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Practical Advice For Those Facing Bankruptcy, From Someone Who Has Been There

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Mixed Race Young Female Agonizing Over Financial Calculations in Her Kitchen.

My journey to bankruptcy began in 2003 after I was in a major car accident that left me unable to work for several months. Injured and unemployed I was forced to move back home with my mother, younger brother and three foster brothers. As I slowly began to regain my financial independence our family was dealt another blow.

In December of 2004, after what should have been a routine knee replacement surgery, my mother contracted a MERSA staff infection and became gravely ill. Needing around the clock care and help with my four younger brothers, I became a full-time caretaker while my mother fought for her life. It took her over a year to win back hear health. Unfortunately Murphy’s Law was not done with its assault on our family just yet.

In the spring of 2006 I had just gone back to nursing school when I had an emergency appendectomy, which left me with an additional $15,000 of debt. Having no insurance I was responsible for the entire amount due. This surgery was the tipping point in which my debt became too much for me to handle and I had to begin looking for a different solution.

I spent the next several months educating myself on how to handle harassing debt collectors, ways to work with your creditors and how to rebuild your credit score. After struggling to send my creditors every spare penny I had I finally came to the conclusion that filing for Chapter 7 bankruptcy was the best solution for my situation.

Walking into bankruptcy court was one of the most nerve-racking things I had ever gone through, but I am so glad that I did.

If you find yourself at a crossroads contemplating bankruptcy there are a few important things you need to take into consideration in regards to your own situation.

Evaluate Your Financial Habits

Before you file for bankruptcy you need to take a long hard look at your finances, your spending habits, and any other situations your currently facing that is causing you financial hardship. Until you know how you wound up in the situation you can’t have a clear plan on how to fix it. This is also the time to decide if going bankrupt is really the right thing for you to do.

[When Should You Consider Bankruptcy?]

Gather All Your Information

Once you have decided to move forward you need to spend some time gathering all of your information. This will include: all of your bank accounts, retirement accounts, your personal property and other assets. Having this information will help you figure out which type of bankruptcy for which you qualify.

Know Your Options

It is very important to know your bankruptcy option and what each will mean for you.

A Chapter 13 bankruptcy does not wipe out your debt. Instead the court will calculate your disposable income and use that number to make a payment plan for you. Over the course of three to five years you will be required to make payments on your debt until it is paid in full or to the agreed upon amount.

A Chapter 7 bankruptcy wipes out your debt completely. There are however a few specific debts that cannot or rarely can be eliminated with a Chapter 7 including back taxes and student loans. It is also important to note that you must qualify for a Chapter 7 bankruptcy. You must prove that you are unable to pay off your debt either because your income level is below the state median or your living expenses are so high that you simply cannot repay your debt.

[8 Steps for Discharging Student Loans Through Bankruptcy]

Find A Reputable Lawyer

There are many websites out there suggesting that you can file for bankruptcy on your own, and that there is no reason to pay a lawyer. What those sites fail to mention is if you make a mistake on your paperwork you may have to start the process over. You may even find that some of your debt was not included in your bankruptcy leaving you responsible for the payments regardless of what type of bankruptcy you filed.

While hiring a lawyer does increase the expense of filing for bankruptcy it is his or her job to make sure that everything is in order and goes as smoothly as possible. Speaking from personal experience having a lawyer by your side during your proceeding can also help you feel more confident when facing the judge.

Have an After Bankruptcy Game Plan

There is a life after bankruptcy, while it may not feel like it in the moment things will get better. You however need to have a plan for how you will handle your finances from this point on. If you do not make a conscious decision to change the way you have been handing your money you will find yourself right back in the financial mess you have just escaped.

Going bankrupt can seem like the end of your financial life, and you may be wondering how you will ever recover from it. The good news is that you can. If you learn from your mistakes and make the decision to move forward with good money habits it is possible. I went from being financially devastated to a credit score of 740 in just a few short years. It took hard work and dedication to my financial health but I did it and so can you!

Tennille Flowers |

Tennille Flowers is a writer at MagnifyMoney. You can email Tennille at tennille@magnifymoney.com

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8 Steps for Possibly Discharging Your Student Loans Through Bankruptcy

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

Students throwing graduation hats

Student loans are the one type of debt you can never discharge through bankruptcy. Or are they?

For years that’s been the case, largely because of a court ruling from 1987 that set an almost impossible standard for student loan borrowers to meet. But the student loan landscape has changed dramatically since then, and in recent years there have been some signs that borrowers in tough spots may in fact be able to find some relief.

If you’re struggling under the weight of your student loans, read on. In this post you will learn:

  • What the current (and strict) criteria are for having student loans discharged through bankruptcy.
  • Commonalities from recent cases where individuals were successful at having their student loans discharged.
  • A step-by-step process for getting on track with your student loans and improving your chances at discharge.

The Current Standard

Individuals hoping to have their student loans discharged through bankruptcy typically have to show “undue hardship” by passing the three-part Brunner test. This test was born from a court ruling in 1987 and it requires the individual to:

  1. Show that he or she has made a good faith effort to repay the loans.
  2. Show that he or she cannot maintain a reasonable minimum standard of living while paying back the loans.
  3. Show that this condition is expected to last for most of the repayment period.

It’s that third criteria in particular that has made student loans so difficult to discharge. After all, how can you convincingly demonstrate that your prospects aren’t likely to improve, especially when student loan repayment periods can extend for as many as 30 years?

It’s proven challenging, but a few recent rulings can give borrowers hope and may even provide a road map for at least opening up the possibility of discharging your student loans through bankruptcy.

Two Commonalities Between Successful Student Loan Discharges

Looking at a few high-profile stories of borrowers who successfully discharged their student loans, there appear to be two big commonalities that may show the path forward for others:

Time: In two cases of successful discharges from 2013, the student loans were 10 and 15 years old. Clearly these were not recent grads at the beginning of their repayment journey.

Significant current hardship: One woman had been unemployed for almost a decade and was caring for her elderly mother. Another woman was 64, on Social Security, working multiple jobs, and cited mental and physical ailments.

In other words, they seemed to be struggling with some of the same factors you might consider when filing bankruptcy for any reason. Which means that if you’re struggling with your student loans and your financial situation in general, it may in fact be possible to have them discharged through bankruptcy as a last resort.

With that in mind, here are some steps you could take to put you in the best situation to either repay your student loans or to successfully have them discharged so you can hit the reset button.

Step 1: Get Organized

Get a complete list of all your debt, both student loan and otherwise, in one place so that you know exactly what you’re dealing with. The most important information you need to know for each type of loan is:

  • The amount you owe
  • The interest rate
  • The minimum payment

For student loans specifically, you will also want to know the type of loan and when it was issued, as that information may impact your repayment options.

You can collect your student loan information from the national student loan data system, and information on your other debts from annualcreditreport.com.

Step 2: Pay the Minimums on All Debts

This one is for both you and the courts.

For you, this will keep your credit history in good shape and keep your debt from spiraling out of control.

For the courts, this is one step towards showing a good faith effort at repayment.

