Over the last several weeks, I have talked to about a dozen people in various states of financial distress. Either through living beyond their means, large medical expenses, job loss, divorce, or the cost of maintaining a house that requires a lot of maintenance – the people I’ve met recently are all looking for the same thing. How do they get this debt under control and make life more manageable? The problem with debt is that when it gets to some point (it’s different with each person), it becomes a serious stress inducer and can flow through and impact the individual’s personal/family life, negatively impact job performance and have ripple effects that erode their health as well.
When talking about debt resolution, there are a limited number of solutions and one of them is typically the right answer for each person I coach through the process. Sometimes, there’s a combination of several solutions that will be the ideal fix for their debt problem. I view this much like my orthopedic surgeon views knee injuries. (I’ve had multiple knee surgeries, so I know the drill now.)
Before a surgeon cuts, there are less invasive ways to approach a painful joint. Rest and ice are the first and least invasive way to go. Strengthening the surrounding muscles so that the joint has maximum support is a useful practice. Physical therapy/rehab require some professional help and in some cases, fixes the source of the pain. When those options have been exhausted and eliminated, the scalpel (or other less invasive surgical instruments) becomes the final stop along the continuum.
If running from the collection agencies isn't your exercise of choice, read this book for tips and tricks on how to crush credit card debt.
Doing It Yourself
Fixing the pain caused by debt has a similar trajectory. The first and least “invasive” way to tackle your debt is through a do-it-yourself process. Contact each creditor and ask for an interest rate reduction so that more of your payments are going to reduce overall indebtedness rather than to simply pay interest charges that can mount rather quickly and keep you in debt for decades.
After seeing what options each creditor offers, you can begin the hard work of getting your debt level to $0. There are several schools of thought out there about the “best” way to eliminate debt. I’m completely agnostic on this and believe that the best debt elimination plan (like the best fitness routine or diet) is the one that allows you to stick with it and experience long term success. The best answer, from a purely mathematical standpoint, is to pay off debts with the highest rate of interest first and then move to the next one after the highest interest debt is completely paid off. This Debt Blaster calculator can help you structure your payments in a way that follows this strategy.
The other strategy that I see being widely used is paying off the lowest balance debt first in order to give a psychological boost. (It feels GOOD to get a statement with a $0 balance!) This has been popularized by the Dave Ramsey Debt Snowball method. For those who are disciplined and want to tackle this on their own, I’ve seen the DIY method get hundreds of people completely out of debt and on their way to financial security. Sometimes restructuring the debt (consolidation loan, home equity, 401k loan, peer-to-peer lending, etc.) is involved, but I’ll keep it simple and not dive into those options as a part of this.
Credit Counseling
If the debt is becoming a bit overwhelming and the DIY method isn’t proving successful, or worse yet, you’ve tried the DIY and after ayear, you find yourself in even deeper debt than when you started, you can work with a reputable non-profit credit counseling service. There are a lot of disreputable companies out there that prey on vulnerable people, but this link to the NFCC’s agency locator should eliminate that type of risk. The way these agencies work is through a debt management plan (DMP).
With a DMP, most creditors have pre-negotiated interest rate reductions (as low as 3-4% with some creditors) so that your dollars work toward eliminating your debt. Typically, you would make one payment to the agency for your DMP and they would pay off your creditors over a 4-5 year window. At the end of that window, you are debt free.
I’ve seen this work repeatedly and the pride that I’ve seen when someone makes their final payment and knows that they’ve tamed a beast is a spectacular thing to witness. The major drawback (if you see it as a drawback) is that for most DMPs, you are asked to close all but one credit card that could be used as an emergency card or to rent cars/hotels. This is a worthwhile option to pursue for those who can’t make the DIY path work.
Debt Settlement
If the DIY and DMP aren’t working, then the problem goes up a level in severity. If you simply can’t afford to pay off 100% of your debt (which happens in the DIY/DMP options) and your credit score isn’t something that you are concerned about in the short run, the next step along the path is to consider some type of debt settlement/debt resolution effort. This is something you can do on your own by agreeing to a settlement offer when a debt has gone into collections and your phone is ringing with debt collectors on the other end or you could work with a company that does this for you.
This is another area where there are some unscrupulous characters at play, but the members of the AFCC are some of the more reputable companies in this space. These companies will negotiate a settlement (often at less than half the balance of the debt) with each creditor on your behalf, handle the processing of payoffs and keep the collections calls from coming in your direction. For this, they charge a fee. What you should know is that this fee is definitely negotiable.
Much like the DMP, you’d make one monthly payment to the debt resolution company and within a few years your debt level is at $0. Once that happens, your ability to repair your credit score is much greater. Another potential downside is that forgiven debt can be considered taxable income. This is one path that I don’t see used all that often, but when I have seen it used, it has been rather effective. I’ve seen it combined with a home equity or 401k loan to provide funds for settlement and a quick resolution to a significant problem.
Bankruptcy
When none of these options can do to your debt what a physical therapist was able to do to my shoulder, surgery – or in this case, bankruptcy – might be the only solution. While I am not a big fan of this because of some of the unintended consequences, (marking “yes” on “Have you ever filed bankruptcy?” questions on job applications, which may make you unemployable in situations requiring security clearance) at times it is the only option that makes sense. If you have to file bankruptcy, check with your employer’s EAP to see if you have a legal benefit available. This could save you precious dollars in legal fees.
If you find yourself in debt and are hearing “you should do X” from people in your life, take a step back and try to objectively solve your problem in the least invasive way possible. Surgeons (at least the good ones) operate only when necessary. Bankruptcy is the same type of solution and should only be used when absolutely needed.
If you see your debt situation the same way an athlete sees an injured joint, the parallels become clear. Hopefully, if you ever find yourself in that position you can work your way out of it and get your financial life back on track to reach a point of financial security later. I’ve witnessed this transformation many times, and helping people get through it is one of the most fulfilling parts of my job.
