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Managing debt

Living with some debt isn't necessarily a fatal financial flaw. But you need to act to avoid increasing your debt.

• Don't skip a month's payment, even if your credit card company makes this offer to you. Skipping a payment doesn't stop interest from accumulating.

• Avoid zero-interest financing programs. You may see tempting ads for "no interest for 12 months." If you fail to pay the entire balance at the end of the zero-interest period, you'll owe interest backed in from the beginning of your borrowing, typically at rates as high as 21%.

• Don't take on debt you don't need. You may have to reassess your standard of living and make changes if you can't avoid new debt each month. Do you really need another sweater? Should you buy such an expensive gift for a friend? You may have to modify your standard of living to keep debt under control.

Caution: If spending is a compulsion or an addiction which has put you into unmanageable debt, you may need professional help. A spending compulsion can indicate a personality disorder requiring special counseling or medical assistance. To locate the best help, start by talking to your family doctor. If you have a relative or friend with a spending compulsion, talk that person into getting help before debt problems mount up.

Getting out of debt

Debt is easy to get into but difficult to get out of-Americans now owe $1.7 trillion in credit card debt. This is because of the interest that compounds on unpaid amounts, requiring an ever increasing portion of available income just to service this debt. Thus, it's important to take control of debt and reduce it to manageable proportions.

Strategy: Use your savings to pay off debt, and use future dollars to rebuild savings. If you're paying 15% or more as interest on your credit card, you're probably not earning anywhere near that on your savings. Pay down your debt first. Save later.

Warning signs of debt that's out of control

Having some debt is a normal part of financial life. Rule of thumb: Spend no more than 20% of your monthly after-tax income (your take-home pay) on all consumer debt other than your home mortgage. Add up your car loans, student loans, credit card debt and other loan payments to see if you are well within this comfort zone.

If things get out of control, you need to take special action before matters get worse. How can you tell if you're in so deep that you need assistance getting out? In addition to exceeding the 20% rule, here are some other warning signs that things are out of control:

• You're making only your minimum payments each month.

• You use one credit card to pay off another.

• You don't know exactly how much you owe.

• You're near your credit limits on your cards.

• You're late in paying, or you skip payments on some bills (including basic living expenses such as utilities or rent).

• You have to tap into savings to pay your bills.

• You're receiving calls from creditors or collection agencies about overdue bills.

If you find that more than one of these signs apply to you, you're in-or at least getting into-financial trouble. Take action immediately.

Strategy: Get your spending under control to head off or reduce debt problems. If you have a spending problem (e.g., you use shopping to fill an emotional void), join Debtors Anonymous (781-453-2743 or www.debtorsanonymous.com).

Working your way out of debt

It took you a long time to get into the financial fix you now find yourself in. It will take you equally long, or longer, to get out of debt. Here are some steps to follow if your debt is larger than you'd like it to be:

• Determine how much monthly income you have to pay your bills.

• List all your current obligations.

• Make a budget, incorporating a repayment plan. Devote a greater share of your budget to the debt with the highest interest rate to pay it off more quickly.

Strategy: Cut up your credit cards (or put them away in a safe place if you know you won't touch them). This will prevent you from taking on any more debt that will complicate your financial life.

Online debt reduction planning

Use online resources to set up and manage your own debt reduction. These include: Quicken's Debt Reduction Planner (www.quicken.com/planning/debt).

Debt consolidation

You can reduce your debt by reducing your interest charges. This can be done in two ways:

• Find lower-rate credit cards. Transfer the outstanding balances from high-rate cards to low-rate cards. Often credit cards have introductory offers with low interest for the first six months or so. If you use this type of card for reducing your interest rate, then you'll have to find a new low-rate card at the end of the introductory period.

• Take a home-equity loan. If you own a home with value greater than its outstanding mortgage, you can roll all of your outstanding debts into one loan secured by your home. A home-equity loan is a second mortgage on your home. Home-equity loans typically carry lower interest rates than credit cards and other debt.

As a rule of thumb, figure that you can borrow up to 80% of the equity in your home. This is the value of your home, less any existing mortgage.

Example: Your home is worth $250,000 and your mortgage balance is $110,000. You can probably borrow as much as $112,000, which is 80% of the difference.

Bonus: The interest on home-equity debt up to $100,000 is deductible on your income tax return (interest on other consumer debt is not deductible, with the exception of limited interest on student loans). Caution: Taking a home-equity loan to pay off debt puts your home at risk. If you go into default, the lender can foreclose on the mortgage and you'll lose your home.

Working with a credit counseling agency

If you can't do it alone, you can find assistance in resolving your credit problems from a credit counseling agency. An agency can help you work out a repayment plan to satisfy your debts as an alternative to bankruptcy. The agency can also provide counseling and education on debt management.

Repayment plan: The agency works with you and your creditors to arrange a repayment schedule. This repayment plan does not reduce the amount of your overall debt. But it does keep creditors and collection agencies from hounding you. It can also avoid garnishment of your wages, a process you probably don't want to involve your employer in. And it can help provide you with a model for better handling your debts in the future.

Both nonprofit organizations and for-profit companies offer this service. I advise people to stick with a nonprofit organization.

Before you agree to work with an agency, make sure you understand:

• Whether credit counselors are certified.

• Whether the agency is accredited. The National Foundation of Consumer Credit (NFCC) provides accreditation to agencies that use certified counselors and meet other criteria.

• The costs to you for any services you take advantage of.

To find a credit counseling agency near you, call the NFCC at 800-388-2227 or go to www.nfcc.org.

Handling collection agencies

If you're late in paying your bills, creditors may turn over the task of collection to collection agencies. These agencies are prohibited from using abusive debt collection practices, as defined by the Fair Debt Collection Practices Act. These include:

• Calling at inappropriate hours of the day. Generally calls must be made after 8 am and before 9 pm.

• Communicating with third parties without your consent. This includes communications with your employer.

• Threatening violence.

• Using obscene or profane language.

• Publicizing your delinquency, other than notifying a credit reporting bureau.

• Refusing to stop contact with you after you notify the agency in writing that you refuse to pay the debt and wish contact to cease.

If you believe you've been the victim of an abusive collection practice, contact your local or state consumer protection agency. You may be entitled to collect actual damages (for example, injury to your reputation, plus up to an additional $1,000).

Bankruptcy

Bankruptcy is a last resort to curing your financial woes. What it is, what it can and cannot do, is often misunderstood. Bankruptcy is a court process in which your debts are settled, often for pennies on the dollar. You're left with certain assets allowed by law. Creditors have an opportunity to contest the proceedings.

Bankruptcy will:

• Stop creditors from hounding you. Once you file for bankruptcy, creditors are prohibited by law from contacting you. Their only recourse is to meet you in court.

• End your responsibility for repayment. The court applies your assets (after allowing you to keep exempt assets) toward your debts. Any excess amounts are forever wiped out.

Bankruptcy won't:

• Give you a fresh start. Bankruptcy history will stay on your credit report for up to 10 years. This can make it difficult for you to borrow money-to obtain a mortgage or a car loan, for instance. If you are able to obtain credit during this period, it's likely to be at higher interest rates than you would pay if you didn't have bankruptcy on your credit report.

• Absolve you of certain personal responsibilities. Bankruptcy won't wipe out your obligation to pay alimony or child support. Additionally, most tax obligations survive bankruptcy.

To determine whether bankruptcy is an appropriate solution to your debt problems, contact a lawyer who specializes in bankruptcy proceedings.