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Empowering your money

How to pay off debt when you're overwhelmed

At a glance:

  • How to start addressing your debt problem

  • When you miss payments on major expenses

  • Handling collection agencies and creditors

  • When creditors can garnish your wages, put liens on your home, or take your assets

  • Debt troubles? Here’s which ones to pay first

  • Summary of what to do when you're overwhelmed by debt

People get overwhelmed by debt for several reasons.

They lose their jobs, they take cuts in pay to keep their jobs, they suffer unforeseen medical expenses or homeowner bills, or they suffer some other event they may not have foreseen.

There are some who never learned good money management skills. Still others have problems delaying gratification, which was made all the worse by the availability of cheap credit.

Whatever the reason, if you can't pay your debts, you need not panic, nor do you need to stay stuck where you are.

Debt problems are so common that many sources of help have sprung up to help people deal with them. You need only reach out to them.

(Getty)
(Getty)

How to start addressing your debt problem

If you find that you have dug yourself into a hole, the first thing to do is stop digging. Limit any further losses.

Beyond this, you have several options at your disposal.

Your options for reducing debt

  • Set up a budget that limits your spending. If you try hard enough, you can probably find money to save, which you can put toward your debts. If debt is a recurring problem for you, a budget will become a necessity at some point.

  • Take on a second job.

  • Sell some possessions—jewelry, collectibles, a second car, things in your attic. Some people even resort to selling their homes and renting for a while as they regain their footing.

  • Withdraw or borrow money from a retirement account. Carefully consider the effect of such a move on your retirement, however. If you do go this route, in most cases you will have to pay taxes and there may be a penalty on the amount you take out.

  • Borrow from friends and family. The advantages are that you can negotiate the repayment terms and the interest rate (if any). The disadvantages are the effects it may have on your relationships.

  • Borrow from a life insurance policy, if that is allowed.

  • Take out a home equity loan and use the proceeds to pay higher-interest debt, or take out a reverse mortgage.

Here are some options that really don't reduce debt at all in the long run. They are very expensive and not recommended by financial advisors:

  • Payday loans. Here is how these loans work: you write a check for a certain amount (say, $500) and receive cash for a lesser amount (say, $450; the remaining $50 serves as payment for the loan's service to you). The lender holds your check until your payday, at which point you must pay it the original amount ($500). If you can't pay that amount, the lender tacks on another fee. The effective interest rate thus becomes exorbitant.

  • Tax refund anticipation loans (RALs). These are much rarer than they used to be. How they work: a RAL cuts you a check for the value of your tax refund, minus a fee. It then takes claim to your refund when it arrives. Various entities other than banks and tax-preparation companies—such as payday lenders—may provide them.

  • Tax refund anticipation checks (RACs). These are offered by tax preparation companies, and they provide a way for you to pay the tax preparation fee out of the refund. They are temporary accounts that wait for your IRS tax refund.

You can fall into debt for reasons beyond your immediate control. You may have lost your job or had big medical problems, for instance.

And your creditors may be sympathetic to you. Also, your creditors don't want to go through the hassle and expense of collections or repossession. They would rather keep you as a customer.

If you contact your creditors and explain your situation, they may let you miss a few payments, revise your loans, or remove or reduce certain finance charges.

If you expect to be in debt for a while

But what if you expect that your problems will last a long time? In that case, foreclosure, repossession, or bankruptcy may be inevitable. But they should be a last resort.

Consider a non-profit debt counseling program instead.

The US Department of Justice maintains a list of approved credit counseling agencies. These counseling agencies can help you negotiate with your creditors.

When you miss payments on major expenses

What should you do if you are about to miss payments on a large debt, such as a home? The last thing you should do is stay silent and hope it just magically works itself out, because it won't.

Your home

If you have a mortgage, your lender will begin foreclosure once you have missed a certain number of payments. Typically, this is four or five, though it varies by state, and it can vary by lender.

