Debt to Pay – Pay off the Most Expensive First

This method makes logical sense.  You sort your debts into order of the interest rate that they charge and use any additional income that you have to pay off the most expensive debt first.  In this way the money that you pay off your debt saves you the most interest.

Debt to Pay – Pay off the Smallest First

One criticism of the above method is that you might spend a long time paying off an expensive debt and not see very much progress.  This alternative method sorts your debts into order of their size.  You then use as much income as you can to pay off the smallest first.  In this way you will reduce the number of outstanding credit balances that you have at the fastest rate.

Debt to Pay – Calculate it Once and Forget it!

The problem with both of the above methods is that they require a level of self discipline and organization that most people that get into debt just don’t have (I know I didn’t).  My alternative suggestion is to try and work out why you have got into debt and address that issue. Once you have done that, then as long as your debt repayments are reducing your debt and you can afford them – just forget about them and concentrate on enjoying your life and not taking on any more debt!  Your credit balances will be cleared eventually as long as you keep up the payments and don’t take on anything new.

The irony is that the debt relief solution that is most suitable for people with extreme financial difficulties (bankruptcy) is the one that is not free. Not only that, it requires you to pay an up-front fee.

Informal Debt Relief

There are a wide range of companies and charitable organizations offering informal debt relief solutions. These usually involve either persuading the creditors to accept a longer time period for the repayment of their debt (debt management plans) or persuading them to accept a figure that is lower than the debt owed (debt write-off). None of these solutions are legally binding on the creditors and so rely on the experience of the debt management/counseling company and the particular mix of creditors for their chances of success. With informal debt relief it is always possible to find debt charities that will work with you for no fee or companies that will only charge a fee if they arrange a successful resolution. In this way, if the fee is taken out of the settlement to the creditors then their services can be effectively free to you, the debtor.

Supervised Debt Relief

This includes Individual Voluntary Arrangements (IVAs) in the UK and Chapter 13 bankruptcy in the United States. These debt relief solutions require the services of a qualified person to setup and monitor the agreement (which typically involves paying back a proportion of the debt owed over an agreed period) and the involvement of the court to ratify it. The requirement for legally qualified advice and the involvement of the courts mean that these debt relief solutions are never free. In some circumstances they can be structured (in the UK) so that the fees are taken from the agreed monthly payments, meaning no up-front fees.

Bankruptcy

I’ll say it again, it seems very unfair that a debt relief solution that you would probably only select if you were in a financial crisis requires you to pay an up-front fee. Both in the US and the UK there are court fees to be paid to declare yourself bankrupt (in the US this applies to both Chapter 7 and Chapter 13 bankruptcy). The only hope of being able to declare yourself bankrupt if you cannot raise the court fees is to look for a local charity that will pay your bankruptcy costs. These do exist but you will probably need to do some local research to find them, and be prepared to justify why you need their help.

Advantage of Debt Consolidation for Your Debt Problem

The main advantage of debt consolidation is the reduction in your monthly payment for all of your debts. It is very important to prepare a realistic budget to make sure that your new reduced payments on your debt consolidation loan are affordable. Consolidation also makes your total debt situation clearer, i.e. you can’t fool yourself about the true total of all your debts. There is an administrative benefit to having only 1 monthly payment instead of lots of little ones, and if you had got to the stage of defaulting on any payments then the resulting letters and calls should stop when you pay off your account using the money from your debt consolidation loan.

Disadvantages of Debt Consolidation

If you use debt consolidation as a debt solution then you must make sure that you have sorted out the original problems that caused you to get into debt in the first place. If you don’t, you will quickly find that you have a debt consolidation loan AND lots of other debts, which would make consolidating your debt completely pointless and is a path that leads to severe debt problems and possibly bankruptcy.

If you take out a debt consolidation loan secured against your home (and I would usually advise against it) then you are making it much more likely that your home will have to be sold in the future. Unsecured creditors cannot usually force you to sell your home, whereas secured creditors can.

If you do enter a formal debt management solution after debt consolidation you will find that taking on an unsecured consolidation loan over a longer period than the original debts will effectively increase the amount of debt that you have, making it harder to get an IVA agreed with your creditors or extending the period of time that a debt management plan will take to clear your debts. This is because most debt solutions calculate your outstanding debt using the formula – Debt = Monthly Repayments * Number of Repayments left, e.g.

Credit card debt of £1,000 would be considered as £1,000 in an IVA or debt management plan. However if this credit card debt was payed off using an unsecured loan then the debt for IVA purposes would be (for a 7-year loan) 84 x repayment (roughly £22) equals £1,848.