Step 3: Look into Income-Driven Repayment Plans

Just like the previous step, this will both help you immediately and help if you eventually move to bankruptcy.

In the short-term, income-driven repayment plans may help to lessen the burden of your student loans by decreasing your monthly payment. They can even provide a path to eventual discharge without bankruptcy.

And if you do end up in traditional bankruptcy, this will serve as more evidence that you have made reasonable efforts to repay.

Step 4: Track Your Expenses

Tools like mint.com and You Need a Budget will help you stay on top of where your money is going now so that you can make more informed decisions about how you want to use it going forward.

Many of my clients, when they sign up for a tool like this for the first time, are shocked to find out how much they’re spending in certain categories and can quickly find some big ways to cut down on their monthly expenses. If you can find one or two of those big wins, you may find that your loans become a little easier to handle.

Step 5: Create a Repayment Plan

Creating a repayment plan for your student loans will not only give you a better shot at repaying them in full, but will give you another thing to point to if the courts want to see that you’ve made a strong effort to repay.

Hopefully you’re able to enroll in one of the income-driven repayment plans mentioned above, but if you have any extra money available you should consider how you want to prioritize it. That is, which loans should you put your extra money towards first? A thoughtful strategy could save you a lot of money in the long-term.

Don’t forget to keep other financial goals in mind here. For example, taking advantage of a 401(k) employer match or setting up a starter emergency fund could be better uses of your extra money, depending on your situation.

Step 6: Find Ways to Free up Cash

There may be some relatively easy ways to free up cash that could either help with your regular living expenses or help you pay down your loans even faster.

Things like switching to a lower cost cell phone provider, cutting cable, or even bringing lunch to work are relatively small changes that could reduce a significant amount of financial burden.

Step 7: Find Ways to Earn More Money

It doesn’t have to be all about cutting costs. Could you negotiate a raise at your job? Could you start a side hustle? Even a small amount of extra income could give you a lot more breathing room.

Step 8: Consider Bankruptcy

If you’ve been doing all of the above for a number of years and your student loan debt still feels like too much to overcome, it may be worth considering bankruptcy.

Keep in mind that there are some real, negative consequences to bankruptcy, so it’s not a cure-all. And it’s likely still a long shot that you could get your student loans discharged.

But for many it can be a huge relief to hit the reset button on their financial situation, and as recent court cases have shown it is possible to have your student loans discharged. If you’ve been diligently taking the steps above, you’ll have a strong history of attempting to pay them back that the courts may look favorably upon and it may be worth giving it a shot.

Matt Becker
Matt Becker |

Matt Becker is a writer at MagnifyMoney. You can email Matt at matt@magnifymoney.com

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Getting a Mortgage After Bankruptcy

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

Purchase agreement for house

Whether you’re drowning in loans, unemployed, racking up medical bills, or guilty of too much online shopping, one thing’s for certain — we all hate debt. And when debt becomes impossible to pay back, bankruptcy may seem like the only way to escape.

While filing for bankruptcy may be the right solution, it can negatively affect your finances for years to come. But, fortunately, life moves on. And despite this financial setback, you may want access to credit in the future. Without it, large purchases like a home can be difficult. It’s not impossible, but applying for a mortgage post-bankruptcy means working through a particular set of challenges. Prepare yourself by knowing these important guidelines.

Know the Difference: Chapter 7, 11, & 13 Bankruptcies

We constantly hear about bankruptcies in the media, but what does filing for one actually mean? Bankruptcy is a legal procedure that can help you wipe out or repay debt under the protection of the United States bankruptcy court.

Chapter 7 and Chapter 13 are the main types of consumer bankruptcies. But what are the key differences?

Chapter 7 is typically the preferred type of bankruptcy because involves liquidation and eliminates all your eligible debt. This means your nonexempt property will be sold and the proceeds will be distributed to your creditors. Exempt property varies from state-to-state, but part of your property may be subject to liens or mortgages, promising it to other creditors. It’s important to know Chapter 7 bankruptcies may, but not frequently, result in a loss of your property. You may lose your home outside of bankruptcy to foreclosure if you fall behind on your mortgage payments.

It is much harder to be eligible for Chapter 7 bankruptcy. If your income is above the median in your state and you prove you have sufficient cash flow to service some of the debt, then you’ll likely be forced to file Chapter 13.

Chapter 13 bankruptcy allows you to keep property, adjust debt, and to pay it back over time. This is a long process as the repayment period is typically three to five years. If you’re behind on mortgage payments, it may be easier to keep your home in Chapter 13 because you may be able to make up payments in your repayment plan.

What about Chapter 11 bankruptcies? If your business is a corporation, partnership, or you own a small business, Chapter 11 may give you a chance to reorganize. Chapter 11 also can help restructure debt so it can be paid back over time.

Unfortunately, bankruptcies may stay on your credit report for up to 10 years. Because of this, many people incorrectly assume bankruptcies ruin your chance at homeownership. This definitely isn’t the case, but it does mean the path to purchasing a home will take more time. 

The Waiting Period After Bankruptcy

Even if bankruptcy stays on your credit report for 10 years, you’re not expected to wait that long before trying to buy a home. However, Fannie Mae knows a bankruptcy increases your likelihood of a mortgage default. Despite this red flag, Fannie Mae encourages lenders to investigate the cause of these issues, make sure sufficient time has passed, and verify an acceptable credit history has been re-established. So, how long do you have to wait? The waiting periods begin upon the completion, discharge, or dismissal date of your bankruptcy.

Both Chapter 7 and Chapter 11 require a four-year waiting period. However, if you have documented extenuating circumstances, it’s possible it may be reduced to two years.

Chapter 13 bankruptcy requires either a two-year or four-year waiting period, depending on what step of the procedure you’re on (discharge or dismissal). If you’ve had more than one bankruptcy within seven years, a five-year waiting period is required. But remember, this time period kicks in after the Chapter 13 bankruptcy is complete, so that’s two to four years on top of the original three to five years working your repayment plan. It could be up to nine years total before you’re eligible.

If you’re anxious to start the home buying process, these waiting periods may feel inconvenient. But they offer a fantastic opportunity to clean up your credit and reduce your debt-to-income ratio before re-applying for a mortgage.

The Importance of Your Credit Score and Debt-To-Income Ratio

As soon as your bankruptcy case has been discharged and closed, it’s time to take a detailed look at your finances. Chances are, you have a lot of room for improvement. Luckily, Fannie Mae’s mandatory waiting period gives you the chance to prepare.