But your lender would rather keep you as a customer than go through the expenses and losses of foreclosure. Therefore, your lender will usually work with you through this period.

It may allow you to pay only the interest for a certain period, it may reduce your monthly payments, or it may suspend a few payments and tack them onto the loan elsewhere. In some cases, it may rewrite the loan. Contact your lender as soon as you are sure you will miss payments.

There are some alternatives worth considering, depending on how bad your debt situation is:

  • Try to sell the house. You can reduce further damage to your credit and even earn enough to pay off your debts.

  • Look into the federal programs that help people in foreclosure.

Your car

Does every ride in your car feel like it might be the last because you won't be able to make payments on your car loan? If this is the case, don't hide in fear.

Contact your creditor and explain your situation. It doesn't want to lose you as a customer and repossess a car that it knows it will have to sell for less. But it will repossess the car if you do not act. Your creditor may be willing to modify your loan or suspend a few payments and add them to the end of the loan.

This is better for you than if it repossessed the car, because in that situation, in order to get it back you must pay off repossession costs and the missed payments (or, in some cases, the entire loan balance).

On the other hand, it may make more sense to surrender the car before the creditor can repossess it. This can save you various costs associated with repossession.

In some cases, it can save you the balance on the loan. Yet another option is to try selling the car yourself to pay off the loan.

Bottom line: contact the creditor and learn what your options are.

Utilities

If you think you will not be able to afford your utility bills during periods of peak use, you might be able to opt for averaging them out over the year. This means paying a set rate that is less during peak use and more during sparse use.

Many cities prevent utilities from shutting off electricity or gas during winter months.

Are you low income or otherwise economically disadvantaged? You may qualify for reduced rates. Contact your utility company to see what it can offer you.

Personal loans or credit cards

If you are about to miss payments on either of these, it is important to remember that your creditors are likely to work with you to avoid the hassles, expenses, and lost revenue of default.

This means that you have the opportunity to negotiate. Contact the person in charge of the type of loan you have and explain your situation.

You may receive a lowered monthly payment, permission to skip a few payments, or perhaps even a reduction in your interest rate. Bear in mind, though, that you might suffer a freeze on any further credit.

Handling collection agencies and creditors

You need not be at the mercy of collectors, though it is to your advantage to work with them.

If you are bothered by collection agencies calling you and demanding payment on your debts, know that federal law prohibits bill collectors at collection agencies from calling you at "unreasonable" hours.

This usually means before 8 am and after 9 pm.

What collectors cannot do

The Fair Debt Collection Practices Act puts a number of prohibitions on collector behavior. Collectors are, to name a few actions, forbidden to harass you, add unauthorized charges to your account, and make false statements to you.

They may not contact you at work if they know your employer disapproves. They must identify themselves to you on the phone. Also, you are allowed to demand in writing that the collection agency stop contacting you.

Fair Debt Collection Practices Act does not apply to the collections department of a creditor; only to outside collectors. There are a few exceptions to this exception at the state level, so contact your state's consumer protection bureau to see what practices it prohibits.

The most effective action

Your most effective action will definitely be to deal with the collector. It can prevent the damage to your credit from getting any worse, and it can help you regain lost privileges (for example, a suspended online auction account).

If you do not cooperate, the creditor can sue you and get a court judgment. The judgment can let the creditor garnish your wages (up to 25%), seize bank accounts, or put a lien on property you own. Court judgments can last many, many years, and in many states the creditor can renew them afterward.

One last note: All states allow the collection of interest on debts.

When creditors can garnish your wages, put liens on your home, or take your assets

If you are in serious debt and afraid that a creditor can garnish your wages or your property, it pays to know how the process works, if only for some temporary stress relief.

Except in three situations discussed below, a creditor can't simply decide on its own to garnish your wages or put a lien on your home and then proceed from there. First it must sue you and get a court judgment. If it succeeds, it can garnish a maximum of 25% of your wages, and you can contest this in court if you wish.