Conclusion

Debt consolidation can be a useful tool on the journey towards a debt-free lifestyle. However you need to be certain that you have the discipline to keep paying the new loan and not create any more debts. If your income does not realistically enable you to pay the cost of your debt consolidation loan then there is little point taking it out. It will make the inevitable process of sorting out your debts properly much harder in the end.

photo credit: Erik Charlton

It is my belief that if you have multiple debts problems then speaking to debt collection agents is not the answer to your problems. Some people will no doubt think that this advice is incorrect or irresponsible so I will explain why I say it.

If you have reached a debt crisis situation you need a debt solution that:

1. Pays your creditors what you can afford AFTER paying all your essential bills such as mortgage/rent/food etc.

2. Allocates the money that you have available fairly between all of your unsecured creditors.

Most agents working in collection do not care about the above points. The sole objective is to persuade (and that’s a polite term) you to part with as much money as possible. It is often no concern to them if you or your family go hungry because you’ve paid money to your creditors. They will also not care if you miss or reduce your mortgage payment for the same reason, pushing you down the road to re-possession/foreclosure.

It would not be fair to suggest that debt collection agents should be considering your other debts, if you have multiple debts they are in competition for your limited money with other commercial lenders. However their desire to increase the share that their company is getting will often create a lot of pointless (from the debtors point of view) pressure.

The best idea is to get independent advice on your debt situation from someone that can also represent you to your creditors. If you don’t want to do this then you can come to an informal arrangement with your creditors by preparing your monthly budget, and allocating the excess income fairly between your creditors. Update all of your creditors every few months or sooner if there are any significant changes and you will be fulfilling all of your obligations to your creditors without ever needing to speak to possibly threatening debt collection agents.

Charitable Organizations Providing Free Advice For Debt Relief

In the United Kingdom there are two main charitable providers of free advice on debt relief:

1. The Citizens Advice Bureau. Many CABs will have specialist debt case workers that can provide top-quality free advice. However there may be a a waiting list to see the debt case worker, as they are very much in demand at the moment. You are definitely not on your own with your debt problems. Although the other workers in the Citizens Advice Bureau will be able to offer general advice on debt problems you do really need to see the specialist debt case worker (who should be a qualified money adviser). After having given advice they should be able to negotiate with your creditors on your behalf if this is appropriate to your situation.

2. The Consumer Credit Counseling Service (CCCS) is a non-profit making organization that is funded by contributions from the credit industry. It can offer advice on your debt situation and will negotiate and administer a Debt Management Plan for you if this is an appropriate solution.

Commercial Organizations Offering Free Advice For Debt Relief

Many commercial organizations offer free introductory consultations that can help you to decide on the best course of action. It is always worth remembering that their advice might be slightly biased towards the solution that they are selling.

In the United Kingdom Solicitors will often offer a free initial consultation. This can often be of limited use because it is not long enough to discuss your options in any detail. You would quickly find yourself having to pay for additional time. Also legal professional are not always best places to advise you on debt problems. They are familiar with the law but not necessarily the way that the laws are applied in practice.

Companies that offer either Debt Management Plans or Individual Voluntary Arrangements will sometimes take you through the initial process of identifying all of your debts, income, and outgoings. They do this so that they can assess whether you are suitable for the particular debt management solution that they are selling. As long as you are aware of this then they can provide very useful advise even if you (or they) decide that their debt management solution is not suitable for you.

In addition to those that have overstretched themselves during the era of cheap credit there are also those that are now suffering redundancy or reduced business/bonuses/commissions.  The situation does not look good (and that was even before Alistair Darling’s ill-chosen remarks about the economy being in the worst shape for 60 years – rationing anyone!)

Debt charities are stretched to breaking point by the numbers of people seeking help.  This only increases the danger of desperate people falling prey to the many companies that would take advantage of them.

My advice is to hold on for free advice and help that you need to deal with your debt problems.  If the local Citizen’s Advice Bureau has a 3 month waiting list to see a money adviser then get on the list.

Checkout one of the companies that don’t charge upfront fees for their debt advice.

Most importantly remember that being unable to pay your debts is not a crime in the eyes of the law.  Don’t be too hard on yourself.  Try and relax a bit (I know this is hard) and believe that there is a life after debt.  I’m living proof of it!

On a normal unsecured debt you are more likely to see a debt collector, but they have no powers whatsoever. You are perfectly entitled to slam the door on them and demand they leave your property! Any persistent attempts to contact you (standing outside shouting, knocking on the door constantly) could be construed as harassment and would therefore be illegal.