Here’s what you need to do:

  • Improve your credit score. First, get a copy of your credit report and a view of your credit score to see what work needs to be done. AnnualCreditReport.com offers a free report every year, but this does not come with a credit score. You can find more information about how to access your score here. Do you know what steps to take next? 35% of your score is based on payment history. That means you need to pay every single bill on time. If you no longer have access to any lines of credit, then consider getting a secured credit card in order to rehabilitate your credit. Start doing this right away and you’ll see improvements. Going forward, you need to monitor your credit report regularly. Remember, your credit score will also affect what interest rate you’ll be able to secure, and consequently, which mortgages you’ll be able to afford.
  • Pay down outstanding debts. After the dust settles from your bankruptcy, do you still owe any money? Try to repay these debts as quickly as possible. Debt-to-income ratio is the single most important factor in getting approved for a mortgage. Looking for your best chance at approval? Aim for a debt-to-income ratio of 40% or less. Also, make sure you don’t take on any additional loans during this period of time.
  • Stick with your Chapter 13 repayment plan. Did you file for Chapter 13 bankruptcy? If so, don’t miss any of your court-ordered repayment requirements. Diligently follow exactly what you’ve agreed to.
  • Save as much as you can. Do you have an emergency fund? A health stash of cash reserves can help keep your debt repayment plan on track as unexpected expenses pop up. Don’t forget, you’re also going to need a chunk of change for your mortgage down payment.

Bankruptcy doesn’t have to create a barrier to homeownership. But bouncing back may take time. Whether you’ve filed for Chapter 7, 11, or 13, Fannie Mae’s mandatory waiting periods offer an opportunity to get your finances back on track. Use this time wisely by committing to improve your credit score and reduce your debt-to-income ratio. Save as much as you can. And when the time comes to reapply for a mortgage, be upfront with your lender. Be honest about your setbacks, show how much progress you’ve made, and explain how you’ve learned from past mistakes. Remember, bankruptcy was never meant to be a life-long penance; it’s a chance for you to start over.

Kate Dore
Kate Dore |

Kate Dore is a writer at MagnifyMoney. You can email Kate at kate@magnifymoney.com

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When Should You Consider Bankruptcy?

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

Young couple calculating their domestic bills

If you’re drowning in debt and having trouble keeping up with your payments while still handling your living expenses, you may have at least begun to consider filing for bankruptcy.

Bankruptcy certainly has its benefits, potentially allowing you to wipe the slate clean and start anew.

But there are a lot of things to consider before making a decision, from the negative consequences of filing to whether bankruptcy would even provide relief for your specific situation.

This is a big decision that requires a significant amount of due diligence before moving forward, and in this post we’ll go over some of the key points to help you get started.

Are You Eligible?

There are two types of bankruptcy for individuals: Chapter 7 and Chapter 13.

There are some significant differences between the two programs, but here’s a high-level summary:

  • Chapter 7 allows you to completely discharge your debts, with some exceptions (such as student loans, certain tax obligations, and child support). But you may be obligated to sell some of your property to settle some of your debt obligation.
  • Chapter 13 allows you to create a payment plan to repay some or all of your debts over a 3-5 year period. So your debts are not discharged, but you will also not be obligated to sell any property in order to make your payments.

Either one could be more or less beneficial depending on the specifics of your situation. But the very first question is whether you qualify for either one, and each has its own set of criteria.

Chapter 7 bankruptcy has what’s called the “means test”, which is meant to ensure that only people who truly can’t afford their debt payments are allowed to file. There are two different wants to pass it, and therefore qualify for Chapter 7 bankruptcy:

  1. If your monthly income is less than the median monthly income in your state for your family size, you pass. You can find current median income numbers by family size here.
  2. If you don’t pass #1, you’ll have to go through a complex calculation to see whether your disposable income after subtracting out certain expenses is enough to satisfy your debt obligations. At this stage it would probably be best to talk to a professional who could help you navigate the process.

Eligibility for Chapter 13 bankruptcy is a little more straightforward. Here’s how it works:

  1. As opposed to Chapter 7, you need to prove that your disposable income is high enough to afford a reasonable repayment plan.
  2. Your secured debt (mortgage, auto loan) can’t exceed $1,149,525, and your unsecured debt (credit cards, medical bills, etc.) can’t exceed $383,175.
  3. You must have filed both federal and state income taxes each of the last four years.

There are some other requirements for each, but those are the major ones. Assuming you qualify for at least one of them, there are a few other things to consider.

What Kinds of Assets and Liabilities Do You Have?

Depending on the specifics of your financial situation, one type of bankruptcy may be preferable to the other. Or it may be that neither would actually be particularly helpful.

As an example, neither type of bankruptcy would likely help you all that much if your primary debts are student loans. They wouldn’t be discharged in Chapter 7 bankruptcy. And while your required payments might be reduced over the 3-5 year repayment period in Chapter 13 bankruptcy, once that was over you would have to continue paying them back as usual.

The type of assets you own and their value also matters, particularly if you’re going through Chapter 7 bankruptcy. During that process your bankruptcy trustee is allowed to sell your property in order to settle your debts, but certain property is protected.

For example, your house and car are protected up to certain limits. Employer retirement accounts like 401(k)s and 403(b)s are fully protected, while IRAs are protected up to about $1 million. But other accounts, such as checking, savings, and regular investment accounts may not have the same protections.

The rules here vary by state, and having a strong understanding of which assets you might be able to keep and which you might end up losing will help you make your decision.

What Are Your Alternatives?

Bankruptcy can have the big advantage of erasing your debts and allowing you to start anew. But there are also some serious consequences, such as a hit to your credit score and a mark on your credit report for up to 10 years. So it makes sense to evaluate your other options before making a decision.

One option may be to call up your lenders and see if you negotiate a lower interest rate, a reasonable payment plan, or a settlement for a smaller amount.

You could also work on making some changes to your spending habits, cutting out certain expenses and possibly selling certain possessions to make room for your debt payments.

If you have student loans, you should look into income-driven repayment plans as a way to decrease your monthly obligation and potentially have some of your debt forgiven down the line.

You could also look into getting some 1-on-1 help from a credit counseling company. Just make sure to stick with reputable companies like The National Foundation for Credit Counseling and to avoid the late-night infomercials promising to wipe your debt away.

Make the Best Decision for You

Filing for bankruptcy is a big decision, and in the end you’re the only one who will know what’s right for you.

Do your research, evaluate all of your options, and then make the decision that most helps you reach your personal goals.

 

Matt Becker
Matt Becker |

Matt Becker is a writer at MagnifyMoney. You can email Matt at matt@magnifymoney.com

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Can You Discharge Student Loans in Bankruptcy?

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

Students throwing graduation hats

Student loans have been a hot topic in recent news and for good reason. The level of student loan debt in the United States has grown substantially over the past several decades. As of 2014, the balance of student loan debt reached $1.2 trillion. Students burdened with debt have one option when it comes to repayment: pay the debt. However, in extreme circumstances, it may be possible to completely discharge student loan debt in bankruptcy.

How to Discharge Student Loans in Bankruptcy

The U.S. Department of Education website provides four cases in which federal student loans may be discharged. Those include:

  1. Closed school discharge
  2. Total and permanent disability discharge
  3. Death discharge
  4. Bankruptcy discharge

There are a few more options for partial discharge with qualifications. The website lists bankruptcy as an option in rare cases.

“If you file Chapter 7 or Chapter 13 bankruptcy, you may have your loan discharged in bankruptcy only if the bankruptcy court finds that repayment would impose undue hardship on you and your dependents. This must be decided in an adversary proceeding in bankruptcy court. Your creditors may be present to challenge the request.”