There are three exceptions:

  • Alimony or child support. Up to 50% of your wages can be garnished by the state.

  • Taxes. The IRS can garnish your wages without a court order.

  • Student loans in default. The federal government can take a portion of your wages.

In the event that you get a tax refund, various creditors may be allowed to take a bite out of it. Consult your tax advisor or legal attorney if this should be a concern of yours.

What about unemployment benefits?

In most cases, unemployment benefits cannot be garnished. Exceptions occur if you owe back taxes to your state or if you owe alimony or child support.

Debt troubles? Here’s which ones to pay first

If you are overwhelmed by debt, you might be tempted to simply avoid all your various debts, or just the big ones.

At the least, it is important to know which ones are essential to pay and which ones are not so essential (for the present, that is). How should you prioritize your debts?

Basically, if they will incur serious consequences, they are an essential debt. Let's get some perspective on the major ones.

Housing

Your rent or mortgage may be your most important expense. Put this at the top of your list. On the other hand, can you sell your home, get a good price for it, and live in a modest apartment?

It could save you the hassles of losing your home through foreclosure and destroying your credit.

Loans

  • Secured loans. Secured loans have collateral behind them. A common example is a car. Can you live without the item if it gets repossessed? If not, it is a priority. If so, you can probably miss some payments; but bear in mind that if you default, your credit report will note this.

  • Credit card bills. If your credit card is secured by an account with money in it, it is a priority and you should not miss payments; otherwise, you will lose the money in the account. If it is unsecured and you miss payments, you will incur late fees. If you default, your credit will take a big hit and you may even get sued.

  • Personal loans. Loans from family and friends are the least likely to affect you negatively if you miss payments or default. They also stand the best chance of being renegotiated.

  • Financial aid loans. There is the possibility of deferring payments on your student loans. There is also the possibility of default. However, you can also lose any tax refunds from the IRS and possibly suffer garnishment of your wages.

  • Back taxes. You can work out a repayment plan if you are in a big crunch. You can possibly defer paying on your bill or, in some circumstances, have your tax bill reduced.

Recurring expenses

  • Insurance. Not keeping current with your insurance could make it harder to get new insurance. For health insurance, it can jeopardize any care you are currently or plan to receive. With auto insurance, in some states you can actually lose your driver's license.

  • Child support. Child support payments should be at the top of your list. If you don't pay them, you could go to jail. The obligation to pay child support never expires and cannot be wiped out in bankruptcy.

  • Utility bills. Unless you can live like a hermit for a while, you will probably need water, power, and other services for your home.

  • Condominium fees. If you own a condo unit, failure to make your monthly association fees can result in a lien on your home. That typically kicks in after a certain number of months of nonpayment.

  • Business loans and credit. Failing to pay back loans related to your business could result in lawsuits and collection attempts.

Other bills and expenses

  • Professional services. Bills for various professional services, such as contractor work, could result in legal action if they are not paid, though you may have some breathing room with them.

  • Medical bills. You typically have a lot of breathing room for medical bills. But they can result in legal action if you do not pay them. You can contact the medical provider and work out a reduced payment plan.

  • Court judgments. Any judgment against you can result in garnishment of your wages or personal property.

Summary of what to do when you’re overwhelmed by debts

Bottom line? Do what you can to keep up with your debts.

Different debts have different effects on your credit and your finances. If you are in a prolonged and difficult financial situation, it certainly can't hurt to contact a creditor or lender and explain this to them.

Many of them will work with you to craft a means of repayment; the alternative can be a lengthy legal fight and lost money.

The results on your end will usually always be negative, however: a bad credit score and difficulty getting loans or services in the future.

Weigh your options carefully, and seek consumer credit counseling if need be.

This content was created in partnership with the Financial Fitness Group, a leading e-learning provider of FINRA compliant financial wellness solutions that help improve financial literacy.

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