Dangers of Debt Settlement

These days advertisements for debt settlement companies are all over the TV, Internet and radio. The promises of decreased debt can be quite tempting for consumers who are struggling financially. However, it pays to get all the facts before turning to a settlement company to handle your debt problem. While these companies promise to reduce your debt what they may not be clear about is the effect of their services on your credit report.

The first step in debt settlement is providing the settlement company with details regarding your creditors and how much you owe each one. This information will be analyzed and the debt settlement specialist working with you will devise a repayment plan supposedly designed to reduce your debt and save you money. You will pay a monthly payment to the settlement company who will distribute it among your creditors.

So what does the settlement company get out of the deal? They take up to four of your payments as compensation for their services. After that, your payments are put in an account and when it has reached a certain balance the settlement company will negotiate debt settlement details with your creditors. While the idea of paying off your debt this way may seem convenient, there are some hidden drawbacks.

A creditor is only able to settle an account after it is charged off. In order for an account to be charged off, there must be six months of consecutive non-payment. This racks up late fees and shows up in a negative manner on your credit report.

You may already know that an item can stay on your credit report for seven years, however you may not know that time resets when you make a debt settlement. When the settled debt is paid off, it is not removed from your credit report. The debt will be marked Paid Settled or Charged-Off Settled.

If you’re overwhelmed by debt consider various alternatives to debt settlement. Credit counseling is one alternative that can help you pay down your debt in a convenient and effective way. You might also want to consider negotiating with your creditors on your own. Many creditors do have special hardship programs for those experiencing financial problems. These programs may reduce your late fees and interest rate for a specified period of time while you get your finances in order.

Types of Bankruptcy

The Constitution of the United States gives citizens the right to relieve their debt when unable to repay lenders and creditors. There are two main types of bankruptcy — Chapter 7 and Chapter 13. Understanding the difference between these two types is important for anyone considering bankruptcy.

Chapter 7

With Chapter 7 bankruptcy, you can discharge some or all your debt owed following the application of liquid assets to debt owed. Liquid assets can be turned into cash easily and quickly. Examples include money held in a savings or checking account. Some liquid assets are exempt, however this is something that varies from state to state. After the application of the liquid assets to your debt, the remaining debt is charged off. The creditors and/or collection agencies to which the debts were owed cannot try to collect them anymore.

To file for Chapter 7 bankruptcy you have to get credit counseling from an agency approved by your state, and you must meet certain income requirements. Your income must be less than the median for your state and family size. If it is not, you cannot file this kind of bankruptcy. You can consider filing Chapter 13 bankruptcy.

Chapter 13

Chapter 13 bankruptcy is different from Chapter 7 because you actually repay your debt via a payment plan stretched out over three to five years. When filing for Chapter 13, you will have to present a repayment plan for court approval. The payments go to the court, who in turn distributes it to your creditors. Your creditors do have the option of objecting to the repayment plan, however the decision is in the judge’s hands.

This type of bankruptcy might be the right choice for you if your debt is secured, such as a car loan with a lien on it. Unlike Chapter 7 bankruptcy, Chapter 13 does not require you to use your liquid assets on debt repayment. With Chapter 13 bankruptcy you are still required to undergo credit counseling.

Because bankruptcy is a complicated legal process it is best handled by an experienced attorney. A bankruptcy attorney can help you choose the right type of bankruptcy filing, handle the legal paperwork and guide you through each step of the filing process.

Many attorneys offer free consultations where you can find out more about what they do and how much their services cost.

Risks of Payday Loans

If you think a payday loan (also commonly referred to as a cash advance loan) is a good way to take care of an urgent financial situation you should think twice. Some people who obtain this type of loan end up paying a great deal more than what they borrowed and have a difficult time paying off the loan.

One reason for this is the exorbitant amount of interest charged, which can range between 300 to 1000 percent. This is about ten times the interest a bank or credit union would charge for a personal loan.

With such high fees you may wonder why anyone would choose a payday loan. These loans are geared towards people with bad credit or no credit who cannot obtain the money they need elsewhere. It can be very alluring, especially to young consumers who need fast cash. Typically you can walk into a cash advance center during business hours and walk out with the money you need in about thirty minutes or so. These companies do not check your credit, but they may ask you for income verification and references.

