Dealing With Debt

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Dealing With Debt

• Barbara ONeill, Ph.D., CFP

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Participants will

• Learn to use credit wisely
• Learn about the danger signs of debt
• Learn ways to cope with financial distress
• Learn about high-cost credit fees

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How Much In Debt Are You?

• Total up
• Number of creditors
• Individual debt balances
• Total debt balance
• Monthly payments for each creditor
• Total of monthly payments

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How Much Do You Currently Owe?

• Creditor Outstanding Balance
• ______________________ ________
• ______________________ ________
• ______________________ ________
• ______________________ ________
• ______________________ ________
• Total Indebtedness _______

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Consumer Debt Ratios

• Consumer debt repayments (monthly)
• Take-home (net) pay (monthly)
• Example
• 390 21.6
• 1,800
• (over the 10-15 recommended amount)

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Annual Debt Ratio

• Consumer debt mortgage or rent (monthly)
• Take-home pay (monthly)
• Example
• 390 720 1110 61.6
• 1800 1800
• (over the 40-50 recommended amount)

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Debt Danger Signs

• Getting a loan to repay existing debt
• Charging more each month than payments
• Juggling (rotating) payment of bills
• Using credit card cash advances for bills
• Chronically overdrawn bank accounts
• Depending on overtime to make ends meet
• Being at or near maximum credit limits
• Calls and letters about overdue bills

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3 Stages of Credit Difficulty

• Early - begin paying late penalties
• pay minimum due
• a month or 2 behind
• Later - bills are months overdue
• difficult to pay minimum
• creditors are making contact
• Final - court proceedings threatened/pending
• wages subject to garnishment
• secured items (car,etc) repossessed

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Strategies to Reduce Debt
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1. Try to Increase Income

• Adjust tax withholding on Form W-4
• Be a 2-income household/work overtime/sideline
  job
• Increase child support or alimony
• Food stamps, SSI, TANF, other public benefits
• Selling assets (second car, jewelry, etc)
• Upgrading employment skills/job training programs
• Charging adult children room and board
• Use of tax benefits (earned income credit)
• Request money loaned to others
• Develop barter networks (carpooling, childcare,
  etc)

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2. Try to Decrease Expenses

• Trade in cars less frequently
• Switch to a long-distance savings plan
• Use only a no annual fee or low interest credit
  card
• Consider less expensive housing
• Install energy-saving devices or insulation
• Lower setting on water heater
• Shop at consignment and thrift stores
• Brown bag lunches and snacks
• Avoid vending machines bring food from home

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3. Contact Creditors ASAP

• Seek a deferment or reduced payments
• Overdue payments -- add to end of loan contract
• Be sure account is reported as CURRENT in credit
  reports
• Two Types of Late Payers
• People having trouble but trying to work things
  out
• Deadbeats who have not paid their bills and
  ignore their creditors

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4.Credit Counseling

• Budget counseling - nominal cost
• Debt management program
• Must incur no further debt surrender credit
  cards
• Administrative fee charged for cost of repaying
  bills
• Will only take on clients with ability to repay
  debt
• National Foundation for Consumer Credit
• 800-388-2227 or www.nfcc.org
• In NJ, look for state-licensed counseling agencies

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5. Debt Consolidation Loan

• Take out one loan (e.g., home equity loan) to pay
  off a variety of creditors
• Cannot not borrow your way out of debt!
• May increase overall cost of loan
• May pay a higher interest rate than before
• May consolidate debts previously interest free
• Temptation to overspend again
• Not a good option if you have spending issues

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6. Chapter 7 Bankruptcy (Liquidation)

• Takes 4 to 6 months
• Erases all obligations except
• - child support - student loans
• - alimony - federal and state tax
• Right to future income is retained
• Surrender to trustee all assets that are not
  legally exempt
• In NJ you can choose either federal or state
  bankruptcy exemptions

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7. Chapter 13 Bankruptcy (Reorganization)

• Plan approved by court to repay all or part of
  debt within 3-5 years using future earnings
• Creditors must get at least as much as would with
  Chapter 7
• Debtors must live within the plan
• Debtors allowed to keep property make monthly
  payments to trustee to pay creditors
• Best for those with steady income equity in
  home or car

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8. Owing the IRS

• Make contact with IRS---do NOT ignore them
• Contact them well before April 15 deadline
• Explain financial situation
• 1 Rule Penalty for not filing tax return is
  much greater than penalty for not paying tax
• late filing 5 of taxes for each month unpaid
  interest
• late payment .5 for each unpaid month interest

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9. Voluntary Surrender

• If unable to make payments
• return secured asset to creditor OR
• Obtain creditors permission to sell the asset
• Saves on repossession fees
• Avoids repossession being listed on credit record
• Sometimes creditor will accept asset as payment
  in full
• For a house, the term for voluntary surrender is
  deed in lieu

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10. PowerPay (Debt Acceleration)

• Start by sending each creditor whatever amount
  was previously sent
• As soon as you pay off one debt, apply the
  monthly payment amount (e.g., 30 to Sears) to a
  remaining debt
• Continue until all debts are repaid
• Greatest savings generally occur by repaying
  highest-interest debt first (e.g., department
  store credit cards)

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More About PowerPay

• Analyses available through Rutgers Cooperative
  Extension
• Users complete worksheet with the following data
• Name of creditors
• Current balance
• Monthly payment
• Interest rate charged (APR)

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More About PowerPay II

• Analyses assume no additional debt
• Can also choose to repay debts in order of lowest
  balance or shortest term first
• Can do analyses with
• optional extra monthly payments (e.g., 50/mo)
• optional one-time lump sum payments
• Calendar shows the amount paid to each creditor

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Credit Card Payback1,000 Balance (20 Minimum
Payment)
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Credit Card Fees and Traps
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The Minimum Payment Trap

