Your Alternatives When Faced with Financial Hardship
—Article by Daniel Gelinas
All too often, individuals facing financial hardship simply continue the status quo,
rather than meet the problem head on. Unfortunately, this seldom solves
anything. Usually the situation worsens and continues to spiral downward.
Debts continue to mount, making payments become more and more difficult and
eventually creditors initiate collection activity and may even take legal action.
It is always to the debtor's advantage to initiate positive steps to amicably
resolve his or her financial hardship. Often, however, debtors are not aware
of their alternatives. Or, led by false promises or a lack of knowledge,
choose the wrong course of action. Failure to act, or choosing the wrong
path could ultimately lead to disaster.
This document was prepared to highlight the most common alternatives
available to debtors, in particular, those individuals experiencing serious
financial hardship. It also warns against the dangers of some of
these alternatives. While this document only lightly touches upon the subject, the information contained
herein should assist you in exploring your options and to help you avoid some of the
pitfalls associated with them.
Read the article in it's entirety, or click on any item of interest.
Increase Income and/or Lower Debt Service
The ideal method of resolving one's financial troubles is to increase one's
income. Depending on the individual's circumstances, there may be numerous
opportunities to so do. Change of employment, a part-time job, a pay
increase, moonlighting, or starting a home-based business are all viable
options.
Oftentimes, just having a frank and honest discussion with your employer
about your current financial situation could make a world of difference.
Such a discussion could lead to additional work hours, suggestions on ways
in which you may increase your salary, or the realization that a pay
increase is in order. If you are a valued employee, your employer should
appreciate your honesty and, at the very least, be sympathetic to your
needs and be vigilant of opportunities that may arise which could assist you
financially.
Additionally, reducing one's monthly debt service and expenses is not only smart for those facing financial hardship, it's absolutely essential. This means eliminating or cutting back on all non-essential goods and/or services, such as
eliminating premium channels on cable TV, reducing long distance phone calls;
substituting franks and beans for steak and lobster, buying second-hand
rather than new, participating in low cost forms of recreation and
entertainment. Expenses that are extravagant and non-essential
should be eliminated.
Increasing one's income and lowering one's monthly debt service, however, is often easier said than done. Nonetheless, for those debtor's able to do so, it could prove to be the turning point in their life. Regardless of whatever options one chooses in resolving their financial hardship, one should always be vigilant of ways to increase their income and to reduce their monthly debt service and expenses. In order to provide assistance in this regard, we have established the Income Resource Center where you will find employment and career resources, as well as numerous business and income opportunities. We also established another sector which we call Cutting Expenses and Fighting Inflation.
The Center For Debt Management™ highly suggest that ALL consumers learn money management and to become financially literate. Managing finances is a long-life venture. You owe it to yourself and to your family to eliminate debt and to become an expert in managing your money. Realizing that this requires ongoing self-study, in an effort to assist you we have spent countless hours developing the
Library For Money Management and the
Bookstore For Money Management, as well as 30 other related sectors on our website. Those who are wise and who truly desire to become debt free and financially literate, would be well advised to avail themselves of all of these resources!
Debt Consolidation Loan
While a debt consolidation loan sounds appealing, the truth is — often it does not resolve the debtor's problem. In fact, the end result may compound the debtor's financial hardship. The reality is, it's very difficult to get a low rate debt consolidation loan unless the debtor has excellent credit (which is seldom the case) and/or very good collateral, typically one's
equity in a home or automobile. Lenders that accept lower standards, and
therefore increase their risk, charge high interest rates, 18% or higher
being common.
In the right circumstances, however, a debt consolidation loan may prove beneficial.
For example, when used for a Debt Reduction Settlement, or in situations where the debtor is "reasonably assured" of greater future earnings and/or a return to financial stability. It must be understood, however, that a debt consolidation loan simply "transfers" the
debt to a new lender — usually with greater consequences if the borrower
defaults.
A major point to consider in obtaining a debt consolidation loan is that the
debtor often consolidates "unsecured" debt in exchange for a "secured" debt.
Should the borrower default, legal action often comes swiftly. Such action
almost always result in foreclosure or a judgement. Lenders who make
debt consolidation loans understand full well their legal recourse and many will
stop at nothing until a judgment is satisfied. While "unsecured" creditors
can take legal action, they are typically slower to do so, and more willing
to negotiate a settlement.