Let’s say you borrow $300 from a payday lender. They may advance you the $300 for a period of up to 14 days with a fee of $56 (fees vary from lender to lender.) However, if you cannot pay your loan in full within that time period, your payments will increase each month because the interest balloons up a high amount in a short time.

Many borrowers who are in dire financial straits are forced to keep extending the loan and end up paying several times the amount they borrowed in fees. It’s a vicious cycle that can leave you in worse shape financially than you were when you obtained the loan.

The Federal Trade Commission (FTC) recommends consumers avoid cash advances and payday loans. Alternatives to these high-interest loans include applying for a loan with your bank or credit union, borrowing from friends or family, taking a cash advance off your credit card if you have one, asking for an advance in pay from your boss and even asking your creditors for extensions on bills you are unable to pay on time.

Establishing a savings account for financial emergencies is also a good idea because it can prevent the need for a payday loan in the first place.

Establishing an Emergency Fund

An emergency savings account is a safety net that can protect you when unexpected expenses arise. For example, your car may break down and need costly repairs. Or you may lose your job and have a period of unemployment before finding another.  An emergency fund is preferable to using credit for these types of financial issues because credit cards and loans create debt and can make your financial problems even worse.

The rule of thumb when it comes to establishing an emergency account is to aim for three to twelve months of living expenses. Of course, the more money you’ve got in your emergency account, the better. For most people building their emergency fund to where they want it takes awhile. The first step is to decide on a savings goal and figure out how much to put towards that goal each week or month. This can be achieved by examining your budget and evaluating the money available for savings.

If there isn’t any money available, you will need to cut expenses, increase income or both. Everyone should have a solid budget plan implemented, if you don’t already have one establish it now.

Your emergency savings should be kept in an account separate from your normal checking and savings accounts. This will make you less likely to take money out of the account for non-emergencies. If you think it will be difficult for you to put money in the fund regularly consider having it directly deposited from your paycheck. That way the money will be placed in the savings account before you even see it.

By depositing to your fund regularly you will eventually meet the goal you’ve set for yourself. Once you meet your original goal, consider raising it and saving even more.

As mentioned previously, an emergency fund is for just that — emergencies. You should only dip into the account when you absolutely must. This might include job loss, medical expenses your insurance policy doesn’t cover, a pending repossession of your vehicle, foreclosure on your home…you get the idea.

You should not use the money in your emergency savings account for merchandise or services that are not absolutely urgent and necessary. You may want a new designer handbag or car stereo system, for example, but the last thing you want to do is buy it with your emergency fund money.

What debt to pay off first?

There are two ways to approach paying off your debt.

Snowball Debt Approach

This approach requires that you pay all the minimums on all your debts except for one (usually the smallest one).  Every month, you pay the absolute highest amount possible until it’s gone.  Once you’ve paid off the first debt, you take whatever you were paying on that debt and put it toward your next target (along with the minimal payment it used to have).

Once you pay off the second debt, you move onto the third debt where you pay the first minimum payment, plus the second and third minimum payments in addition to any extra you can handle.

This method is called the snowball approach because the amount you’re paying into each debt continues to grow (like a snowball) after each new debt is paid off.  For example, if you had six credit card payments all with a minimum payment of $100 a month, plus another $200 a month you could pay towards them ($800 total a month), you’d start the snowball approach by paying $300 toward one debt.  Once that was paid off, you’d pay $400 on the next debt, then $500 when that’s paid off, etc.

Mathematically Speaking

While it sounds like a good approach, not all financial advisers believe that it’s the best way to pay off your debts.  While the snowball approach is good because it keeps you motivated as you keep seeing credit card accounts hit $0 owed, mathematically speaking it makes sense to concentrate on paying off the cards with the higher interest rates first.

When it comes to paying the higher interest rate first, you also have to consider the balance on these cards.  You may have a card with an APR of 29% and a balance of $900, but you also might have a card with an APR of 27% and a balance of $3,000 — obviously, paying the higher interest rate off first would be more costly.

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