Did you think that to tackle your debt is simple and straight forward?
You see, when we first realised how much debt we had all I wanted was that it disappears.
Oh, I know this would have taken magic I regretfully don’t possess. It may have been done by going bankrupt were we ready to take the consequences.
This wasn’t our way and we did it ‘the proper way’. We reduced our spending by developing and using the ERR strategy for money management. We learned how to make more money. And we put it all against the debt.
All that was left to do was watch the whole heap of debt crumble!
This is one way, I suppose. It is not the one way to tackle debt though.
Lately, I’ve been researching these ways. Debt is never a problem that can’t be solved. Solutions vary within and between countries. I’ve been learning about IVAs and Scotlands Trust Deed in the UK; the ‘ins’ and ‘outs’ of bankruptcy in different European countries and marvelling at the relatively debtor friendly bankruptcy rules in Israel.
In the US, there are four ways to tackle your debt.
#1. Just go for it and pay it off
This is how we did it (though we did it in the UK). Choosing this way to tackle your debt, however, means that the debt was incurred mainly and predominantly through mismanaging your finances.
Hence, the first step towards ensuring that you are not getting in further debt and that you have enough money to start paying it off, is to change the way in which your manage your finances.
This way to tackle your debt is for you if you can:
- Generate positive cash flow to make a regular monthly payment towards your debt by eliminating the waste in your budget, by replacing what you do and how you do it and by reducing your consumption (this is known as the ERR strategy for money management).
- Muster the discipline and determination to make regular monthly payments towards your debt.
- Develop additional income streams and increase your income.
- Muster the discipline to throw most of this money against your debts.
- Access credit at lower interest (which means that your credit score is pristine like a just washed linen).
#2. Debt consolidation
Debt consolidation simply means that you’ll be taking out one loan, usually secured against an asset, instead of a number of smaller debts.
Debt consolidation is a notion in personal finance that attracts debate. It is by far not easy to decide whether to consolidate your debt. It is also by far not certain whether using this opportunity you’ll reduce or increase your debt; many people do, you know. For that matter, we did it couple of times.
Consolidating your debt has the following advantages:
- Taking out a consolidation loan usually saves interest: Currently credit cards interest, even the most favourable one, is running at about 20%; one can still get a bank loan at less than 10% interest.
- Taking out a consolidation loan means you are paying your debt down: loan repayments are calculated so that one always pays some of the principal rather than only interest.
- Taking out a consolidation loan means that you are not exposed to interest rates increase: the contract that sets out the conditions of the loan also state the interest rate.
- Debt consolidation saves energy and bother: yep, I really mean this one. It would have really drained me to have had to deal with debt across nine different places.
It is not all a bed of roses though. On the negative side:
- Taking out a consolidation loan usually entails collateral: this means that the lender ensures you are going to pay back by asking you for security. Usually it is your home!
- You are stuck with the interest rate: most of the time this works in your favour. However, if your credit rating is good and your borrowing to income ratio is not atrocious there may be cheaper options.
- Loans can stretch over a long period: in fact they usually do and this can seem like a life prison sentence. Very demoralising!
In light is these points, you have to ask the following three questions to decide whether this is the option for you:
- Can you take the collateral?
- Do you have a strategy for overpayment of the loan and have you checked that its conditions allow this?
- What kind of runner are you? If you are a sprinter stick with many smaller debts; if you have the mentality of a long distance runner consolidating is for you.
#3. Debt Management Plan(s)
A debt management plan (DMP) reduces the number of payments you make each month and can save you money in fees and interest.
Enrolling in a DMP is a way to gain (regain) control over your finances and develop healthy personal finance discipline. You’ll be helped with setting a realistic budget (yeah, this is going to be tight) and the negotiations with your creditors. You’ll make one, agreed monthly payment which the credit counselling organisation you enrolled with, will distribute towards your debts.
There are many positive things to say about enrolling in a DMP. I think, there are three particularly attractive points:
- You will get and stay organised and focused;
- You can save on fees, interest and other charges you’ll have to pay were you ‘just going for it’;
- You won’t be worried to pick up the phone any longer (or at least not that much) because creditors and collectors will stop calling you.
There are also potential problems with it as well:
- Your budget will be very tight;
- It can take a long time to repay the debt (up to 60 months);
- You’ll be in a very deep heap of trouble if you are late with your monthly payments or don’t make them. I don’t even want to tell you about it.
I believe, a DMP is for people who have a problem with finding the money to repay debt, have problem with being sufficiently disciplined to maintain the payments or both.
Do you know how many people went bankrupt in the US in 2012?
I didn’t think you do. In 2012 in the US 1,221,091 people filed for bankruptcy. If you are not sufficiently impressed by the number let me tell you that this is the population of Estonia (an European country across the Baltic sea from Finland).
It is a small country but still…
The most popular type of bankruptcy is Chapter 7: about 70% of the non-business bankruptcies fall here. Under the conditions of this, your debts are discharged and you are no longer responsible for paying them.
This is the only good thing that can be said about Chapter 7 bankruptcy and the costs are:
- The bankruptcy will stay on your credit report for 10 years;
- It will prevent you from getting credit in the future;
- It is likely to affect your job prospects;
- Your assets will be sold to pay the trustee, administrative costs and, if there are some funds left, some of the creditors;
- You can keep your house with no more than $16,500 equity;
- You can keep your car if the equity is less than $2,500.
And it is a complex and expensive process.
I’m not going to go into detail about the other bankruptcy Chapters. Just one thing, though:
Bankruptcy is a very serious matter. Make sure that you really have no other option before you decide to go for it.
These are the four ways to tackle your debt. Some will choose to ‘just go for it’ and good luck to them. Others will need the help of a consolidation loan or the discipline of a DMP.
Choose wisely and remember that bankruptcy is a choice of last resort. Apart from being complex, expensive and damaging to your future, you are unlikely to learn anything about money management. And this is such a loss of opportunity!