It seems like everyone out there has advice on getting out of debt. Some of it is good, some of it is bad. Most of it is incomplete because as non-attorneys, people who tell you how to get out of debt don’t understand all of the options. So check out the below steps, some of which you may have heard before, some of which you probably haven’t.
Step 1 – Stop the Bleeding. In other words, stop using credit. Some “experts” (I use that word loosely) tell you to immediately shred your credit cards and stop drawing on credit. That is generally appropriate but oftentimes not possible. Sometimes people have large expenses, emergencies, or other unanticipated events arise which make immediate abandonment of credit an unlikely event. So, if you have to wean yourself off of credit that is acceptable. However, this process should take not more than 2-3 months. You should start operating on a cash only basis. I don’t mean start using only green cash, but use your debit card as well.
Step 2 – Create a Budget. Sounds easy, right? Wrong, this is actually harder to do than most people think. To do this you first need to figure out your income (bonuses do not count as income). For a salaried position this is easy. For those who are hourly, commission based, or have fluctuating income (note another reason why sometimes it is hard to get off of credit right away in that you might have to wait for the next payday) it is much more difficult. To be honest, the best way to figure it out is to look at the last 12 months and determine an average monthly amount. That is the first line of your spreadsheet.
The next step is to categorize your expenses. This is a bit tricky, you don’t want to get too broad. When you sit down and try to figure out categories for your expenses it is amazing all of the little things that can shift from category to category with relative ease. But don’t get to narrow as well, you need to be able to track where your money is going. You shouldn’t need more than 20-30 categories. As the old saying goes, “KISS”, Keep It Simple Stupid. Don’t over categorize, keep it simple and easy to figure out.
You should then pay your bills on the 1st and 15th of the month so you can get a sense of your cash flow needs and have the ability to cover the basics, like food and rent. Remember always try to keep a bit back each month for necessary but unanticipated expenses.
Step 3 – Pay it the Debt. If you can pay your debt you should do it. Obviously focus on the high interest accounts first. Try to pay more than the minimum’s. If you get a tax refund it goes to your debt. If you get a bonus at work it goes to your debt. With the exception of a company match 401(k), stop contributing to your retirement and use that money to pay off the debt (though see below if you are nearing retirement age as not building up a nest egg if you are older is not a good idea). The interest that is charged on credit cards is incredible when compared to the average 10% return you can expect to receive if you invest long term in the stock market. The better investment is paying off your debt.
Step 4 – Do the Math. You need to take time, figure out on an excel spreadsheet (or something similar; search for templates on the web) how long it is going to take you to pay off the debt. You need a realistic picture of how long it is going to take so you can set your expectations early on. You may be surprised, minimum payments plus a few extra bucks here and there, can take a VERY long time to pay off. This is even without new purchases. If you add to the debt, you can kiss the dream of paying off your debt anytime soon goodbye. You need to be realistic about your timeframe. If you are close to retirement age, have health problems which prevents working, or any other timing issue in which you can’t wait for it all to be paid off you should consider your other options.
Step 5 – Don’t Pay It. Very rarely is this a good option. If you don’t pay your debt you will get sued. You will likely lose because you owe the money. By the time you get sued the balance will have increased dramatically because of the interest, late fees, and attorney fees (by the provisions you will likely be paying their attorneys to sue you). In most states after you lose, you will start to be garnished or otherwise collected upon. They can liquidate bank accounts, garnish a percent of your wages, put liens on houses, take property, none of which is a good thing. The only time this is ever a good option is if you are judgment proof. This means that if a creditor gets a judgment, who cares, they cannot legally take anything you own. The classic example of a ‘judgment proof’ debtor is usually someone with only social security income, no car (or other substantial assets), and renting.
Step 6 – Settle It. Be VERY careful about settling your debt. There are thousands of outfits out there who claim they will settle your debt and reduced rates. They will make all kinds of promises to get you signed up and rarely deliver. There are two types of debt settlement, 1) Debt Consolidation & 2) Traditional Debt Settlement. Debt consolidation is the program in which you ‘consolidate’ your monthly payments and your debt settlement company pays your bills for you. This works sometimes, but at least twice a week (I’m not kidding) I get a phone call from someone that says something like this, “I hired this company and they said all my bills were being paid, they never really got back to me when I called them, and now I am getting sued!”
The second route, traditional debt settlement, is where you pay lump sums to your creditors for reduced amounts and settle the entire debt. The primary problem with this is that you need money to do this and you may get a form 1099 for the forgiven amount and have to claim it as income on your taxes (thus increasing your taxable base and getting you cross with the IRS).
The better advice is to run, not walk away from these companies. If you decide to do this, be very very careful and do you homework. Make sure you get everything in writing, including balances that are forgiven. I have seen on several occasions, after a debt has been settled, the creditor simply sells it to another buyer who starts collecting again. (Note: think not twice, but three times before you cash out your retirement to pay your debts. Again, depending on your age or other conditions this is oftentimes a bad idea. Retirement is almost always exempt in bankruptcy, meaning you won’t lose it!)
Step 7 – File Bankruptcy. If all else fails, file bankruptcy. The vast majority of people who file bankruptcy end up wiping out there debts and keeping their stuff. There are two primary types of bankruptcy, Chapter 7 or Chapter 13. The former is a liquidation where the courts take property that is not protected (depending on the state most property is protected) and the latter is a plan for reorganization where you pay back part of the debt.
Look, here’s the deal about bankruptcy, the vast majority of the time bankruptcy is the better financial option for the individual. What does this mean? It means that you will save more money filing bankruptcy (even if you do have to turn over some property) than you would paying it all off or even debt settlement. Moreover, the legal protections you receive in bankruptcy are federal, enforceable, and final.
If you’re worried about the potential downsides of bankruptcy, keep reading these blog posts but contact a Denver bankruptcy attorney near you. You would be surprised at the type and amount of people who end up filing.
DISCLAIMER: The information contained in this distribution is intended for informational purposes only. It is not intended to be legal advice. Your situation may vary and different facts creates different advice. So do not take legal action based on this content! Always contact a lawyer near you. The attorney’s posting this advice are licensed in COLORADO only and thus there may be a dramatic difference in procedures in any other state. This is not an advertisement for legal services except where permitted by law.