5 First Steps to Deal With Debt

Kirk Shinkle

If your credit card's monthly minimum payment is starting to look more like your old balance or you're not answering the phone for fear of another call from a creditor, it's time to take drastic action.

As thousands of Americans are finding out during this recession, personal debt can become a nightmare. The costs -- both financial and emotional -- make it tough to face the reality of just how bad the situation might be. But the sooner you face the problem, the sooner you can get back to even.

Mitchell Allen, author of A Survival Guide to Debt: How to Overcome Tough Times & Restore Your Financial Health outlines how to take those first steps in dealing with out-of-control debt.

1. Understand your debt; cut your spending.

It's the first, most obvious, and ultimately the most important step in getting back into the black. Most people can pull out a pay stub confidently and list exactly what they're bringing in each month. What gets murky is the spending. So make a personal balance sheet. That's your income compared with your spending, including housing, utilities, transportation, food, clothing, entertainment, insurance costs, and any other sort of regular outlay you can pin down. Remember to include the costs of servicing debt you already have. Allen says it's often small expenditures -- eating out, your morning coffee -- that make the difference for people on the edge. Spending $10 a day on lunch can add up to more than $400 a month for a household if two people are eating out. If you're living paycheck to paycheck, it's enough to push you over a financial cliff. See what you can cut. "As we get through the lists, people often find a pretty big surplus," he says.

2. Manage your debt the right way.

If you can't deal with debt just by tightening your belt, there are several options to consider immediately when putting together a debt management plan.

-- Credit counseling: Get started

Nonprofit debt management companies are popular options for creating a plan to repay debts and halt harassment from creditors. Debt is consolidated into a single monthly payment, often with a lower interest rate, and ongoing damage to your credit score will begin to reverse as long as you make payments on time. Allen recommends Money Management International, a Houston-based firm that's the nation's largest nonprofit counseling service. He says other reputable counselors can be found through the National Foundation for Credit Counseling (NFCC) and the Association of Independent Consumer Credit Counseling Agencies (AICCCA). A couple of caveats when entering into a debt management plan with a counselor: Keep an eye on monthly fees, and make sure your credit counselor has relationships with all of your credit card lenders so that your entire debt is represented in the plan.

-- Debt settlement companies: They're an option, but not a great one.

Debt settlement companies are a controversial tool for deeply troubled borrowers, especially those with hefty credit card debt. These for-profit firms agree, for often hefty fees, to try to negotiate a lower debt balance with your creditors. Creditors are willing to work with debt settlement firms because getting partial payments from customers is a better option than customers filing bankruptcy, in which case the creditors would likely get nothing. The problem is, debt settlement firms have a less-than-sterling reputation, and if creditors decide to sue you, the settlement firm isn't legally obliged to represent you in court. Allen recommends that you request documentation from other settlements to make sure the company you choose has a solid track record.

-- Home equity loans: Don't do it.

Taking a loan out against the value of your home was a popular option during the housing boom. But using home equity to pay off credit cards, for example, isn't the safest way back to fiscal health. Allen warns that home equity loans simply replace unsecured debt (credit cards) with secured debt (your house). If you can't repay a home equity loan, it gives another creditor (in addition to your mortgage lender) the legal right to take your home. "The negative consequences of not making those payments are such that it's a poor decision for people to take a home equity loan to pay off credit card debt," he says.

3. Talk to creditors.

Before you go to someone else to help manage your debt, remember that there are steps you can take by yourself to get control of the situation. The first step is opening up communication with your creditors. Acknowledge and take responsibility for your debt. If you meet creditors halfway, they'll be more willing to work with you, Allen says. His advice: Be as specific as possible about why you can't pay. The death of a spouse or divorce, loss of income, medical expenses, or other unexpected outlays are the main reasons people fall into debt, and the more creditors know, the easier it is to outline the available options. Also, reinforce your intention to pay, and say specifically that you are trying to avoid bankruptcy -- that alone lets creditors know that there's a chance they aren't going to be paid at all, and it should motivate them to offer solutions.

Then, ask for help. Remember: Times are tough for banks, credit card companies, and mortgage lenders right now. Lower interest rates, payment plans or extensions, or even changing the total amount you own on your loan have become more common as the economy and finance sector suffer. Some credit card companies even offer hardship plans, including forgiveness of some part of the total debt. For example, some offer "60/60" plans that allow you to pay 60 percent of the balance over 60 months, Allen says.

Another key tip: As the process continues, document, document, document. Log phone calls and keep an organized file of bills, notices, and a copy of your personal balance sheet (mentioned above) handy. Lastly, follow through: If you commit to a payment, make it on time and in full. "People are scared to answer the phone when creditors call. They won't answer the phone or open the letters. It's entirely the wrong thing to do," Allen says. "If you communicate with these people, you can work it out."

Also, there's a flip side to communicating with creditors: What if they're harassing you? In that case, Allen says, you have rights, too. If you feel a collection agent is being abusive, speak to a supervisor and keep detailed records of times and frequency of calls and the names of agents you speak with. You can also request that creditors not call you at work. Thanks to the Fair Debt Collection Practices Act, you can file a complaint with the Federal Trade Commission if harassment persists. "People are shocked to learn they have some power. You can tell people they have to stop calling you," Allen says.

4. The last option: bankruptcy.

If you're truly drowning in debt, bankruptcy may be the only option. If it's clear that paying back debt will be almost impossible, the first step, Allen says, is to get some legal help. Although hiring a lawyer is never cheap, finding a professional who has handled bankruptcies for people with similar financial profiles to yours is worth the cost. He or she will be able to steer you through the types of bankruptcy (usually Chapter 13 or Chapter 7) that work for you. "It's a last resort, but in many ways, it's the most powerful tool available if you're in serious financial trouble," Allen says. "Bankruptcy is not for everybody, but it can give you a fresh start if you make the changes necessary in your life so it doesn't happen again."

5. Stay positive.

There's an emotional component to getting through tough times. Dealing with debt is never easy, and the stress can affect your family, your work, and your mental health. Allen says the most important thing to remember is that the situation isn't hopeless, and that by taking some of the steps above, financial recovery can happen over time. In the meantime, he says, it's best to keep financial strain as separate as possible from the rest of your life. "People need to realize they are not their debt. They need to separate their net worth from their self worth," he says. "People don't realize they have options, and stress because of their debt is really ruining their lives."

Available at Amazon.com: A Survival Guide to Debt: How to Overcome Tough Times & Restore Your Financial Health

 

Personal Finance - 5 First Steps to Deal With Debt; The moves you need to make to get back to even