Debt Management Options

Unit 2: Debt Management Options

Managing Your Debt Alone

By managing your debts alone, you plan to reduce debts through disciplined budgeting.  The first step toward taking control of your financial situation is to do a realistic assessment of how much money you take in and how much money you spend. Start by listing your income from all sources. Then, list your "fixed" expenses, those that are the same each month such as a mortgage payment or rent, car payments, and insurance premiums. Next, list the expenses that vary such as entertainment, recreation, and clothing. Writing down all your expenses, even those that seem insignificant, is a helpful way to track your spending patterns, identify necessary expenses, and prioritize the rest. The goal is to make sure you can make ends meet on the basics: housing, food, health care, insurance, and education. 

  • Contacting Your Creditors:  Contact your creditors immediately if you're having trouble making payments. Tell them why it's difficult for you, and try to work out a modified payment plan that reduces your payments to a more manageable level. Don't wait until your accounts have been turned over to a debt collector. At that point, your creditors have given up on you.
  • Dealing with Debt Collectors: The Fair Debt Collection Practices Act is the federal law that dictates how and when a debt collector may contact you. A debt collector may not call you before 8 a.m., after 9 p.m., or while you're at work if the collector knows that your employer doesn't approve of the calls. Collectors may not harass you, lie, or use unfair practices when they try to collect a debt. And they must honor a written request from you to stop further contact.
  • Managing Your Auto and Home Loans: Your debts can be unsecured or secured. Secured debts usually are tied to an asset, like your car for a car loan, or your house for a mortgage. If you stop making payments, lenders can repossess your car or foreclose on your house. Unsecured debts are not tied to any asset, and include most credit card debt, bills for medical care, signature loans, and debts for other types of services.
    Most automobile financing agreements allow a creditor to repossess your car any time you're in default. No notice is required. If your car is repossessed, you may have to pay the balance due on the loan, as well as towing and storage costs, to get it back. If you can't do this, the creditor may sell the car and pursue collection activity for the balance owed.
    If you fall behind on your mortgage, contact your lender immediately to avoid foreclosure. Most lenders are willing to work with you if they believe you're acting in good faith and the situation is temporary. If you and your lender cannot work out a plan, contact a housing counseling agency, many offer free help to any homeowner who's having trouble making mortgage payments.

QUICK TIP: There's no underestimating the importance of formulating a budget. It's a process that helps you develop the self-discipline you'll need to manage your money and keep needs, wants and desires in their proper relationship. A spending plan also forces you and your family to develop disciplined attitudes about earning, saving and living within your means. To learn more about establishing a budget download a free copy of It’s Not What You Make, It’s How You Spend. 

Debt Settlement Programs

Debt settlement is the process of negotiating with creditors to reduce overall debts in exchange for a lump sum payment. A successful settlement occurs when the creditor agrees to forgive a percentage of the total account balance. Normally, only unsecured debts not secured by real assets such as homes or autos can be settled. Unsecured debts include medical bills and credit card debts—not student loans, auto financing or mortgages. For the debtor, this makes obvious sense, they avoid the stigma and intrusive court-mandated controls of bankruptcy while still lowering, sometimes by more than 50%, their debt balances. Whereas, for the creditor, they regain trust that the borrower intends to pay back what he can of the loans and not file bankruptcy (in which case, the creditor risks losing all monies owed).

In order to work with a debt settlement company, a consumer needs lump sum cash or needs to build up enough funds over a pre-determined period of time. For consumers who have no cash to make a lump sum settlement offer, debt settlement companies set up a third party "trust" account where funds accumulate for the settlement process.  A consumer makes monthly payments to the debt settlement company, or to the bank that holds the "trust" account. A portion of each payment is taken as fees for the debt settlement company, and the rest is put into the trust account. The debt settlement company's fees are usually specified in the enrollment contract, and may range from 10% to 75% of the total amount of debt to be settled.

While creditors have no obligation to agree to negotiate the amount a consumer owes, they have a legal obligation to provide accurate information to the credit reporting agencies, including your failure to make monthly payments. That can result in a negative entry on your credit report. And in certain situations, creditors may have the right to sue you to recover the money you owe. In some instances, when creditors win a lawsuit, they have the right to garnish your wages or put a lien on your home. Finally, the Internal Revenue Service may consider any amount of forgiven debt to be taxable income.

Quick Tip: For information about your credit score and how outstanding debts affect your score review MoneyEd’s Credit Smart

Tax Consequences

Depending on your financial condition, the amount of savings you obtain from debt settlement can be considered income and taxable. Credit card companies and others may report settled debt to the IRS, and the IRS considers it income, unless you are "insolvent." You are insolvent when your total debts are more than the fair market value of your total assets. Insolvency can be fairly complex to determine, talk to a tax professional if are not sure whether you qualify for this exception.

Settlement Disclosure Requirements

Before you sign up for the service, the debt settlement company must give you information about the program:

  • Price and terms. The company must explain its fees and must tell you about any conditions on its services.
  • Results. The company must tell you how long it will take to get results. That is, how many months or years before the company will make an offer to each creditor.
  • Offers. The company must tell you how much money or what percentage of each outstanding debt you must save before it will make an offer to each creditor.
  • Non-payment. If the company asks you to stop making payments to your creditors—or if the program relies on you not making payments—the company must tell you about the possible negative consequences of doing so.
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