The U.S. bankruptcy court will use the three-part Brunner test to determine if the student loans are eligible for discharge in bankruptcy. To show hardship you must show that:

  1. If you were forced to repay the loan, you would not be able to maintain a minimal standard of living.
  2. There is evidence that this hardship will continue for a significant portion of the loan repayment period.
  3. You made good-faith efforts to repay the loan before filing bankruptcy (usually this means you have been in repayment for a minimum of five years).

If you are unable to satisfy any of the three requirements, the loan will not be discharged. However in a study published in the American Bankruptcy Law Journal by Jason Iuliano, 39% of those who applied were granted at least some discharge.

For example, if you are 30 and your student loan payments make up a significant portion of your total income, and you can prove that this hardship will continue for many years you might be able to have your student loans included in your bankruptcy.

But if you just started making payments and have not attempted to use available programs such as income-based repayment, then you may have a harder time discharging your student loans.

If you feel that bankruptcy is for you, consult a lawyer and consider including your student loans.

[Struggling to pay back private student loans? Learn about loan modification here.]

Ramifications of Bankruptcy

Choosing to eliminate your student loans using bankruptcy is a difficult path. Moreover, you will mark your credit report for 7 or 10 years with a bankruptcy filing. This could prevent you from purchasing a home, opening new lines of credit, and benefiting from the best rates to borrow money. It could also prevent you from getting a job with credit pre-screening.

Options So You Can Avoid Bankruptcy

If you would rather avoid bankruptcy, here are more ways to eliminate your student loan debt.

Reduce or Halt Your Current Payment

Determine if you are eligible for deferment or forbearance. A deferment is a period during which repayment of the principal and interest of your loan is temporarily delayed. Depending on the type of loan you have, the federal government may pay the interest on your loan during this period.

If you can’t make your scheduled student loan payments, but don’t qualify for deferment, a forbearance may allow you to stop making payments or reduce your monthly payment for up to 12 months.

[Miss a student loan payment? Learn how to find help here.]

Choose a Reduced Payment Plan

For federal loans, there are a few repayment plans that can help you manage your student loan repayment. Choose one of the following:

  • Income Based Repayment Plan – Payments are calculated based on your discretionary income and can extend up to 25 years of repayment.
  • Graduated Repayment Plan – Payments start off small then increase every two years for a maximum of 10 years of repayment.
  • Extended Repayment Plan – Payments can extend up to 25 years of repayment.
  • Pay as You Earn Repayment Plan – Payments are calculated based on your discretionary income and can extend up to 20 years of repayment.
  • Income-Contingent Repayment Plan – Payments are based on your adjusted gross income and can extend up to 25 years of repayment.
  • Income Sensitive Repayment Plan – Payments are based on your annual income and last for a maximum of 10 years; however, you will pay more over time versus the standard 10-year repayment plan.

[Read about Student Loan Forgiveness Programs Here.]

Career Based Discharged

You can also have your student loans discharged if you take a certain career path and your loans are: Direct, FFEL Program, or Federal Perkins loans. Private loans are often not eligible for forgiveness programs. As an eligible public service employee you can have 100% of your loan balance forgiven after 120 consecutive payments; this assumes that you maintain your status as an eligible public service employee while making those payments. If combined with one of the reduced payment plan options that could mean a substantial reduction in total repayment balance.

Check out our Student Loan Refinance table to compare your options.

 

LaTisha Styles
LaTisha Styles |

LaTisha Styles is a writer at MagnifyMoney. You can email LaTisha at LaTisha@magnifymoney.com

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When Bankruptcy Makes Sense

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

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The word “bankruptcy” usually gets an emotional response from anyone who hears it. Lawyers, advertising it on television, sell bankruptcy like it is a flat-screen television. Radio talk show hosts often call it immoral, telling you to live on beans and toast for 10 years before you break your vow of repayment and walk away from debt.

At MagnifyMoney, we think the truth lies somewhere in between. For certain situations, bankruptcy is the single best solution. For others, it can’t help them. And for some, who can actually afford to repay their debt, it does raise serious ethical questions.

And this isn’t just our opinion. The Fed just recently released a report, showing that bankruptcy can be an excellent solution for some people. And it also showed that the 2005 reform, which made it harder to file bankruptcy, has harmed individuals who stopped filing for bankruptcy. Not filing has condemned them to a life of chronic debt, with daily calls from collection agencies, low credit scores and reliance upon payday lenders for any future emergencies.

In this article, we will:

  • Help you figure out if you should consider bankruptcy
  • Explain how it works
  • Show the cost of not filing for bankruptcy
  • Talk about how to avoid filing again

Is Bankruptcy for Me?

Bankruptcy should only be considered if you are in financial crisis. Although financial crisis can have different meanings to different people, we think the following can be a good way to answer the question:

  • Do you find it impossible to make all of your basic monthly payments? Do you struggle to cover mortgage/rent payment, auto payment, insurance payments and credit card minimums?
  • Is your total debt (excluding mortgage) more than 50% of your gross annual income?

If you answered yes to either (or probably both) of those questions, you are likely in an unsustainable situation. For example, someone who makes $40,000 before tax and has $30,000 of credit card debt in addition to a mortgage will likely never get out of debt, unless he is able to significantly increase his income. That person has a net monthly income of about $2,000 (may vary by state and cost of healthcare and other deductions). Just the minimum due on $30,000 of credit card debt would be over $1,000.

In our example, that individual would work incredibly hard to stay in debt for over 30 years. During those 30 years, he would pay over $50,000 of interest alone to the credit card company. In addition, because of the high credit card balances (and the high likelihood of missing payments whenever there is an emergency), his credit score will remain incredibly low, making everything else in life much more expensive. A low credit score will result in more expensive auto loans, auto insurance, mortgage re-finance and every other type of borrowing.

It makes no sense for that individual to just keep paying the minimum due. He will be stuck in a life of poverty, unless he can increase his income.

Bankruptcy is not for you if:

  • All of your debt is in student loans. It is virtually impossible to discharge your student loan debt in a bankruptcy.
  • All of your debt is with your mortgage or your auto loan. Secured debt is not considered as part of the bankruptcy. (However, you may have the opportunity to get your auto loan balance reduced as part of a bankruptcy. The process is called a cram-down, and the amount of the loan that is greater than the value of your car can be forgiven if you negotiate properly).
  • You can afford to repay the debt. Beyond the moral issues of walking away from debt, there is now a means test and you may not be able to file bankruptcy if you have sufficient assets or income to service the debt.

How does Bankruptcy Work?

There are 2 types of bankruptcy: Chapter 7 and Chapter 13.

