Background Information

Debt, when managed correctly is an important aspect of building good credit and developing a strong financial portfolio.  In today's society everyone should have at least one or more credit cards that they use to make purchases they can afford to make and to pay off.  Credit cards are a matter of convenience and should not be used as a printing press to create money that does not exist. Your credit worthiness is based on your ability to access and to manage credit wisely.  Sometimes we are not able to manage our credit wisely and we fall into debt that goes beyond what our financial resources and income can comfortably repay.  In these cases you must take action immediately to both preserve your credit rating and to repay your debt.

What to do Right Now!

• Debt creeps up on us. Often the fact that we are in too deep financially creeps up on us.  If we are not used to maintaining a budget we can easily find that we have way overspent our ability to repay.  So, the very first thing to do is to take stock of the situation and lay out our assets ( what we own) and our liabilities (what we owe) as well as our income and our expenses.

• What you own and what you own. There are many software programs that can help you to sort our your finances but for right now a notebook and a pencil is all that you need. Begin by writing down everything that you own and what it is worth.  For example, if you own a car write down the current value of the car if you went to sell it.  On the other side of the paper put what you owe on the car if it is financed. How much of the loan is left to repay? The difference between the value of the car and what you owe on your loan will either be a positive or negative number.  This difference is your equity in the car or how much of the car you actually own from a financial perspective.

• Be complete. You must also put all of your debts in the liability side.  This includes each of your credit cards (how much you own in total) and any other money that you owe. Be thorough.  Don't forget school tuition for the kids, car, house, life insurance payments, etc.

• Do we have any equity? The reason we are taking stock of what we own and what we owe is to see if we can sell any of our assets to raise money to pay off debt.  Two of the most commonly used types of assets to find equity are vehicles and your home if you own it.  The goal is to see if you have any equity that can be turned into cash and be used to pay down very high interest debts such as most credit cards or revolving charge cards.  For example, if you own a home and your equity is $40,000 if may be to your benefit to obtain a second mortgage or home equity loan and use that loan to repay your highest interest debts. 

• How much is your income? Now that you can see on paper your net worth (the difference between your assets and your liabilities) you are ready to look at your income versus your expenditures.  Take another sheet of paper and at the top put down your current income from all sources.  If you have one job then just put the gross (total) income from your last paycheck.  Add as many paychecks as necessary to get to one month's work of income.  We are going to look at our budget on a monthly basis since most bills come on a monthly basis.

• How much must you spend? Below the monthly income list everything that you must pay out of that income.  First start with the deductions from your paycheck such as federal taxes, state taxes, local taxes, social security, Medicare, pension plans, etc.  Then continue with the mandatory items such as ongoing bills for rent or mortgage, car payments, insurance, utilities, tuition -- anything that you are obligated to pay monthly.  Also include each of your credit cards by listing the minimum payment due from your last statement.  To that minimum payment add twenty-five dollars.  This is the amount that you want to minimally pay down on the balance of the credit card.

• Add it all up. Now that you have listed the mandatory bills total up that column and subtract it from the income.  If you have a positive number that is the amount left over for other items such as gas, food, clothing, entertainment and other expenses.  You have control over these expenditures.  You can choose not eat out or to only drive to where it is absolutely necessary. 

• Are you in the negative? If you already have a negative number meaning that you must spend more than you make we have just identified the first problem to be addressed.

• Closing the gap. This negative gap must be closed.  There are many ways to do this.  You can try to make your regular monthly bills lower.  Reduce your utility bills by turning off lights, not using the air conditioner, eliminating cable or satellite television, etc.  Any area in which you can make a reduction you need to see what you can reasonable expect to accomplish by the next monthly payment.  Do not feel badly that you need to give up something you like such as satellite television.  You will be able to get it back down the road when you can afford to pay for it each month.

• Can you close the gap? Try making these adjustments and writing the new amount down next to the current amount.  For example, if you can eliminate cable television put a zero next to the amount you normally spend on the monthly cable bill. 

• Still negative? Now add up the new column including the adjusted items and compare the new total to your income each month.  If it is still negative you have a larger problem and may need to take more dramatic steps such as credit counseling where steps can be taken with some of the larger creditors to reduce your monthly payments.  Or, you may need to take another job, (even temporarily) to make some extra money to get the debts paid down.  Don't laugh, but you can make up to $1,000 a month delivering your local newspaper.  You have to work from 1:00am to about 6:00am seven days a week and you may be tired but it may be a good alternative.

• If these adjustments can help your monthly income number be more than your monthly expenditures you are in good shape because you many be able to get out of debt without more drastic steps.

What to do next

• If you are finding out that there is no way that your income can meet your expenditures you need to take more dramatic steps.

• These steps include: negotiating with your creditors to lower their monthly payments; refinance your home to use the equity to pay off debts; and as a last resort you can declare bankruptcy.

• If the gap between your income and expenditures is not that great--say twenty percent or less -- you may be able to negotiate with your creditors to lower your payments and establish a payment arrangement.  This will almost always mean that your credit line will be closed and you will have the payment arrangement noted on your credit file.  This is not ideal but it is better than bankruptcy when considering your credit history.

• The links below will refer you to several credit counseling services that can help you to accomplish this goal.

• The last resort is to declare bankruptcy.  While this is not an ideal option because it goes onto your credit history for up to ten years it will give you immediate relief from debt collection. 

• Chapter thirteen bankruptcy allows you to reorganize your debts and to negotiate repayment terms with your creditors.  Chapter seven bankruptcy will allow you to walk away from virtually all of your debts (excluding student loans and most tax debts) and start with a clean slate.  In the links below you will find information about these options.

What can you learn from this experience?

Whatever you do you MUST DO SOMETHING!  Ignoring the fact that you are in debt beyond your ability to pay will only make your problems worse and will force you into drastic action.  By being proactive you can also avoid some of the more embarrassing situations such as when your salary is garnished (a percentage of your salary goes towards paying your creditors who have succeeded in obtaining a court judgment against you) or having your car or other personal possessions  repossessed.

Making the mistake of spending too much money and then learning from this mistake can be very helpful in turning around your financial life.  Many people who have recovered from debt have learned how to live within their means, have started to achieve savings and retirement goals, and have learned to delay the instant gratification of spending money for luxury items.

Dealing with financial problems has also helped many individuals reevaluate their career goals and their need to earn more money.  Often that results in continuing educational goals, going into a vocational training program, or building their resume and looking for a new job.

When you consider that everything happens for a reason let the darkest times be the light at the end of the tunnel for better decision making and more positive actions in the future.  Living through financial hardship can be a very positive step towards a more stable, happy, and secure future if you let the lessons learned guide your next steps.