In addition, by consolidating, the borrower is faced with "one large payment
to one creditor" rather than "many smaller payments to many creditors." While
this can be very beneficial in the right circumstances, the problem is — one
large payment is, to use a cliche, a harder nut to crack. If the debtor is even one dollar
short, the account is considered in default. While being a little short may
not in itself result in foreclosure or legal action, usually late fees
and/or penalty charges kick in and warning alarms sound off. These
additional fees often make it more and more difficult for the borrower to
catch-up, and with each successive payment the debtor falls further and
further behind. Before long, the borrower is considerably past due and legal
action may soon follow.
In the above scenario the perceived benefit of having only one payment
becomes a nightmare. Had the borrower dismissed obtaining a consolidation
loan and elected to continue making smaller payments to many creditors,
running short of funds would allow for greater options. The debtor, for
instance, could then be selective and direct available funds to critical
creditors, and perhaps allow an account with an "unsecured" creditor with a
small balance and/or one who typically does not access late fees become
delinquent. As noted above, unsecured creditors, especially those with small
balances, are least likely to take legal action. Lenders making large
debt consolidation loans, however, are prone to do so and some are downright
ruthless.
Important Notice:
Do not confuse a "debt consolidation loan" with consolidating debt through a
credit counseling or debt management agency. For example, when clients
consolidate their debt through a nonprofit credit counseling agency, the
agency does not then become the creditor. In this regard, the agency is, in
essence, a conduit for disbursing payments to their client's creditors. In
a Debt Management Program should a client be unable to make the full
amount of their consolidated payment, the agency typically accepts and encourages clients to
make a partial payment. The agency then disburse these funds to critical creditors
on behalf of the client. While being late with payments, in any circumstances, can present problems, consolidating debt through this program allows for a greater number of options should the client run into difficult times.
Another concern with debt consolidation loans is that borrowers are usually
allowed to keep their credit cards. Having access to these cards, debtors
often fall into the same trap — charging many of their purchases and/or
expenses. Before they realize it, these charges mount beyond their ability to pay. In addition to having
to make their consolidated loan payment, now they must again make a credit
card payment. Short of funds, eventually they take cash advances to make
their payment, thus only increasing their debt. It becomes a vicious cycle,
until finally bankruptcy is the only alternative.
Please Note: Debtors taking cash advances to make monthly payments are
one of the most common trends we see with applicants for the Debt Management Program. Many of these
consumers will even boast how they have a "perfect" credit rating.
However, they are only fooling themselves, and perhaps their creditors — but
only for a while. No one has unlimited credit and the day of reckoning will
soon arrive. When that day comes, sadly, for many, it will be too late.
They may be beyond help — even from our agency! Their only recourse may be
bankruptcy — and recent large cash advances may not be
dismissed in bankruptcy.
If you are following this trend, we strongly urge you to act at once by either enrolling in a Debt Management Program or seeking a Debt Reduction Settlement. Taking cash advances to make monthly payments is a "red alert" signaling danger! It's like cancer; if you catch it early
enough, there's hope; if you prolong seeking help, death is imminent.
Beware: Newspapers, magazines, junk mail, online services and the internet are replete with ads offering debt consolidation or other
types of loans. These ads often claim:
Guaranteed Loans — Bad Credit, No Problem! — Loans Even If You Filed Bankruptcy
Poor Credit Accepted — Nobody Ever Refused — Easy Approval
— Borrow By Mail
Borrow As Much As You Need — No Interest Loans — Below
Prime Rate — etc.,etc.,etc
These "so-called" companies typically require up-front money and will tell you whatever it takes to get you to
apply. They will offer you the world, promise satisfaction guaranteed, and after you send in your required fee, you can bet your family jewels you'll never see a dime!
For consumers interested in a debt consolidation loan The Center For Debt Management™ highly suggest that you check with your local banking institutions. But, we also believe that it is extremely important that you shop around for the best rate. To assist you with your online search, Go To Credit and Financing.
It is important to understand, however, that lenders providing Debt Consolidation Loans will not use the funds to "settle" your debts for less than the amount owed. They will want to pay off your creditors "in full." If your intention is to use the equity in your home to pay off your debt through a Debt Reduction Settlement, you will need to do so through a Home Equity Loan, a Home Equity Line of Credit, or by Refinancing Your Home and pulling out some of your equity. In these cases, you can request to use your available equity as YOU so desire. In other word, the cash is given to you directly to use as you please.