Chapter 7 is a true “fresh start.” In most cases, all of your unsecured debt (credit cards, personal loans) will be discharged. That means creditors will no longer be able to do any form of collections. The phone calls stop. The wage garnishment stops. The lawsuits stop. There is a record of the debt discharge on your credit report, and it will stay there for 10 years. However, for most people the recovery from bankruptcy is remarkably rapid. If you are in debt crisis (as we defined above), a bankruptcy can help you recover in as few as 2-3 years, compared to a lifetime sentence of poverty. 70% of all bankruptcy filings are Chapter 7. We should warn you: for the full 10 years, you will still have some limitations. Some lenders will never lend to someone with a bankruptcy on their credit report. Some employers will not hire employees with former bankruptcy. And, in the military, filing bankruptcy can result in the loss of intelligence clearance, which could cost you your career. All of these factors need to be considered before filing.

In Chapter 13, you do not have all of your debt discharged. Instead, a portion of your debt is written off, and a payment plan is created for the remainder of the debt. It takes longer to recover from a Chapter 13 bankruptcy, and for most individuals a Chapter 7 is preferable. The main reason people end up in Chapter 13 is because they fail to qualify for Chapter 7 (because they have too many assets or too much income relative to their debt to qualify for Chapter 7).

You should speak to your lawyer, but in most cases for people in debt crisis, a Chapter 7 makes the most sense and will certainly lead to the fastest recovery.

Just remember: Chapter 7 and Chapter 13 generally can not help you with mortgage, auto and other secured debt or student loans.  The only way it will help is by eliminating other debt, helping you to make payments on your mortgage.

The Cost of Not Filing for Bankruptcy

In 2005, bankruptcy “reform” was passed. It did 3 big things:

  • Introduced a means test. If you household income is above the median, you have much higher hurdles to cross before having your bankruptcy petition approved
  • Increased the cost of filing. The cost of filing for bankruptcy has increased by 44%, from an average of $697 to an average of $975. As you can imagine, higher costs make it more difficult for those with the least amount of money to afford the filing.
  • Made student loans off limit. Student loan debt is now a protected bubble, and it is virtually impossible to have that debt discharged.

As a result of these changes, the number of people filing for bankruptcy declined significantly. The Fed has looked at the impact of this decline in bankruptcy filings, and the results are startling. They clearly show that many people would have been much better off had they filed. Here are the findings:

Because bankruptcy now costs more, the poorest people are least likely to file. (And they need it the most)

The Federal Reserve tracked the likelihood of people to file for bankruptcy before and after the change to the law. People with higher incomes continued to file for bankruptcy, whereas those with the lowest incomes filed at a much slower rate. The Fed concludes that “liquidity constraints” kept people from filing. In other words, people were too poor to file for bankruptcy.

People who file for bankruptcy recover much quicker than people who don’t file.

People who file for bankruptcy see a much quicker improvement in their credit score than those who don’t. Why? People who don’t file bankruptcy (but are in financial crisis) continue to struggle to make minimum payments. They continue to deal with accounts in questions. They continue a life of chronic debt.

The table below (from the Fed) shows that people who file bankruptcy could get a score of 620 within a year of filing.

BK score

The top 2 lines show people filing for bankruptcy (3 months and 12 months after filing). The lines at the bottom show people who remain in chronic collections, but don’t file for bankruptcy. Their credit scores stay in the low 500s.

In addition, the ability to open new credit accounts (like an auto loan or mortgage) is severely restricted for people who can not file bankruptcy, but remain in collections. The chart below shows the number of new accounts opened by those stuck in default, versus those who filed bankruptcy:

Quarters

You can see on the red line that people who don’t file bankruptcy, but stay in collections, are unable to open any new form of credit. If they do need to borrow, they will be forced to payday lenders, title loan companies or worse.

How to Prevent Future Bankruptcies

There are 2 criticisms against bankruptcy that we agree with at MagnifyMoney. First, some people have abused the system historically. They enjoy spending the money that they borrow, they can afford to repay, but they use bankruptcy as a way to walk away from debt. In addition to the moral questions, it also drives up the cost of borrowing for responsible people (because they have to pay for the people who don’t pay back through higher interest rates).

Second, people use bankruptcy as an easy way out of debt, but they never fix the core problem. As a result, 5-7 years later they are back in the same situation.

The bankruptcy reforms of 2005 did introduce a means test. If you income is below the national medium, you can file for bankruptcy easily. If, however, you income is above the median, you will have to pass a means test. That makes it difficult for people who have assets and income to walk away from debt.

The second issue is trickier. We believe that before filing for bankruptcy, everyone should truly understand why the problem happened, and deal with the root cause. In the Self-Assessment chapter of our free ebook (which you can download here), we dig deep into your budget. You should look to understand:

  • Are your fixed expenses too high? When mortgage and car payments eat up a big chunk of your monthly income, you can very quickly end up borrowing on credit cards to get through the month. Although difficult, selling your home or car and downsizing could be the difference between avoiding debt, or ending up back in the same place you started.
  • Can you control your discretionary expenses? Can you actually live within a budget? Do you even have one?
  • Do you have health insurance? So many big medical expenses were the result of no health insurance. With Obamacare, most Americans can find a health policy that can at least protect against massive medical bills.

If your fixed expenses are too high, and you can’t live within a budget, you will likely end up in bankruptcy again. You should do the hard work now to make sure bankruptcy is a tool that you only use once.

Final Thoughts

For many people, bankruptcy is the fresh start that they deserve. Too many people stay in a chronic state of debt, when bankruptcy would be the right answer. However, the decision should not be taken lightly. And everyone (whether you have filed for bankruptcy or not) should be taking the necessary steps to build a secure financial future.

 

Nick Clements
Nick Clements |

Nick Clements is a writer at MagnifyMoney. You can email Nick at nick@magnifymoney.com

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Debt Guide: When to File Bankruptcy

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

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Below is an excerpt from our Debt Free Forever Guide. Be sure to download the free guide to help dump debt for good.

For some people, bankruptcy may be an appropriate option. In a bankruptcy, you may be able to eliminate some or all of your debts. However, debt forgiveness does not come lightly. Chapter 7 (where all eligible debt is eliminated) stays on your record for 10 years. Chapter 13 stays on your report for 7 years. And, during that time (especially in the first 3-5 years), you may find it virtually impossible to apply for any new credit. And credit is not limited to mortgages and auto loans. It can even include pay-as-you- go mobile phone packages. If you work in the financial services sector, you may find that bankruptcy will make it impossible to get a job. So, this decision should not be taken lightly.

However, for some people, this may be the only option. I will give a few examples of people whom I have met, where bankruptcy made complete sense:

  • A hardworking man had a medical emergency. Unfortunately, he did not have medical insurance. The total bill was over $500,000. And his annual salary was $40,000. There was no chance that he would ever pay off that debt. Bankruptcy made perfect sense.
  • A married couple unfortunately did not plan for the future. They had no life insurance, no savings and credit card debt. The husband was a professional, and the wife stayed at home with the children. The husband died unexpectedly. Between the funeral, the credit card debt from before the marriage and the costs of the transition, the widow had over $75,000 of debt. She was able to get a secretarial job for $25,000. It made sense to eliminate the debt with bankruptcy.

