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Dealing With Debt

By: Financial Hotline
Fall 2020 (Vol. 38, No. 3)

Q: I owe more than I can pay. What are my options?

A: There are many companies that offer to help but most will charge you for things you can do yourself. Start with self-help. You need a realistic assessment of how much money you take in and how much money you spend.

  1. List your income from all sources.

  2. List your secured debt payments. These are things you would lose if you don’t pay and include fixed expenses like mortgage payments or rent, car payments.

  3. List the expenses that vary — like groceries, entertainment, and clothing.

  4. List unsecured debt payments like credit cards.

The goal is to identify necessities and eliminate any extras to make sure you can meet the basics: housing, food, health care, insurance, and education. Then determine what you have left for unsecured debt payments. If there isn’t enough left to pay the minimum due, you will need to negotiate lower payments based on what you can afford. Next, contact your creditors. Tell them you are experiencing a hardship and how long you expect it to last. Ask them to work out a payment plan that reduces your payments to what you can afford.

Q: I get letters every week from companies promising to settle my debt. Is this an easier option?

A: Debt settlement programs are offered by for-profi t companies. The way it works is you stop paying your creditors for several months and pay money to the debt settlement company instead. After several months, the company will try to get your creditors to settle your debt for some smaller amount. If your creditors agree, you will make that debt payment along with a sizable fee to the settlement company. You may end up paying less but your credit will be damaged, and you may owe tax on the amount of debt forgiven.

You could probably eliminate the fees to the settlement company and accomplish the same results yourself. If you stop paying your bills, the creditor will eventually contact you or you can contact them to negotiate a settlement. Either way you go, keep in mind, your creditors are not required to settle your debt, and they may choose instead to take you to court or turn matters over to a collection agency.

Q: Is a debt management plan the same as debt settlement?

A: No. A debt management plan (DMP) is usually offered by a credit counseling agency. The counselor will help you set up a budget and contact your creditors for you to negotiate payments you can afford. You deposit money each month with the credit counseling organization and they use that to pay your unsecured debts according to a payment schedule the counselor develops with you and your creditors. You usually must agree not to apply for or use any additional credit while you are participating in the plan. Again, your creditors are not required to cooperate, and your credit may be affected. Before you sign up, complete the self-help list above to see if your creditors offer the concessions that a credit counseling organization describes to you.

Q: What are the tax consequences of settling debt?

A: Depending on your financial condition, any savings you get from debt relief services can be considered income and taxable. Credit card companies and others may report settled debt to the IRS, which the IRS considers income, unless you are eligible for the insolvency rule. Insolvency is when your total debts are more than the fair market value of your total assets. Fill out the worksheet for IRS form 982 to see if this applies for you.

Q: There are so many offers to settle my debt and fix my credit and the ads are so convincing. Are there any warning signs to look for?

A: Yes. Watch out for the following:

  • Companies that charge fees before they settle your debt or begin your DMP plan

  • Pressure you to make “voluntary contributions”

  • Advertises a “new government program” to settle your debt

  • Guarantees to eliminate debt

  • Tells you to ignore your creditors without explaining the consequences

  • Say they can stop all debt collection calls and lawsuits

  • Guarantees they can settle all your debt for pennies on the dollar

  • Will not send you free information about their services it provides unless you provide personal financial information like your credit card account numbers

  • Tries to enroll you in a debt relief program without a comprehensive review of your finances

  • Offers to enroll you in a DMP without teaching you budgeting and money management skills

  • Demands that you make payments into a DMP before your creditors have agreed to the program

Q: Is debt consolidation a good solution?

A: You may be able to lower your cost of credit by consolidating your debt through a second mortgage, cash out refinance or a home equity line of credit. On the plus side, these loans may also provide a tax deduction. On the downside, these loans may come with high closing costs and they will also require you to put your home as collateral. As a rule, it is not a good idea to switch unsecured debt for secured debt. If you cannot pay your credit card bills, your credit will be damaged and in the worst-case scenario, you may get a judgment against you or your wages could be garnished. However, if you cannot make your mortgage or home equity payment you could lose your home.

Q: I have exhausted my other options and I am considering bankruptcy. What are the different options?

A: Bankruptcy is a legal procedure that offers a fresh start for people who can’t satisfy their debts. However, bankruptcy information stays on a credit report for 10 years and can make it difficult to get credit, buy a home, get life insurance, or sometimes get a job.

There are two main types of personal bankruptcy: Chapter 13 and Chapter 7. Each must be filed in federal bankruptcy court. Filing fees are several hundred dollars.

Chapter 13 allows people with a steady income to keep property, like a mortgaged house or a car, that they might otherwise lose through the bankruptcy process. The court approves a repayment plan that allows you to use your future income to pay off your debts during three to five years, rather than surrender any property. After you make all the payments under the plan, you receive a discharge of your debts.

Chapter 7 is known as straight bankruptcy; it involves liquidating all assets that are not exempt. Exempt property may include automobiles, work-related tools, and basic household furnishings. Some of your property may be sold by a court-appointed official, called a trustee, or turned over to your creditors.

Both types of bankruptcy may get rid of unsecured debts and stop foreclosures, repossessions, garnishments and utility shut offs, as well as debt collection activities. Both also provide exemptions that let you keep certain assets, although exemption amounts vary by state. Personal bankruptcy usually does not erase child support, alimony, fines, taxes, and some student loan obligations. And, unless you have an acceptable plan to catch up on your debt under Chapter 13, bankruptcy usually does not allow you to keep property when your creditor has an unpaid mortgage or security lien on it.

You must get credit counseling from a government approved organization within six months before. If you’re thinking about filing for bankruptcy, be aware that bankruptcy laws require that you get credit counseling from a government-approved organization within six months before you file for bankruptcy relief. You can find a state-by-state list of government-approved organizations at, the website of the U.S. Trustee Program.