Notice: Using funds from a debt consolidation loan, second mortgage, home equity loan or line of credit to pay off unsecured debt should ONLY be done when it results in significant savings, and the effect of it resolves your financial hardship. You should be reasonably certain that you will never default on the obligation. Otherwise, it is not practical and financially sound to convert unsecured debt to secure debt and risk losing your home!
Second Mortgage or Home Equity Line of Credit
Everything mentioned above regarding debt consolidation loans apply here as well.
In fact, a debt consolidation loan is typically nothing more than a second mortgage, often called a home equity loan. A debt consolidation
loan, however, need not be a home equity loan.
A home equity line of credit and a second mortgage both use the equity in your home as
collateral. A home equity line of credit provides, you guessed it, a "line of credit," and only
when funds are drawn from it do interest charges accrue and payments begins.
In contrast, a second mortgage typically provides the borrower with a "lump
sum" of money. Interest is charged on the entire amount borrowed and monthly
payments begin immediately. Both types of loans may require processing
fees, an appraisal fee and possibly other costs.
The apparent interest rate of the loan may seem reasonable (and it may be),
however, after factoring in all of the costs of getting the loan, the
actual annual percentage rate may increase substantially. Even so, the net result could end
up with a better interest rate than your current average interest rate of
the debts you intend to pay off — if that is what you intend do with the
proceeds! On the other hand, depending on many factors, including your
credit worthiness and equity, the cost of processing the loan and resulting
monthly payments might not provide you with any relief at all.
The problem most debtors have — is not having enough equity in the first
place. Typically, lenders use a formula for determining eligibility and how
much they will lend. This is usually based on a percentage — from 50% to 80%
of the current market value of the home, less the amount that is still owed
on it. If the current market value is appraised at $100,000, lenders will
typically lend $50,000 to $80,000 maximum — that is, if you own the home
free and clear. If the amount owed is $75,000 and the home owner is able to
find the right lender, he or she may get a $5,000.00 loan. Of course, after
paying the processing fees and other costs, they may, in effect, only get a portion of
this amount.
The advantage of a second mortgage or a home equity line of credit is that the
interest may be tax deductible for tax payers itemizing deductions. Therefore,
one must take this aspect into consideration and analyze the net result
after taking this deduction. It may be wise and prove beneficial to discuss this issue
with an accountant.
Whether a second mortgage or home equity line of credit is right for you depend on
many factors, but generally you need a fair amount of equity in your
home to make it worthwhile. Also, as noted under "Debt Consolidation Loan" there
are many risks and concerns that must be considered. In particular, should
you default on the loan, you could end up losing your home. If the purpose
for acquiring the loan is to consolidate primarily "unsecured" debt, you are
well advised to give it serious thought.
A better option may be to borrow just enough to pay off "secured" debt, and perhaps certain unsecured accounts that are likely to result in legal action should the debtor default. This should lower the debtor's overall monthly debt service and reduce the risk of defaulting on the remaining debts. Should the debtor later run short of funds, the debtor could then take funds from the budget allocated for the remaining unsecured debts to make the newly acquired, and all-important second mortgage or home equity line of credit payment. While doing so would place the unsecured account(s) in jeopardy, such action could, as they say, save the farm!
If a debtor has significant secured debt and unsecured debt, another option that may be available is to obtain a home equity line of credit or debt consolidation loan to consolidate "secured" debt and then seek a debt reduction settlement or enroll in a debt management program to consolidate "unsecured" debt. For heavy debtors this is an extremely viable option that provides a safety factor and could yield significant savings in interest charges, late fees and other charges.
One of the more effective uses of a home equity loan is when the funds are used to negotiate a Debt Reduction Settlement, which can not only settle unsecured debts, but in some cases, secured debts. Depending on the particular circumstances, this could be a very worth while option and can often slash a debtor's overall debt in half.
Notice: Using funds from a debt consolidation loan, second mortgage, home equity loan or line of credit to pay off unsecured debt should ONLY be done when it results in significant savings, and the effect of it resolves your financial hardship. You should be reasonably certain that you will never default on the obligation. Otherwise, it is not practical and financially sound to convert unsecured debt to secure debt and risk losing your home!