The biggest reasons for bankruptcy are medical and divorce. We always try to work with people to help them prepare for the worst. Everyone should have medical insurance, even if that means paying for a high deductible (low premium) policy that at least insures against bankruptcy. If someone depends upon you (like the husband in the story above), term life insurance is necessity, and it doesn’t cost much. In medicine, it is always better to prevent (via a good diet and exercise) than to fix after something goes wrong. The same is true in financial matters. However, if you are now in the emergency room, a bankruptcy may be the right option.

What can a bankruptcy do for me?

A bankruptcy gives you the opportunity to eliminate a significant portion of your debt. The bank has to write off the debt, and is no longer able to collect on the debt.

In Chapter 7 bankruptcy, all of the eligible debt is eliminated. It takes about 3-6 months to have the bankruptcy discharged.

  • Most or all of your unsecured debt will be erased. Unsecured debt would include things like credit card debt, personal loan debt, medical bills, mobile phone bills and other debt.
  • Certain types of debt are usually excluded from bankruptcy. These include student loan debt, tax obligations, spousal support, child support and some other types of debt can not be eliminated.
  • Some of your property may have to be sold to pay off your debt. However, in most cases, your primary property is exempt.
  • For secured property (like an auto loan), you will be given a choice. You can continue to pay, you can have the property repossessed, or you can make a lump sum payment (at the replacement value).

If your problem is with credit card debt and/or medical debt, than Chapter 7 makes sense. All of that debt will be wiped out. You continue to pay (and keep) your mortgage and auto loan.

In a Chapter 13 Bankruptcy, you are not able to eliminate all of your debt. Instead, you will be forced to make regular monthly payments towards your debt before it is completely eliminated.

Chapter 7 or Chapter 13?

If given the choice, most people would choose Chapter 7. From a credit score perspective, they both have equal (negative) impact on your score. In fact, here is what FICO says:

The formula considers these two forms of bankruptcy as having the same level of severity and, for both types, uses the filing date to determine how long ago the bankruptcy took place. As with other negative credit information, the negative effect of a bankruptcy to one’s FICO score will diminish over time.

So, if you get the same penalty, but in one form of bankruptcy all of your debt is wiped out, and you still have to pay back some debt in the other form, then you would probably choose Chapter 7. And most people did, until the law was changed in 2005.

Note: there may be some instances when you will want to file Chapter 13 instead of Chapter 7. For example, if you are behind on your house payments and want to keep your house, Chapter 13 may make more sense. Why? In Chapter 13, you can put your past due mortgage payments into your repayment plan, and pay them back over time. In Chapter 7, your past due mortgage payments may be due right away.

However, in the majority of cases, Chapter 7 is more favorable to the borrower than Chapter 13.

There are now some “means tests” required to see if you can file for Chapter 7. Here are some very basic rules:

  • If your family income is below the median income of your state, you will probably be able to file Chapter 7. The income used is the average of your last 6 months income. You can find the median incomes here.
  • If your income is above the median, you may still be able to file bankruptcy. However, you will have to pass a means test. Your income and expenditures will be looked at, to see if you have the ability to make payments towards a payment plan over 5 years towards the accumulated debt.

In addition, if you tried to be clever, you will likely be caught. Any recent cash advances on your credit card, and any recent luxury purchases can be exempt from the bankruptcy completely.

It used to be very easy to file for Chapter 7 and have all of your unsecured debt eliminated. That is no longer the case. But, if you have low income, you can still proceed. And, if you have a very difficult situation, you can still find a path towards eliminating a significant portion of your debt.

How to Proceed

As part of the bankruptcy legislation, you need to meet with a non-profit debt counselor before you are allowed to file for bankruptcy. So, whether you are thinking about negotiating settlements or filing for ?bankruptcy, it makes sense to meet with a counselor. You can find a list of the approved agencies here.

For further reading on bankruptcy, we recommend this website (NOLO) – they have an excellent library of information.

In Summary

If you are in too deep, bankruptcy may be the only remaining viable option. I have met many people who filed bankruptcy, and went on to live very fulfilling and prosperous lives. Companies file bankruptcy all the time – and I believe that people should have the same legal protections that companies have.

You just need to be realistic about what bankruptcy can and cannot do. If you have student loans, tax liens, spousal support or child support – you will not be able to use this tool. You need to find a way to pay back your debt.

But, if you have been hit with a big medical bill, or your credit card debt is just too large relative to your income, bankruptcy could be the best option. It will be a very difficult 2 years. By Year 3, things will look a lot better. And, 7 years later, your score will reflect the person you have been in the last 7 years. A very good friend of mine had filed bankruptcy. He now has a home (purchased with a mortgage at a low rate). He has a car (purchased with a 0% car loan). And he has a rewards credit card (that he pays off in full every month). His score is high. It was a rough couple of years, but it made sense. Otherwise, he would have been making minimum payments for 30 years and still wouldn’t be out of debt.

Weigh your options carefully. Meet with a non-profit counselor. We are always available at MagnifyMoney to talk as well (just email us at info@magnifymoney.com).

Good luck with your decision.

Download our Debt Free Forever Guide! It’s FREE and will help get you back on track.

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Nick Clements
Nick Clements |

Nick Clements is a writer at MagnifyMoney. You can email Nick at nick@magnifymoney.com

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Best Credit Cards for Fair Credit

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

Having fair credit doesn’t mean you’re ineligible for great credit cards. We’ve rounded up the top credit cards with the best offers in a range of different categories that you’re still likely to be approved for, even with fair credit. These credit cards can help you build credit as long as you use them wisely. In this guide, we’ll show you the best credit cards for fair credit scores as well as how to use them to boost your credit score even higher.

Here are some of the products we will be discussing today:

Check If You’re Pre-qualified

Before applying for any credit card it’s helpful to check if you’re pre-qualified from a variety of institutions. The soft credit check the institutions perform does not harm your credit score and allows you to compare credit options. Sites such as CreditCards.com provide good tools that can match you to offers from multiple credit card companies without impacting your credit score. You can read our complete guide to getting pre-qualified for a credit card here.

Build Credit with Secured Cards

A great approach to rebuilding credit is to get a secured credit card. In order to get the card, you will have to deposit money that will be your line of credit. To effectively rebuild your credit, you must use the card, and we recommend not charging more than 20% of your credit line. For example, if you have a $500 credit line, you should not charge more than $100. Then, pay off your balance in full every single month. You can even build credit with $10 a month on a secured card and see your credit score rise.

After you’ve consistently managed your secured card well over a period of time, you may be able to increase your credit line beyond your initial deposit or migrate to an unsecured credit card.

We’ve reviewed the best secured cards in the market and found our top pick — the Discover it® Secured Card. This card has no annual fee, a reasonable security deposit and offers an easy transition to an unsecured card. In addition, Discover offers a rewards program and free access to your FICO score. These reasons are why we recommend the Discover it® Secured Card for people with fair credit.

Build Credit with Secured Cards

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Best for Cash Back

If you have fair credit and want a cash back card the QuicksilverOne® Rewards credit card from Capital One® is a good option. As a consumer with fair credit you may not qualify for all cash back cards, but you may qualify for the QuicksilverOne® Rewards card since it is made for those with fair credit. With this card you will earn unlimited cash back, with no changing categories, and the rewards never expire.

