services
There are many regular service providers who will pull credit scores before approving service applications. If customers have low credit scores, most providers will require a hefty down payment or prepayment on accounts to prevent risk of the bill not getting paid. For instance, with a low credit score, you may have to put up several hundred dollars on your mobile phone account or if you open a new account with the electric company, a deposit might be necessary to start services. Such deposits are often held for up to a year to gauge prompt payments each month and only then will you receive a credit.
If you are looking to apply for a new credit card but have a poor credit score, your options will be seriously limited. In some cases, you will only be eligible for secured cards, which means you need to send several hundred dollars as a prepayment. Secured cards will also require you to keep up with timely payments to keep the account loaded and change significant fees for transactions and penalties for late payments or over-the-limit charges.
While credit repair is possible by anyone, what is important to remember is that it is a time-intensive process that should begin as soon as possible. Even if you are not anticipating a need for a loan in the near future, there are too many other resources relying on credit scores for you to ignore the importance of your credit standing. Over time and with good financial management practices, you can improve your credit score to where it should be. Today, lenders are looking for borrowers with a credit score of 730 or higher in order to afford the best deals and the most options.
This is a guest post by Ed O’Brien. Ed is an expert writer on personal finance, specializing in credit repair. You can find more of his articles located at CreditRepair.org.
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