Refinancing
Refinancing can be a great way in which to reduce debt, however, whether it's effective depends on how favorable the current Prime Rate is—the rate in which the FED lends money to its most favored financial institutions. For example, at the time of this writing the Prime Rate was 4.5%, which is considered low and presents a great opportunity for many homeowners to refinance their home, regardless whether they are in debt or not.
Depending on the amount of equity in the home, debtors may be able to refinance for more than their current mortgage and use the extra funds to pay off debt. This can be extremely effective when used as part of a Debt Reduction Settlement.
Let's look at some examples:
Bill and Mary own a home valued at $250.000. They have a first 30 year fixed mortgage at 7.5% (with about 27 years remaining) and a second 15 year fixed mortgage at 8.5% (with about 13 years remaining). Their combined mortgage payments total approximately $700 per month and their combined mortgage balance is approximately $88,000. Bill and Mary learn that they can refinance their home with the proceeds of $88,000 used to pay off both mortgages. They elect to get a 15 year fixed mortgage at 6.25%. The cost to refinance is $600 and their new mortgage is now $733.
In the above scenario it will increase Bill and Mary's monthly mortgage payment by $33. However, their home would now be paid off in 15 years instead of 27 years. Had they not refinanced, they would have paid $83,160 in interest on their remaining balance. With their new $88,000 mortgage, they will now only pay $44,000 in interest, a substantial savings considering that the extra $33 per month will only cost them $6,000 during the 15 year time span. Bill and Mary's total savings amount to $32,560.
Now let's suppose the same scenario, except that Bill and Mary are $50,000 in debt and they elect to get a 30 year fixed mortgage at 6.75%. Their mortgage payment would now drop to $500 and their total interest paid would amount to $92,070. Bill and Mary will now have $200 extra per month to help pay down their debt. While they will now pay some $8,910 more in interest had they not refinanced, the fact is, with a $200 reduction in their monthly mortgage payment, they will now pay $31,200 less over the term of the mortgage. Thus, overall they save $22,290. By using the $200 each month to pay off high interest debts, they would save thousands more!
Let's take it another step. The same scenario as the last, however, this time Bill and Mary opts to borrow an extra $50,000 to completely liquidate their high interest debt. They now refinance for $138,000, taking out a 30 year fixed mortgage at 6.75%. Their new mortgage payment is now $784 with total interest amounting to $144,382.
Whoops! Did Bill and Mary make a mistake? Let's take a closer look!
Bill and Mary owed $50,000 with an average interest rate of 18%. Their creditors required a minimum monthly payment of 2%, which means their current balance of $50,000 would require a payment of $1,000. Of this $1,000, $250 would go to principle and reduce their balance to $49,750, that is, assuming there are no late fees or overlimit fees. $750 of the payment would go to interest. Bill and Mary's next payment would be reduced to $995.00, with slightly more going to pay off principle and slightly less going to interest. This process would continue until the debt is liquidated.
How long would it take to liquidate the debt making minimum payments? It would take 601 payments, a span of 50 years, and total interest of $142,625.
Had Bill and Mary not refinanced and paid off their $50,000 high interest debt, they would have paid some $225,785 in combined interest to liquidate their debt and amortize their mortgage. By refinancing they eliminated their monthly debt payment altogether, however, they had to increase their mortgage payment by $84. Thus, in the span of 30 years, would pay $30,240 more in mortgage payments. If you add that to their total mortgage interest of $144,382 which equals $174,622 and subtract it from $225,785, Bill and Mary saved $51,163 by refinancing. And probably thousands more considering that they may have had to pay multiple late fees had Bill and Mary not taken corrective action to reduce their monthly debt service.
Could Bill and Mary have done better? Possibly. Depending on circumstances, they may have been able to accomplish a Debt Reduction Settlement, saving them anywhere from 20% to 80% off their $50,000 debt. In a typical Debt Reduction Settlement resulting in a 50% savings, they would have settled their debt for $25,000. Therefore, Bill and Mary would have only needed to refinance $113,00, instead of $138.000. That would have resulted in a mortgage payment of $642.00 and total interest of $118,226. In addition to paying $26,156 less in interest, they would have reduced they mortgage payment by $142—a savings of $51,120 over the term of the mortgage. They would have saved in additional $77,279, for a total savings of $128,439.
