Despite what you may have been taught about personal finance there is actually such a thing as good debt. It’s defined as debt used to buy something that will increase in value. The number one example of this is a home mortgage. Most experts consider it to be good debt because the house will grow in value in the years ahead in addition to providing you with shelter. Borrowing money for an education can also be considered good debt because it should help you earn more money over the course of your working life.
An article in the Providence Journal posed a question about personal finance and debt and where do you stand?
According to the website Statistics Brain 24.3% of all Americans have no savings at all. We owe an average of $95,500 on our home mortgages. We have an average household debt of $117,951 of which more than $15,000 in just in credit card debt.
The Fed’s interest increase and your personal finance
If your family has a lot of debt things are going to just get worse. Last week the Federal Reserve raised U.S. interest rates, which is going to make debt more expensive. For example, the credit bureau TransUnion has forecast that the per customer average credit card balance will rise $100 by the end of this year to reach $5437. And it further forecasts that by the close of 2017 our average credit card debt will be $5509.
The impact on us is that as interest rates rise so will monthly payments on credit card debt. Fortunately, the interest rate on your mortgage should stay the same – unless you have a variable rate loan.
How do you stack up?
Does your family owe more than $15,000 in credit card debts? Is your household debt more than $117,000? Do you owe more than $95,000 on your mortgage? Are you part of that 52% of Americans who say they find it difficult to pay their bills?
And what about student loans?
The Wall Street Journal has reported that approximately 43% of the 22 million people with student loans are not making their payments. Again, according to the Wall Street Journal about one in six of every student loan borrowers were in default, which meant they had gone at least a year without making a payment.
We hope you’re not part of this group because defaulting on a student loan can have terrible consequences. You could see your wages garnished, you would lose your eligibility for deferment, forbearance and repayment plans. You would also lose your eligibility for any future federal student aid.
DIY debt consolidation
Do you have good or excellent credit – a score of 720 or above? In this case, you should be able to get a $10,000 personal loan with an interest rate ranging between 6% and 10%. One smart move would be to get a personal loan and use the money to consolidate your debts.
This would be good for your personal finance as your credit score will likely improve because you would now be using less of the total amount of credit you have available. This is your credit utilization ratio, which makes up 30% of your credit score. It’s calculated by dividing the amount of credit you’ve used by the total amount you have available. For example, if you had $13,000 in total credit available with total balances of $5500, your credit utilization ratio would be 42%, which potential lenders would view as being too high.
However, if you were able to get a debt consolidation loan for $10,000 and use $5500 of it to pay off those other balances your credit utilization ratio would drop to 23% so that your credit score should get a nice boost.
A second way to consolidate debts is through a debt management plan. This is where you pay off your unsecured debts (usually credit card debts) in full but at a reduced interest rate with late fees waived. You would then be making a single payment each month to a credit counseling agency, which would then distribute the money among your creditors.
On the downside, this will be a problem in personal finance because your credit card accounts will be closed so that you’ll have to live without credit cards until you complete your debt management plan., On the upside a debt management plan by itself will not affect your credit though closing those accounts could hurt your score.
Here’s a video that provides more specifics about a debt management plan including what to expect if you choose to work with a credit counseling agency.
Debt relief through debt settlement
Debt settlement is where you contact your creditors and offer lump sum payments for less than your balances to settle your debts.
While it’s possible to settle your debts yourself most people turn to professional debt settlement companies.
If you choose this option, you’ll stop paying your creditors and will make a monthly payment to the debt settlement company instead. When enough money has accumulated in your account to settle one of your debts the settlement company will contact you and ask that you allow it to use the money to settle the debt. This process will continue until it has settled all of your debts, which typically takes from 24 to 48 months.
Of course, debt settlement companies don’t work free. They charge fees that generally range from 15% to 25% depending on the size of your debt.
Unlike a debt management plan, debt settlement will definitely have a bad effect on your credit. This is because none of your debts that are settled will be reported as “paid in full”.
However, on the upside your debts will be consolidated and you’ll be freed from the stress of dealing with your creditors.
The ultimate solution – bankruptcy
If you’re in so much trouble with your personal finance and your debts that you can’t see any way to make payments in a debt management plan or in debt settlement and there is no way you could get a debt consolidation loan, you could file for bankruptcy.
There are two forms of bankruptcy – a chapter 7 and a chapter 13. The most popular of the two is a chapter 7 liquidation bankruptcy. It will erase or discharge almost all of your unsecured debts including credit card debts, personal loans, payday loans and medical debts.
However, it will not you erase secured debts such as your mortgage or auto loans and certain types of unsecured debts including spousal support, past-due taxes, child support and student loan debts. Plus, it will decimate your credit scores and stay in your credit reports for as long as 10 years. This is a big thing because it could hurt your eligibility for certain jobs, increase the cost of new debt and your auto insurance and possibly even damage your chances of leasing a house or an apartment.
If you’re swimming in debt you have – as you have read – several options for achieving debt relief. You’ll need to consider the pros and cons of each and then choose the one that you believe will best fit your financial circumstances. However, the really important thing is to choose one and get started as this is the only way you can ultimately achieve debt relief.