If you are unlucky enough to be visited by a bailiff then you will want to know…

Bailiff Rights of Entry – What Are They?

The first thing you should do when confronted by someone saying they are a bailiff is to get them to prove who they are. They must be able to provide some evidence of their identity and their instruction to collect a debt that you owe. If they don’t have this then they are just a debt collector, and can be sent packing as described above.

If they are a bailiff then unless they are recovering a tax debt and have obtained a court order, they are not allowed to force there way into your home. They cannot push past you when you stand at an open door. They have to gain “peaceful entry” to your home which means entering through an unlocked door or open window (or being invited inside by you). If they visit the house when there are only children present (younger than 18) then they must leave. It is very important to realize that your relationship with the bailiff and their powers to enter your home are massively changed if you let them into your home (or they manage to get in through an open window or unlocked door. If you keep them out then they have no powers. Once they have gained peaceful entry then they can:

Make a list of possessions to be seized (a walking possession order).
Break into locked areas within your house.
Return at a later date and break into your home to gain access to the good listed on the walking possession order.

Letting a bailiff into your house is a disaster and should be avoided at all costs. Don’t fall for any trick regarding using your phone/toilet etc. as it could have terrible consequences.

How do You Resolve the Situation?

You need to get the debt out of the hands of the bailiffs and back with either the courts or the creditor. To do this requires urgent and skilled money advice from the Citizens Advice Bureau or similar debt charity. Remember that the rules regarding unsecured debt mean that you should only have to pay an amount that you can afford (after allowing for essentials) so negotiating to pay your debt by instalments should be a lot less traumatic than being visited by bailiffs.

“Declare bankruptcy and you will lose your home, you might be put in prison and all of your possessions will be sold to pay your debt.”

Two extreme points of view often held on either the benefits or the perils of declaring bankruptcy. As ever in life the truth is somewhere between these two extremes.

So What is Declaring Bankruptcy?

Bankruptcy it a legal status that means that you are unable to pay your unsecured debt. It does not directly effect secured debt. The procedure and implications are exactly the same whether you have been declared bankrupt by a creditor or you have declared yourself bankrupt. When you enter bankruptcy all of your unsecured debts are wiped out (except for certain specific debts like student loans).

What Happens When You Become Bankrupt

You will enter a period when your financial affairs are not under your control. As you have failed to pay back your debts your finances will be managed to try and produce some money to pay your creditors back. You will not be able to obtain new credit until your bankruptcy has been discharged, usually in less than a year. Any major assets that you have will be sold to try and raise money to pay back your creditors. Your bank accounts will be frozen and you will have to open a new basic bank account (one that has no overdraft facility). You will have to attend an interview with the Insolvency service to go over your financial affairs and the reasons for your bankruptcy.

What Happens to my House?

If you own your house then your share of it will need to be sold to help pay off your creditors. If your partner or a family member is able to buy your share of the house at market value then this will remove it from the danger of being sold. If you cannot do this and you share your house with your partner/family then you will have at least a year before the house has to be sold.

Will My Other Possessions be Sold?

Only valuable possessions are at risk of being sold, e.g. cars, boats, antiques etc. The insolvency service are typically not interested in everyday household items. They cannot seize items that are either jointly owned or required for basic living. Even your car might be safe if you can prove that it is required for your work.

Will I Have to Pay Some of My Earnings?

In theory if you earn enough then you can be made to pay an amount each month for 3 years. In most cases this will not be the case. Remember when filling in the forms that your partners income should not be included in the equation, i.e. if you have rent, food, utility bills it is perfectly acceptable for you to say that you pay all of them. This fact alone means that most people do not have any additional income to be paid into their bankruptcy.

How Long Will my Bankruptcy Last?

Rules have been relaxed so that the maximum period for most personal bankruptcies is a year. Many will be discharged in six months or even less. After this time you are free to conduct your life as you please, although you will experience trouble getting credit for a number of years since the bankruptcy will stay on your credit file.

photo credit: SqueakyMarmot

If you are worried about your level of credit card debt then there are a number of solutions open to you. Exactly which solution you choose to reduce your credit card debt will depend on the size of the debt, and your income compared with your total outgoings. There are a number of helpful things that would be common to most situations:

If your credit score is still in good shape then look around for better rates of interest for your credit card debt. Zero percent balance transfers are not as common as they once were but they are still available. Use the reduced/free interest period to reduce your debt as much as possible.