However, this card comes with a high APR and annual fee. To earn enough cash back rewards to pay for the card itself each year you’ll need to spend $2,600 annually ($217 per month). To net a cash back of $50 you need to spend $5,933 in a year ($494 per month). This card may be an option for you if you want to earn more than 1% cash back.

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Best Low Ongoing APR

No one wants to carry a balance on their credit cards, but if you must, it’s best to get a card with a low ongoing APR. Many lenders charge high APRs around 25%, but you can potentially qualify for an APR as low as 9.15%. This card will charge you less money on your debt than the typical credit card, which can save you big dollars in the long run.

Best Low Ongoing APR

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Best for Small Business Owners

Running a business is hard. Small business credit cards can make it a bit easier for you by giving you rewards for everyday purchases. Nevertheless, be aware: Business credit cards forego certain protections that personal credit cards have under the Credit CARD Act. For example, card issuers can change the payment due date or interest rate without giving you prior notice.

Still, small business cards can be a great option for you to build your credit and save money, even if you don’t have a traditional brick-and-mortar business. You can apply for these cards with just a DBA or even your own name, if you’re a freelancer.

Best for Small Business Owners

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You may have a fair credit score because you are a student. Student cards provide a great way for you to build your credit score and establish good credit history. The Discover it® for Students card is made with students in mind and offers ways to help you build credit and also earn rewards.

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FAQ

There’s a lot of math that goes into computing your credit scores, but at the end of the day, a fair credit score is defined as being between 649 and 699. Here’s how a fair credit score sits in relation to other credit scoring classes:

  • Excellent: Above 760
  • Good: 700-759
  • Fair/Average: 649-699
  • Poor: 600-648
  • Very Poor: Under 599

You can check your credit score for free on sites like Credit Karma, Chase Credit Journey, or AnnualCreditReport.com.

Having a good or excellent credit score unlocks a lot of advantages, such as lower interest rates and better approval odds for high-value credit cards and other financial products. These advantages will result in more dollars in your wallet at the end of the day. For example, having a high credit score can save you tens or even hundreds of thousands of dollars in interest payments over your lifetime, especially for big-ticket loans like a home mortgage.

But if you have a fair credit score, don’t fret! There is a reason that your score is less than optimal, and thus there are real, concrete steps you can take to boost your credit score into the good and excellent range.

If you play your cards right, you can even join the exclusive 800+ credit score club (unfortunately, it’s not an official club, and you don’t get a shower of balloons and confetti once you reach it — but you will get access to some of the most exclusive financial products).

There can be many reasons why your credit score is below 700. Here are some of the most common ones:

  • You have late payments on your credit report. Having even just one late payment on your credit report can seriously harm it because payment history makes up 35% of your credit score. Unfortunately, unless it’s an error, you’ll just need to wait for it to drop off of your credit report in seven years. To prevent this from happening, make sure all of your debt payments are set up on autopay. That way, you won’t have to worry about it.
  • You have a lot of credit card debt. Credit utilization ratio is one of the biggest factors in calculating your credit score — it affects 30% of the final score. It’s simply how much you owe relative to how much you are allowed to spend. For example, let’s say you have two credit cards with a $5,000 limit each, and you owe $2,000. Your credit utilization ratio is 20% because you owe $2,000 out of a possible $10,000. Luckily, this is one of the easiest factors to correct that will boost your credit score big time in the short run: Pay off your balance, and your score will bump up immediately.
  • You don’t have a long credit history. Although credit history doesn’t factor into the calculation of your credit score as much as the credit utilization ratio and payment history, it still makes up a sizable chunk at 15%. There’s not much you can do about this one: Simply wait for your accounts to age.
  • You have a lot of credit inquiries. Banks don’t like to see you applying for credit like an out-of-control spender in Las Vegas. Each time you apply for credit or a loan, it’s recorded on your credit report as a credit inquiry, and it stays there for two years. To minimize the number of credit inquiries you have, always shop around and make sure creditors use a soft pull credit check unless you’re absolutely ready to apply for the line of credit. This factor makes up just 10% of your credit score, but it’s an easy one you can affect as long as you’re careful about applying for credit.
  • You don’t have a wide variety of account types. You may be an ace at handling your student loans, but creditors also want to know you can handle other types of credit like mortgages and credit card debt, too. The more types of credit accounts you have on file, the better. However, we don’t recommend taking out a loan just for the sake of boosting your credit score — that costs money, and you’ll only receive a modest benefit from it because credit mix only makes up 10% of your credit score.

As you can see, you do have a lot of options when it comes to fine-tuning your credit score into the good or excellent category. We recommend the helpful credit score simulator at Chase Credit Journey to check your current score and see how these adjustments can potentially change your credit level. It’s available whether you’re a Chase customer or not. Give it a try!

Applying for a credit card is easy. You’ll need some basic information like name, address, and Social Security number. You’ll also need employment and income information. Simply enter it into the online form on the credit card company’s website, visit a branch of the bank (if they have one), or call the credit card company directly. You’ll usually receive instant notification if you’ve been approved or not.

There are many ways for you to increase your credit score. Ultimately practicing responsible credit behavior is the best way to see your score rise. Here are a few ways you can increase your credit score:

  • Have someone add you as an authorized user: If you have a willing (and very trusting) friend or family member with better credit, you can ask them to add you as an authorized user onto one or more of their credit cards. Their credit will not be harmed by this (as long as you don’t rack up charges or missed payments), and the credit card will show up on your credit report just as if you had applied for it — boosting your credit utilization ratio, number of accounts, and account age if you keep it for a long time.
  • Increase your credit history length: Unfortunately, you can’t go back in time, but you can still affect your credit history length. Your credit score is partially based off of average credit history length, and the more old accounts you have, the better. If you already have credit cards open, consider keeping them open so your average credit history won’t decrease and ding your credit. Each new credit card you get will drop your average account age, and it’ll take longer to boost this portion of your score.
  • Maintain a low credit utilization: Credit utilization (the percentage of available credit you’re using) is one of the biggest factors in calculating your credit score. The lower, the better. To decrease your utilization ratio, simply pay off your credit card. You can also request a credit limit increase from your credit card issuer to lower your credit utilization ratio — just make sure not to rack up a balance again with that extra credit or you’ll be back to square one.

Missing a payment can single-handedly cause your credit score to drop by 100 points or more. To avoid this, simply set up your credit card on autopay for the minimum amount due — that way you’ll never have to worry about missing a payment.

You can always apply for a personal loan if you need some cash right now for something. You can use this tool to shop around for the best interest rates without hurting your credit score. It’s smart to avoid hard inquiries until you’re ready to actually apply for a personal loan so that your credit isn’t dinged with multiple inquiries.

Each credit card is different, so you’ll need to check the fine print. Usually, though, you’ll need to both charge a purchase and pay off your bill before you’re eligible for those cash back rewards. Then, they’ll tally up this amount and periodically either send you a check, or offer a statement credit.

If you’re running a small business, it’s often easy to mix your personal and business accounts, especially if you’re self-employed. This creates an accounting nightmare to sort through, so it’s recommended (but not required) that you have a separate business banking account and credit card, if you need one.