Notice: Refinancing to pay off unsecured debt should ONLY be done when it results in significant savings, and the effect of it resolves your financial hardship. You should be reasonably certain that you will never default on the obligation. Otherwise, it is not practical and financially sound to convert unsecured debt to secure debt and risk losing your home!
Consumer Credit Counseling / Debt Management
For individuals who are heavily burdened with debt but not a prime candidate
for bankruptcy, a credit counseling or debt management agency is
often their best option for debt relief. It's not, however, designed for
everyone. First off, a lot depends on who the creditors are. Credit
counseling agencies primarily work with unsecured debt, such as credit cards,
installment loans, retail finance plans, medical bills and personal debts.
Second, contrary to popular belief, credit counseling agencies cannot force
creditors to accept their proposals. Although most creditors will work with
these agencies to effect a workable solution, many creditors have minimum
payments (based on the outstanding balance) that they will accept.
Applicants, therefore, need to have sufficient income to support the
revised lower payment, as well as enough income left for basic living
expenses.
Unlike bankruptcy, clients have to repay their financial obligation through enrollment in a Debt Management Program, but there are many benefits. There are no legal expenses, no court hearings,
assets and possessions are retained, credit reports usually improve and all
transactions are confidential. In addition, amicably resolving
their financial obligation rather than simply having them dismissed through
bankruptcy, debtors have a better sense of self-esteem. Future prospective lenders and those aware of the
situation may also have greater respect for the individual realizing his or her effort and determination to liquidate their debt in a manner approved and
supported by the individual's creditors.
Typically, enrolling in a Debt Management Program will consolidate accounts into one "lower" monthly payment, eliminate past due amounts, reduce interest rates, stop expensive late fees, bring accounts current and put an end to upsetting collection calls. If you are currently experiencing financial hardship, you should weigh all
of your options, especially a Debt Management Program. A Debt Management Program will amicably resolves your financial problems, puts an end to upsetting collection calls, provides a path to financial freedom and "save" you money in the process.
Debt Reduction Settlement
A Debt Reduction Settlement, negotiated properly, can quickly and dramatically reduce one's debt. Essentially, a Debt Reduction Settlement is a negotiated settlement for less than what you owe. If negotiated properly on behalf of the debtor it can quickly and dramatically reduce the debtor's debt. Settlements range from 20% to 80% of the current debt, with the typical debt settled for 45 cents on the dollar. After paying Agency fees, a typical client realizes a savings of around 40% of their original debt placed in the program.
While the debtor may negotiate their own settlement, it is usually best working through a third party debt negotiator who knows the ropes and can watch out for the debtor's best interest. There is definitely a right and a wrong way to handle this procedure, and failing to do so correctly may yield negative results.
Consumers in financial distress typically raise funds to settle their debt by opening a mandated savings account, whereas money is deposited into the account on a regular basis. Oftentimes, to accomplish this debtors elect to stop making payments on their unsecured accounts, opting to place whatever funds are available into the account.
When enough money is saved, a debt reduction settlement is negotiated for one of the accounts. The strategy, of course, is to first settle the account which is most troublesome and which may provide the greatest savings. The process continues in this fashion until all debts have been settled in full.
Other methods used by consumers to acquire the needed funds, or sources to withdraw funds from, in order to settle their debts include:
- Savings Account, Money Market Account, CD's
- Stocks, Bonds, Mutual Funds or Other Investments
- Borrow from Family, Friends, or Relative
- Retirement Funds
- Borrow from Whole Life Insurance Policy
- Sell Assets
- Credit Card Advance
- Home Equity Loan
- Home Equity Line of Credit
- Second Mortgage
- Home Refinancing
- Reverse Mortgage
- Personal Loan
- Increase Your Income
While it typically takes 4 to 6 years to pay off debt through Debt Management Program, often the same amount of debt can be settled in 12 to 36 months through a Debt Settlement.
Filing For Bankruptcy
Bankruptcy is the ultimate recourse to debt problems and should only be
considered as a last resort. This course of action may have long lasting
consequences, therefore, one must always give this option serious thought
before filing. While anyone can filed pro se, in many cases, personal
bankruptcy is best handled by attorneys that specialize in consumer debt.