If you are having trouble making enough money to pay your credit cards minimum payments then you have a problem. If you have missed any payments then you probably won’t be able to look around for a better deal, but it might be worth double checking. Try reducing your other regular monthly payments (e.g. insurance, utility bills etc.) by using a money comparison site. If you can reduce your monthly outgoings to the point where you can pay you minimum amount on your credit cards then you will eventually pay them off. If you can manage even a small amount more than the minimum payment it will reduce the length of time to pay off your debts significantly. It is important to point out that you should not be going short of food, clothes or basic things to pay off your debts. If this is the case then you should really (for the health of you and your family) be considering some for of debt solution that will bring your monthly payments down.

If you cannot adjust your budget to the point where you have enough money to pay your credit card bills each month then you will have to consider more drastic measures.

1. You could consolidate your debt into either a secured or unsecured loan. It would probably be best to try and avoid a secured loan if you can, since problems with paying this debt could result in you losing your home. Be very wary about any form of consolidation. You have to be absolutely certain that you will not build up credit card debt in the future. Also, if you have problems with your unsecured debt in the future a consolidation loan will increase the amount that you owe your creditors.

2. You could try an negotiate reduced payments with your creditors. Either yourself or via a debt management company or charity. This may be a good solution if you have a relatively small debt.

3. If your debts are larger you may be suitable for an individual voluntary arrangement (IVA) which will write-off a proportion of your debts leaving you to pay only what you can afford. This needs to be negotiated for you by an specialist company. Beware any that try and charge you large up-front fees.

4. You could investigate declaring yourself bankrupt. This is debt solution that will have the most negative effect on your credit score and future ability to get credit. However it is the quickest way to become debt free and is very suitable for people that don’t own their own home.

Make time to write down all of your regular monthly outgoings. Your bank statement is a good place to get this information. Most people’s monthly budget would include the following items:

Rent/Mortgage
Utility Bills (gas, electric, water)
Tax bills (e.g. council tax in the UK)
Insurance
Telephone
Pension contributions

Mobile phones
Internet
TV Subscriptions

Car loans
Personal loans
Credit card payments

Next add an allowance for food/clothing (if you’re not sure how much this is then keep a diary for a month and total up how much you spend).

If you need to, then make an allowance for luxuries such as eating out/leisure activities/holidays.

Now total up your income, not forgetting to include your partners income (if appropriate) and any benefits that you might receive on a regular basis.

Your path to becoming debt free depends on the relative size of your total outgoings and total income.

If your total income is more than the total of all your outgoings (including allowances for all luxuries etc.) then you don’t really have a debt problem. Simply allocate all of the surpless each month to paying off your debts and in time your debts will be gone.

If your total income is more than all of your total outgoings except the luxury items then you are going to have to make some lifestyle changes to pay off your debt/stop accumulating any more. Cut down on eating out/go to cheaper restaurants. Go on fewer/cheaper holidays. Look at the amount that you spend on things like mobile phones and TV subscriptions. Checkout a money saving site (such as MoneySavingExpert) to see if you can reduce the cost of utility bills/insurance credit card payments etc. Investigate whether you can pay off any car loans by selling the car and driving a cheaper one (be careful if trying to do this since the car is actually the property of the loan company until the loan is paid off). Use the surplus that you generate to pay off your debts. Also if you have any savings then use these to pay off debt as you will almost always save more in interest paid than you could earn by investing.

If your total income is more than all of your regular outgoings but less than the amount that you need for all the regular payments that you need to on your debt (loans, credit cards, car loans) then you have a potential debt problem. Take the steps described above to try and get your monthly budget to balance. If you can then you will just have to carry on paying off your debt until it becomes more manageable. If not then you should stop accumulating any more credit (unless your problem is going to be very short-lived, e.g. 6 months or less) and consider a debt solution. More on the different types of debt solution available in another post.

If your total income is less than your essential outgoings then you have a bigger problem. You will need to work at reducing the size of your outgoings (by all the steps described above) and if this doesn’t reduce them by enough then you will have to consider moving to a smaller house/refinancing your mortgage to reduce monthly rent/mortgage payments. No debt solution will help you to cope with your situation if you cannot meet your regular essential monthly requirements.

The last option that I will mention, that applies to all of the above cases is to try and increase your income by taking on different or additional work or investigating whether you are entitled to any benefits or tax credits. I mention this last because it is often something that people use to postpone doing something about their debt problems. They will say “I’m getting a pay rise soon” or “I’ll take on a part-time job when I’,m a bit less busy” or most dangerous of all “the business that I am starting will save me”. It will take me another post to explain why these options are usually no help.

For all of the above if you feel you need help then there will be an agency that can assist you. In the UK try the Citizens Advice Bureau.