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Dealing With Debt

Barbara O’Neill, 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 Credit800-388-2227 or www.nfcc.orgIn 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 creditor’s 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 Payback$1,000 Balance ($20 Minimum Payment)Annual InterestRate

Credit CardFeatures

4% MinimumMonthlyPayment

2% MinimumMonthlyPayment

19 % APR # Payments

Total Paid

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$1,467

99

$1,987

15% APR # Payments

Total Paid

55

$1,355

79

$1,584

13% APR # Payments

Total Paid

53

$1,282

73

$1,463

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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 you’re required to pay per month

• the MORE a debt will cost you over time

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Low Minimum Payments

BeginningBalance

APR MonthlyPayments

Total Interest Paid Months to PayOff Balance

$2,000 15.04% 2% $2,205.63 169 (14 yrs.)

$2,000 15.04% 5% $589.74 65 (5.5 yrs.)

$2,000 15.04% 10% $269.31 36 (3 yrs.)

Always pay morethan the minimum:

It will save you alot of money.

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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 you’re 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 cardholder’s 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 applicant’s 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 Can’t 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