This is especially true when there is a home and/or major assets involved.
Court fees are currently set at $160 and attorney fees typically range from
$500 to $1,500.
Bankruptcy is a Federal process which requires filing specific legal
documents and appearing in bankruptcy court. All listed creditors are
notified when one files bankruptcy. Pending legal suits are given an
"automatic stay" and all collection activities must immediately stop. In
some circumstances, however, a creditor may ask the court to "lift" an
automatic stay. In addition, all creditors have a right to appear and be
heard at the bankruptcy hearing.
While bankruptcy can dismiss all or some of an individual's debt, those
filing bankruptcy could very well loose many of their assets and
possessions. It should be noted, however, that oftentimes individuals are allowed to keep all or most of their assets.
What individuals are allowed to keep vary from state to state according to
Federal and State exemption laws. Bankruptcy typically will not dismiss
child support, alimony, taxes, recent students loans, certain judgements,
fines and penalties imposed for violating the law, debts due to recent
extravagant purchases or any transactions that may be considered fraudulent.
As bankruptcy is essentially an act to dismiss one's financial obligations,
it is often frowned upon by most individuals. It may be recorded on the
consumer's credit report up to 10 years and forever remains public record.
Many banks and lenders refuse to extend credit to anyone who has filed
bankruptcy. You should also be aware that employers and landlords often
check applicant's credit history. In addition, unbeknown to most
individuals, Federal law allows credit bureaus to maintain two records; the
standard file and a lifetime file. Credit bureaus may give out
an individual's lifetime file under these circumstances:
- For credit transactions involving at least $150,000. (for example, a mortgage)
- To insurance companies when applying for a policy at least $150,000.
- To employers in regards to a job that pay an annual income of at least $75,000.
One of the biggest drawbacks to filing bankruptcy is that lenders who do elect to lend money in the course of time, will typically only do so at a higher-than-normal interest rate. On high ticket items, especially a new car or home, a bankruptcy may cost the individual big time! Just an extra 2% to 4% in higher interate rates could easily add up to many thousands of dollars during a spans of 10 years depending on the amount of money borrowed.
On the up side, the Bankruptcy Act was enacted to assist debtors who have no
other alternative. It may dismiss a debtor's total debt or leave them with
only minor debt. If the consequences of bankruptcy are fully understood and
the debtor is willing to accept these repercussions and takes positive steps
to better manage his or her financial affairs, filing for bankruptcy may provide the
individual or family a new lease on life.
In time and with proper money management, credit may once again be granted. Some creditors may even grant credit immediately after one files bankruptcy realizing that the consumer now has a fresh start and is prohibited by law from filing for bankruptcy again until waiting a period of six years. It must be remembered, however, that many individuals regard bankruptcy as an easy fix, fail to learn from their experience and again find themselves in financial hardship
Final Thoughts
We sincerely hope that this article has been insightful and assist you in resolving your financial hardship. Whatever decision that you make may have long term consequences, so it is important that you weigh your options carefully. You will find many people and companies, especially on the Internet, that will quickly dismiss any of the above options as being fruitless (or foolish), except of course, the one's that they offer. But the truth is, any of the alternatives noted above can be a viable option in the right set of circumstances.
If you are facing financial hardhip and have substantial equity, then you certainly need to consider using some of that Home Equity to resolve your debt. And all debtors should look for means to Increase Income and Reduce Expenses. For consumers deep in debt without home equity or other financial assistance, however, there are only 3 real alternatives:
Debt Management Program
Filing Bankruptcy
Debt Reduction Settlement
© Copyright 2002 by "The Center For Debt Management" All Rights Reserved
|
Click Below To Check Out More Financial Resources
|
|
|
|
|
The Center For Debt Management™
Helping Consumers Save Money and Reduce Debt Is Our Only Business!™
We invite you to explore the sectors listed below. We promise that you'll find exceptional values, offers and resources in which to reduce your living expenses and to enjoy life!
|
Debt Management and Financial Services! The Internet's oldest and most comprehensive debt management
agency! Resources for debt management, consumer credit counseling, debt consolidation, debt reduction settlements, legal aid, financial aid, loans and financing, credit repair, credit reports, insurance quotes, income sources, tax assistance, and more.
Established in 1989 and serving the online community since 1992!
|
|
