Thursday, May 13, 2010

Prof. Pennywise tells how to get out debt

At Chronicle of Higher Education, Prof. Pennywise offers a terrific column, "In Debt to Your Degree". It is very possible that you may not be able to access the column linked here without a Chronicle password. So, I am going to snip some of her best bits of advice here. But her column is witty and pithy, and if you can access it in full, I heartily recommend reading it in full. here are snips:

Take responsibility. No matter how you got in this predicament, only one person can free you from it. Look around. Is anyone else offering to pay off your debt?

Buy only the life you can afford. To erase debt, you must spend less than you bring in. That means you must control your spending. If you notice a pattern of credit-card expenditure followed by regret, then cut up all your cards and throw them away—or at least put them on ice or in a drawer. Keep only a debit card in your wallet. Instruct the bank to turn off the overdraft protection so you can spend only if there is actually money in your account. Either get personal-finance software like Quicken or just collect your bank and credit-card statements for a month. Look over your expenses. What can you cut? Could you rent more cheaply? Do you really need 137 channels? Should you eat in more? Nothing is off limits. If you free up $150, $375, or $600 a month to put toward debt reduction, your debt will begin its descent. Sacrifice. Get out of the red and into the black.

Tally your debt. Before you can conquer debt, you have to know its extent. Download a free credit report at (this site, unlike its competitors, will not fleece you). The report will detail your credit history and status, enabling you to know your total debt, since it will identify every loan in your name. Alternately, you can save all your credit-card bills and other financial statements for a month and determine your total in credit-card, student, auto, and mortgage debt. Track this monthly, whether in an Excel spreadsheet, personal-finance software, or a simple piece of paper tacked above your desk. Your objective: zero balance.

Pay the minimum religiously. Late payments result in fees, high interest rates, and a disastrous credit rating. Pay your minimums on time, every month, without fail.

Go beyond the minimum. If you make only the minimum payment, it will take you decades, literally, to repay a loan. The minimum goes mostly to interest, not principal. Pay more—much more—than the minimum.

Pay off your lowest-balance card first. That will give you an immediate morale boost, eliminate one mandatory payment (freeing up money you can use to pay down another debt), and improve your credit rating (which affects what rates you are charged).

Next focus on your highest-interest card. Determine your rates (the APR's) by looking at statements or calling each card issuer. Any interest rate north of 20 percent is killer, but even run-of-the-mill rates of 14 to 18 percent are ugly. Rank your credit cards, with the highest-interest one on top and the lowest at the bottom. Pay off each card in sequence, eliminating the most expensive first. Do that, and you'll achieve success faster and pay far less interest in total.

Transfer balances. Use or similar sites to find a low-interest-rate card. Consider transferring high-interest balances to it. But be attentive: A transfer fee will likely be charged, and after a teaser time the interest rates may go sky-high. Do the math, because consolidation may not be worth it.

Find new income. Do you have books, CD's, or clothes to sell on eBay or Could you tutor high-school students? Moonlight in an SAT-preparation center? Read AP exams? Proofread for a publisher? If you add an income stream or two to your current ones, put any resulting cash to debt reduction.

Call your creditors. Tell them you are organizing a financial turnaround and ask for a reduced rate or minimum-payment level. More is negotiable than you might imagine. If you are severely delinquent, ask for balances to be slashed. Be polite, but assertive. Ask to speak to a manager if the frontline employee is unhelpful.

Tap your wealth. Retain an emergency fund of three months' expenses, but if you have other savings devote them to debt reduction, which boasts a guaranteed return. Other wealth can be deployed. If you have a Roth IRA, you can retrieve past contributions. A home can be tapped for equity, or an employer-based retirement plan borrowed against. But think hard before depleting such assets.

Restructure. If you are in real trouble, a nonprofit credit-counseling service may be the way to go, but beware high fees and scams. Bankruptcy, the last resort, wipes the slate clean—in the fashion of a neutron bomb.
Additional notes from your OOTJ reporter. Credit counseling can be tricky. Be careful how you go and careful choosing if you choose a credit counselor. The Wikipedia article on Credit Counseling states:
The Federal Trade Commission has filed lawsuits against several credit counseling agencies, and continues to urge caution in choosing a credit counseling agency. The FTC has received more than 8,000 complaints from consumers about credit counselors, many concerning high or hidden fees and the inability to opt out of so-called “voluntary” contributions. The Better Business Bureau also reports high complaint levels about credit counseling.
The IRS also has weighed in on the subject of credit counseling, and has denied nonprofit 501(c)(3) tax-exempt status to around 30 of the nation's 1000 credit counseling agencies. Those 30 credit counseling agencies account for more than half of the industry's revenue. Audits of non-profit credit counseling agencies by the IRS are ongoing.
Other organizations have voiced criticisms of the credit counseling industry, often citing the Fair Share funding model as evidence that credit counselors serve the interests of the creditors over the interests of consumers, and that credit counselors are not forthcoming in speaking out about the actions of creditors for fear of losing what little funding remains. Credit counselors respond that their job is not to take sides but to negotiate with all parties equally to help successfully resolve debts. They further argue that the steady decline in Fair Share funding belies the notion that creditors are in control of the credit counseling industry.
Another common criticism of credit counseling is the assertion that participating in a Debt Management Plan will ruin a consumer’s credit. Fair Isaac Corporation, the company that pioneered the use of credit scores, states that participation in a Debt Management Plan has no effect on a consumer's FICO credit score. However, the participation in such a plan may appear on consumer credit reports, and the client may have more difficulty obtaining a car or home loan and be denied any further unsecured credit, such as a credit card. This is because lenders often use multiple risk factors to determine creditworthiness. The major factor holding consumers back is the amount of debt they have relative to their income (the debt to income ratio) and not enrollment in a credit counseling plan. While credit card banks offering relatively low-credit-line cards may use a credit score alone to approve a new account, a mortgage or car lender typically will scrutinize the entire credit report more extensively and verify employment and income information. Some lenders view a prospective customer's participation in a Debt Management Plan as indicative of the customer being unfit to manage their finances.
Also, student loans can be reconsolidated under better terms than ever. Visit the GOVERNMENT website to explore and use the calculator and see if it's worth consolidating your loans at the new rates.

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