When looking for ways to eliminate debt, it’s important to understand what your options are so you can choose the methods that are most realistic for you. There are several ways for people in trouble with debt to make their situation more manageable. Some of the options available to borrowers include:
Debt Consolidation: Debt Consolidation is the process of taking all of your debt and combining it, to make one big monthly payment instead of several small payments. Very often, this is accomplished through a home equity line of credit, or HELOC. The borrower would need to secure a line of credit, use the credit to pay off all outstanding debt, and then make one monthly payment until the HELOC is paid off. The advantages of debt consolidation are that the overall interest you’re paying on your debt is generally lower and the interest you’re paying is tax deductible.
There are also companies who offer to pay off your debt and become your creditor. This option may be appropriate for those who don’t qualify for a HELOC, but can also be costly. It’s important to research this option and talk to a credit counselor before signing up and paying upfront fees.
Debt Negotiation: Debt negotiation is simply paying someone to talk to your creditors and strike a deal with them to lower your balance due. Why would a lender ever agree to an arrangement like this? If a negotiator can convince the creditors that the borrower is on the verge on bankruptcy, the credit card company would rather receive part of what they’re owed than nothing at all.
It’s vital that you do your research before beginning the debt negotiation process. There are countless scams popping up on the Internet all the time and many consumers get fooled and end up paying a lot of money and making their debt problems worse, not better. Also, there are adverse tax consequences with debt negotiation, as the money you save is viewed by the IRS as income. You may have a larger tax bill than you expect after taking this step.
Bankruptcy: This should be the last resort and should only be used if debt has become an insurmountable financial hardship in your life. Through bankruptcy, a court of law deems that the borrower is unable to pay the debts and that they don’t need to be repaid. The slate is wiped clean, but the consequences will last for 10 years or longer. A bankruptcy will stay on your credit report for 10 years. If you need credit, it’s still possible to get a loan. However, the interest rate on the loan will be much higher than it would be if your credit report was clean.
Pay it Off: This may be the most difficult option, but will also be the most rewarding. Through budgeting, credit counseling, and most of all discipline, getting out of debt slowly but surely on your own will leave you in the best position for the future.
One of the most important factors in determining whether or not a consumer qualifies for a particular loan is the individual’s debt ratio. The debt ratio is essentially a way to determine how much of an individual’s monthly income is spoken for every month in the form of payments that are due. A debt ratio of 60%, for instance, means that 60% of your income every month is required to make your minimum payments on all of your outstanding liabilities.
For example, let’s look at an individual that makes $5000 per month. This person has an auto loan that requires a $450/month payment, student loans that require $120 to be paid monthly, and credit card debt with a required minimum payment of $200 each month. This individual’s debt ratio can be determined by adding the monthly payment amounts and dividing them into the $5000 per month income. In this case, a minimum of $770 is due each month, so the debt ratio is 15.4% (found by dividing $770 into $5000).
For a corporation, the debt ratio is defined as the amount of debt a company has on the books relative to its assets. If a company accepted a loan from a bank of $1 million and the company has $2 million in assets on their balance sheet, the company’s debt ratio is 50% ($1 million divided into $2 million). A debt ratio of great than 1 (or 100%) would indicate that a company has borrowed more money than they have assets to show for it. For a company, the debt ratio will show investors and creditors just how much the company relies on debt to finance its assets.
Why are these numbers important? Because whether you’re an individual looking for a mortgage loan, or a corporation looking for additional financing to grow your business, will find ourselves in situations where we’d like to receive a loan from time to time. When a lender is evaluating us as borrowers, they’re going to take a close look at our other obligations to ensure that they can feel confident that we’ll make our payments.
A lender who makes home loans for example, may establish a rule that they will not issue a mortgage loan that would cause an individual’s debt ratio to exceed 38%. When the lender is deciding how large a loan an applicant qualifies for, they examine all outstanding debt and determine the maximum monthly payment that individual can handle without exceeding their 38% maximum debt ratio. Thus, individuals with a lot of debt and a high debt ratio may have a hard time qualifying for the loan they want, regardless of their credit score and other factors.
Your debt ratio is an important measure regardless of your income. Lenders will only lend to those with a balance sheet that inspires confidence in the borrower’s ability to make their payments. Keeping your debt ratio low will increase your chances of getting the loan you want when you need it.
In my last post I talked about how the credit card companies are making some of the best interest rates of any investment, on the money that they’re lending you. You’re basically paying for their yachts, mansions and all the other extravagant things the bigwigs at those companies buy.
But you know, there is another side to the interest rates they’re charging.
If you’re already deep in debt on these high-interest credit cards, it’s too late to avoid the problem. You’re already helping them double their money every couple of years.
But think about this…
If you get those cards paid off as fast as humanly possible, you’re basically “earning” that interest you no longer have to pay for yourself.
Instead of paying twice as much for the same purchases after 3 years of financing them, you’re only paying a bit more than the original cost, and your putting the rest of that future interest back in your own pocket.
Or freeing it up to pay off other lower-interest debts.
If you’re carrying a balance on any of these credit cards that are up in the 27-28% range, get them paid off as fast as you can.
You’ll be the one “earning” that 27-28% once they’re paid off.
Have you heard of Peter Lynch? He’s the “hall of fame” investor who averaged about 29% annual gains while he led the Fidelity Magellan fund.
How would you like to earn 29% on your money, year after year?
Sound like a pretty attractive rate, doesn’t it? You’d be able to double your initial investment in about 3 years if you could maintain this kind of performance.
Well, I’m here to share a big secret with you and tell you how you can do it.
Are you ready for this?
Start your own credit card company – that’s the secret.
Okay, maybe it’s not something that just anyone can do. I’m being silly in order to make a point.
A lot of consumer credit charge almost that much interest every year. Most department store credit cards are up around 27% or 28% interest.
So if you’re paying the minimum payment on those cards, the stores are doubling their money roughly every 3 years.
And that means it’s costing you twice as much for any purchases that you finance for more than that.
If you pay $500 today for a new mattress and make the minimum payments for 3 years, it’s going to cost you closer to $1000 for that same mattress. Would you have bought it at that price?
If you think about the fact that the credit card companies are making hall of fame returns on their “investments” – that’s the money they’re lending you at crazy interest rates – it suddenly seems a lot less important to buy that new gadget today, like they try to convince you to.
Think about that next time you’re tempted to put something on that credit card. Do you really want to help the credit card companies put all that money in their pocket?
US News & World Report is reporting that Americans are all the more ignorant of their credit scores, putting their financial future in danger just because they can’t be bothered to take the time. When’s the last time you got your credit score or looked at your own credit report or both? A year? Two? Not knowing how to use this information can cost a consumer many thousands of dollars over the life of their financial dealings, and it’s simply not smart to entrust your future to a bank or a finance company.
Missing a payment or even just being late once can result in raised interest rates that can thwart many plans you may have for your own money. Not knowing what’s going on in your accounts can have nearly the same consequences. Buried deep in most credit card fine print are clauses that enable them to raise the interest rates at any time for any reason. Betcha didn’t know that, did ya? If you don’t keep an eye on things you won’t.
And just like there are ways to ding your credit for the worse, there are also ways to raise your FICO scores and qualify for better loans and rates. This can be accomplished in relatively short periods of time as well.
The bottom line here is to keep an eye on your credit reports and FICO scores. This will serve you well in the long run!
