Figuring Out a Repayment Plan
Once you have figured out how much you owe and prioritized your bills it is time to see if you can pay them all off in a time period that should span from between three and five years.
Why is a three to five year time period the right amount of time over which to span a payment schedule? It is the standard amount of time used in a bankruptcy to pay an owed amount back. The theory is that if you could have enough income and assets to pay off most or all of your bills within that time frame you would probably not have to pursue a Chapter 7 bankruptcy. No judge would allow it. So before things go to court you might want to give the three-year pay back plan a try.
The best way to figure out a repayment plan for your debts is to use one of the many free online tools available on the Internet. There is a great one on the Quicken.com web site called the Debt Reduction Planner. With it you can experiment to see how long it might take you to pay off your unsecured debts. Similar tools are available in personal finance software such as Money and Quicken.
When inputting figures into one of these programs see how much progress you can make by adding in lump sums that you estimate that you could raise by selling stuff or taking some of the last-ditch options (such as not paying into a 401k) described in the last chapter.
You should also consider, with great wariness, taking out a home equity loan or line of credit to pay off your cards. However don’t think for two seconds about taking out a home equity loan to do this unless you can promise the following …
• You won’t use your credit cards to pile up more debt
• You won’t borrow more than 90 percent (and preferably less than 80%) when your mortgage and home equity borrowing is combined together. Home equity can be an important source of emergency funds you don’t want to squander on something simple like credit card debt.
• You can pay off the debt in the same three to five year period. In other words don’t use the home equity loan as an excuse to stretch out the debt over an even longer period of time.
Remember that if you are unable to be disciplined about the above three solutions then all you will succeed in doing is driving yourself even deeper in debt.
If you are diligent you should be able to retire your credit card and other unsecured debt in less than five years and still maintain good credit scores. Sometimes you can even convince the lenders to lower your interest rate so you can pay off the debt faster. It is definitely worth trying this tact with a credit card company. They are often enthusiastic about giving their customers a break with regard to their interest rates rather than risk losing them to competitors.
Of course if you have already fallen way behind on your payments that option might not be available to you. Late payments to even one of your creditors can cause all of the other creditors that you owe to raise their interest rates too. They can also get tougher about their terms and make your life hell by not giving you notice when they raise interest rates or payments.
Most credit companies today periodically check your credit report and as soon as then notice any ruckus on your accounts they take disciplinary action. This means doing things like jacking up your rates by ten percentage points or more or quickly lowering your credit limit so that you start racking up over the limit fees. Of course with all of these setbacks being flung at you, getting over your credit crisis becomes all that harder.
Late payments adversely affect your credit scores but not as badly as an account that remains unpaid for months. When this happens the lender can react by listing the account as a charge off on your credit report. A charge off is an accounting term that means that the lender has given up all hope of collecting. This is like the kiss of death on a credit report and there is nothing like a charge off to quickly degrade your credit report.
Usually it only takes about six months of no payments for an account to become a charge off. Although some creditors then turn the account over to their internal collections departments many sell the account for pennies on the dollar to independent collection firms.
It cannot be repeated enough—it is the charge off that does the most damage to your credit score. It is pretty much the worst thing that a creditor can say about you.
As far as your credit score is concerned you should keep these three main points in mind while figuring out a repayment plan –
Although late payments can really hurt a credit score, a charge off is even worse. If it is all possible, you should avoid letting an account lapse for so long that it is charged off.
If an account has not yet been charged off, try to pay the balance in full either at once or over time. Settling the account with the original creditor for less than you owe could really hurt your credit score. This is because settlement on collection accounts don’t have such a profound negative effect as the charge off.
If an account has been sent to collections you will have the most leverage to negotiate if you can pay a lump sum. If you do have to make payments try to negotiate to have the collection action deleted from your credit report if at all possible. Although having the collection deleted from your report won’t eliminate the negative comments from your file, the most damaging mark is the charge-off, which the original creditor typically will refuse to drop. Getting rid of the collection notation can help your score.
If you can’t find a way to get all of our unsecured debts by prioritizing and managing them in this way then you essentially have two options left – credit counseling or bankruptcy.