Debt Free

As we sail headlong into the new year, you may have accumulated considerable debt and be looking for some relief. The natural question to ask is: “What are my options?” Good question. Before you can establish your best options for debt relief, you have to answer some other important questions, otherwise you risk finding yourself back in the same predicament you're in now.

The single, most important thing you must know is why you're in debt. That knowledge is vital in order to determine how you'll proceed. If you're in debt due to unforeseen, extraordinary circumstances you'll take a different course of action than if you have a pattern of spending in excess of your income. According to Bankrate.com the most common cause of excessive debt is failing to reduce expenses when your income is reduced. Growing one's expenses to match one's income is one of the most natural personal finance patterns. It can be seen almost every time someone's income rises. Almost invariably their expenses will rise right along with it.

The problem here is twofold. One, by allowing expenses to rise, you are depriving yourself of valuable retirement and investment contributions. Two, you are reducing your margin for error in the event of an income reduction. The second situation happens all too frequently, and is disastrous for your finances. You lose your job and your next one pays less, or you are working on a project that allows consistent overtime pay and it ends; whatever the reason, a reduction in income will put you in a real financial hole if you allow yourself to grow your expenses with your salary.

f you spend more than you make, for whatever reason, you have established a pattern that guarantees long term indebtedness, and there's little you can do about it unless your spending habits change. That's priority number one if you're seeking debt relief; get your spending under control, or all your actions will be for naught. Gambling (debt reason number 5) is a surefire way to find yourself with massive debt. That is even more likely if you are one of the 2.7% of the U.S. population that has a gambling problem (State of CT Department of Mental Health and Addiction Services).

If you are in debt due an extraordinary event such as divorce (the number 2 cause of excessive debt) or medical problems (the number 6 cause of debt) than you will be more successful by using a debt consolidation or other program to secure debt relief. Entering a debt relief program if you are one of those that has a spending problem, whatever the source, is a recipe for disaster. Priority number 1 in this instance is to cure the root cause of the spending imbalance. Only then can you reign in your debt problems.

One of the first things you should find out in the debt relief process is your credit score. That will help you lay out your options. The higher your credit score, the more options you have, and the more you have to lose by screwing the whole thing up. You should know your credit score in any case, because it's just good, personal finance common sense.

The next thing to determine is weather or not you have any assets that can be used as security. If you have assets for collateral, primarily real estate, you can get a debt consolidation loan. This is only acceptable if you have no spending problems. I'll repeat that once again for those that are reading this early in the morning, before they've had their coffee. Under no circumstances should you ever get a debt consolidation loan if you have a pattern of spending in excess of your income. One of these loans isn't always the best solution even if you have no spending problem. Like any other financial instrument, it is only a tool to be used when the situation warrants it. Just when does the situation warrant it, you may ask?

If you have exhibited financial responsibility, consistently pay your bills on time, but are saddled with several high interest credit card or other debts, a debt consolidation loan will allow you to make a single payment while saving substantially on interest payments. Be advised that you can actually pay more in total interest by using a debt consolidation loan, even if the interest rate is much lower than the loans you're paying off. How the heck is that possible? Two possibilities. One is that many of these loans have fees that you'll be required to pay. While not technically interest, the fees still contribute to the APR of the loan. The second reason is that many of these loans have long terms. When you stretch the repayment of your loan over a longer term, you're naturally paying interest for a longer period of time. It adds up, and you can actually pay more in interest over the long term.

The other thing to consider is that you can lose whatever you are using for security on the loan. That security is why debt consolidation loans have a lower interest rate than credit cards and store charge cards. The loan is secured, and so represents a lower risk for the lender. The lower risk translates directly into a lower interest rate. Be that as it may, it won't make much difference to you if you default on the loan and your collateral is repossessed. The overwhelming number of people use their primary residence as collateral, so if you default, it will be foreclosed upon. You'll be living at that big underpass on the 5, next to that guy with the blue tarp. That's serious business, so go into any such loan with both eyes open.

You may also consider credit counseling services as a way to find debt relief. There are two varieties of credit counseling. In the first one, the counselors will go through things with you and help you plot a course of action to steer your way through your debt minefield, hopefully plotting a course that results in your being debt free. It can be an excellent way to help you decipher all the subtleties that can affect your financial future. When you're finished, you'll have a financial action plan to eliminate your debt. Since 1998 FICO ignores the fact that you're visiting a credit counselor when calculating your credit score.

The other variety of credit counseling involves counselors too, but they actually negotiate with your creditors to allow you to pay back only a portion of your debt. They will also stop most of those harassing collection calls, if you've let the situation get that far. This is also called a debt management program. So, now you're saying “Wow! This is great. I can pay back only a portion of my debt and stop those nasty phone calls? Of course I'd rather go that route.” Not so fast, Bucko! That kind of debt relief will come at a cost; namely to your credit rating, which will typically plunge it's way into the financial toilet for a while, although not nearly to the extent that a litany of missed or late payments will do.

The last form of debt relief is through bankruptcy. If your credit score is already atrocious, say under 550, you obviously have less to lose by declaring bankruptcy. You should be fully aware however, that you'll have that bankruptcy on your credit report for a decade and it will make getting any sort of loan much more difficult and expensive during that time. In addition a pattern of poor spending habits will only continue after you've declared bankruptcy, unless you take steps to correct it. Once you've declared bankruptcy, you can't just do it again, either. You have to wait for 7 years before you can do so again (Chapter 7).

There are many options for debt relief. They all have their advantages and disadvantages. Carefully choose the best option for your situation.