• Credit card minimum payments are calculated as a
  percentage of outstanding balance (usually
  average daily balance)
• Typically 2 to 3 of amount outstanding
• The lower the percentage required
• the LESS youre required to pay per month
• the MORE a debt will cost you over time

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Low Minimum Payments
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Example 5,000 balance and 17 Interest Rate

• 2 minimum payment
• 100 this month (5,000 x .02)
• 11,304 total interest
• 40 years to repay

• 3 minimum payment
• 150 this month (5,000 x .03)
• 4,296 total interest
• 18 years to repay

1 difference costs 7,008!
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Low Minimum High Cost

• A credit card with a low interest rate and a low
  minimum payment can cost MORE THAN a card with a
  high interest rate and higher monthly payment
• Assume a 5,000 balance
• 15.9 rate and 2 minimum payment costs 9,538
  total interest and takes 41 years to repay
• 19.8 rate and 3 minimum payment costs 5,858
  total interest and takes 21 years to repay

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Pay More Than the Minimum

• When you send in more than the minimum required
  payment, you
• Shrink the outstanding balance
• Reduce the amount of interest owed
• Cut the time youre in debt

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Small Payments Add Up 17 Interest and 2 Minimum

• 5,000 Balance
• Extra 10 cents/day save 11 years and 2,257
• Extra 25 cents/day save 19 years and 4,148
• Extra 1.00/day save 30 years and 7,624

• 10,000 Balance
• Extra 10 cents/day save 12 years and 3,060
• Extra 25 cents/day save 20 years and 5,970
• Extra 1.00/day save 35 years and 12,615

Interest savings can exceed amount originally
borrowed!
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Late Fees Are Increasing

• Consumers have less time to pay bills
• Leniency periods are reduced or eliminated
• Earlier payment posting deadlines

Buyer Beware Some credit cards with low
interest rates charge high nuisance fees
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Over-The-Limit Fee

• Fee charged for exceeding credit limit
• Even though creditor approves purchase
• Charged monthly until balance drops below

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Transaction Fees

• Fee charged each time a credit card is used
• Example 50 cents per charge
• Most common transaction fees are for
• cash advances
• balance transfers

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Penalty APRs

• High punitive interest rates
• Lenders profit from borrowers mistakes
• 2000 survey of 100 credit cards
• Average penalty APR was 22.84
• 8 higher than average APR for purchases
• Can be triggered by just one late payment

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Common Penalty APR Triggers

• Minimum payment just one day late
• Two consecutive payments missed
• Two late payments within 6-month period
• Late payment to another creditor
• Account balance over the limit
• Change in cardholders financial situation

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Tiered Pricing

• Risk-based interest charges
• Range of possible APRs quoted
• One example (2000 survey) 7.99 - 20.24
• APR determined by applicants credit score
• Lower scores (subprime) pay higher APRs
• APR unknown until consumer gets card

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Cash Advances

• Cash loans from a credit card
• Expensive way to borrow money
• No grace period
• Cash advance transaction fee
• Higher APR than for purchases
• May use different method to calculate interest

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Punitive Policies

• Inactivity fees for
• not using credit card within specified period
• using card less than specified number of times
• charging less than a certain dollar amount
• Penalty for paying bill in full on time
• Target convenience users who do not pay
  interest

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Look For a Credit Card With

• A regular (non-teaser) APR of 15 or less
• A grace period of at least 25 days
• Late over-the-limit fees of 20 or less
• No annual fee
• No penalty APR or a rate less than 20

Source The Credit Card Trap, The State PIRGs
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Credit Card Disclosures-Front

• Introductory or promotional APR
• Example 1.9 APR with a balance transfer
• Advertised credit line
• Example Credit line from 5,000- 100,000
• Special offers and privileges
• Example Year-end summary of charges
• Application deadline date
• Example For transfers until April 1, 20xx

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Credit Card Disclosures- Back

• Schumer Box required by law to include
• Actual APR (after introductory period)
• APR formula (if rate is variable)
• Length of grace period
• Amount of annual fee, if any
• Minimum finance charge
• Transaction fees (e.g., cash advances)
• Method of computing balance for billing
• Late payment fees
• Over-the-limit fees

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Online Credit Card Resources

• www.truthaboutcredit.org
• Information and balance payment calculator
• www.creditalk.com
• User-friendly credit card information
• www.bog.frb.fed.us/pubs/shop
• Semi-annual credit card survey results
• www.consumer-action.org
• Annual credit card survey results

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Credit Repair Scams

• CREDIT PROBLEMS ? NO PROBLEMS!
• ERASE BAD CREDIT! 100 GUARANTEED!
• REMOVE BANKRUPTCY AND LIENS FROM YOUR FILE
• REPAIR AND REBUILD YOUR CREDIT FILE
• CREATE A NEW CREDIT IDENTITY LEGALLY

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Credit Repair Companies Wear Many Disguises

• Many of these companies call themselves--
• Credit Advisors
• Credit Rating Correction Services
• Credit Consultants
• Credit Doctors or Debt Doctors
• Credit Loan Consolidators
• Credit Clinics

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Credit Repair Cant Be Done!
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Reporting Negative Information

• Late payments up to 7 years from payment due
  date
• Chapter 7 bankruptcies up to 10 years from
  filing date
• Job paying over 75K and loan/life insurance
  over 150K no time limit

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Know The Warning Signs

• Advance payment required
• Legal rights not explained
• Advice to create a new identity
• Advice to file frivolous disputes

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Credit Report

• Review for accuracy every 2-3 years and before
  making application for a large loan
• Credit File Request Form (handout)
• FREE once a year to all NJ residents

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Questions? Comments? Experiences?
For additional financial resources, visit
www.rce.rutgers.edu/money2000