Lindsay VanSomeren
Lindsay VanSomeren |

Lindsay VanSomeren is a writer at MagnifyMoney. You can email Lindsay here

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With the Fate of Public Service Loan Forgiveness Uncertain, Here are Tips for Confused Borrowers

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

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More than half a million Americans are working toward Public Service Loan Forgiveness (PSLF), a program that eliminates federal student loan debt for people with jobs in the public sector. But the proposed 2018 White House budget reportedly calls for ending PSLF for future borrowers — and even current participants’ status could be in doubt, with a lawsuit claiming the government has reversed previous assurances given to certain borrowers that their employment qualifies.

Final decisions have not yet been made in either scenario. But even with this uncertainty, there are steps both current borrowers and interested potential future PSLF participants can take to make themselves as secure as possible.

First, a quick primer on PSLF: The program began in October 2007 under George W. Bush, and it wipes clean the remaining federal student debt for qualifying borrowers who have made 120 payments, or 10 years’ worth (more information is available at StudentAid.gov/publicservice). So the earliest any public service worker could receive loan forgiveness under PSLF is October 2017.

“The idea is to avoid making debt a disincentive to choosing public service,” explains Mark Kantrowitz, a student loan expert and publisher at college scholarship site Cappex.com. “Think about a public defender. They might make $40,000 a year, but they’ll incur $120,000 in debt for law school. That debt-to-income ratio is impossible, so PSLF makes that career path possible — and attracts people who might have otherwise taken high-paying private-sector jobs.”

Public Service Loan Forgiveness — on the chopping block?

At this time, the biggest threat to the future of PSLF is President Donald Trump’s 2018 White House education budget proposal. The budget proposal would eliminate PSLF — citing costs — and replace all current income-based repayment/forgiveness plans with a single income-driven system. While existing borrowers would be grandfathered into PSLF, any new students who take out their first federal loans on or after July 1, 2018, would not qualify. Still, all of this can happen only if Congress passes the budget — and it remains to be seen whether this section will pass as currently written in the proposal.

If you’re one of the more than 550,000 borrowers who is already working toward forgiveness — that is, you have already taken out at least one federal loan and/or you’ve completed school and are working in public service — the proposed cancellation of PSLF won’t affect you. Again, if the program is cut, it will impact only students who take out their first federal loans on or after July 1, 2018.

But even existing borrowers working toward PSLF can’t fully relax. As first reported by The New York Times, the Department of Education added a serious wrinkle by sending letters to people saying their employment was no longer eligible for PSLF, after the borrowers had confirmed with their loan servicer that they qualified. Four borrowers and the American Bar Association have filed a lawsuit against the department, and the case is currently in progress.

That may leave many workers questioning whether or not they will ultimately be eligible for loan forgiveness after all — even if they work in the nonprofit or public sector. MagnifyMoney has spoken to experts and reviewed the rules of the program to help.

How Can I Be Sure I Qualify for Public Service Loan Forgiveness?

Qualifying for PSLF depends on meeting several specific requirements, so the first step in determining your eligibility is to make sure your loans and employment check all the boxes.

1. Your student loan must qualify for forgiveness.

PSLF provides forgiveness only for federal Direct Loans:

  • Direct Subsidized Loans
  • Direct Unsubsidized Loans
  • Direct PLUS Loans—for parents and graduate or professional students
  • Direct Consolidation Loans

Note that loans made under other federal student loan programs may become eligible for PSLF if they’re consolidated into a Direct Consolidation Loan, but only payments toward that consolidated loan will count toward the 120-payment requirement. And, according to ED, parents who borrowed a Direct PLUS Loan “may qualify for forgiveness of the PLUS loan, if the parent borrower—not the student on whose behalf the loan was obtained—is employed by a public service organization.”

2. You must be enrolled in the right type of repayment plan.

You must be enrolled in one of the Direct Loan repayment plans, some of which are income-based. The umbrella term for these plans is income-driven repayment plans, which include the Pay As You Earn and Income-Based Repayment plans. While payments under other types of Direct Loan plans, like the 10-year Standard Repayment Plan, do qualify and count toward your 120 payments, you’ll want to switch to an income-driven plan as soon as possible — because if you stick with a standard 10-year repayment, you’ll have paid off your loan in full after 10 years with nothing left to be forgiven under PSLF. Check the official PSLF site for more details. And note that private loans, including bank loans that are “federally guaranteed,” do not qualify.

3. You must make 120 on-time payments while employed full time by an eligible employer.

If you drop to part-time work, those payments won’t qualify. You must also be employed full time in public service at the time you apply for loan forgiveness and at the time the remaining balance on your eligible loans is forgiven. After you make your 120th payment you’ll need to submit the forgiveness application, which the Department of Education says will be available in September 2017.

4. Your employer must count as a public service organization.

This is the big one, and the most complicated step of the process for some borrowers to figure out. While the Education Department does address types of employers that fit under the PSLF program, there are some gray areas. Broadly, the types of employers that qualify include governmental groups, not-for-profit tax-exempt organizations known as 501(c)(3)s, and private not-for-profits. That last category includes military; public safety, health, education, and library services; and more.

Pro tip: Certify that your employer is included in the program every year.

Each year and whenever you change employers, you should fill out and send an Employment Certification form to FedLoan Servicing. The form isn’t required to be submitted on an annual basis, but it’s highly recommended to fill it out annually so there are no unhappy surprises down the road. It also helps you keep track of progress toward your 120 payments and gives you a chance to find out whether there is any change to your eligibility status.

What if you fear your job’s eligibility is unclear?

The validity of that FedLoan Servicing certification form is at the center of the lawsuit against the Department of Education. Although it’s important to have your employer’s eligibility certified by the department, the Education Department has said the form isn’t necessarily binding and the eligibility of employers can possibly change. As The New York Times put it, the department’s position implies “that borrowers could not rely on the program’s administrator to say accurately whether they qualify for debt forgiveness. The thousands of approval letters that have been sent … are not binding and can be rescinded at any time, the [DOE] said.”

That puts existing borrowers in a tough spot, says Joseph Orsolini, CFP and president of College Aid Planners: “[PSLF] is sort of an all-or-nothing in that you can’t apply for the forgiveness until you’ve already done your 120 payments. So to have someone choose this career path and work for years only to be told, ‘never mind, you no longer qualify even though we said you did,’ it would be hard for them not to see that as reneging on a deal.”

That possibility is “terrifying” for Frances Harrell, 35, a preservation specialist who works for a nonprofit that supports small and medium-size libraries in caring for their collections. She completed a library graduate school program in 2013 and emerged with a total of about $125,000 in debt, including her undergraduate loans.

“Everyone I know is in public service, and we all saw the Times article [about the PSLF lawsuit] and flipped out,” says Harrell, who currently lives in Gainesville, Fla. “I felt like I had been dropped in a bucket of ice. We’re making life decisions based on this understanding, and it feels so precarious not to have any true confirmation that we’ll get the forgiveness in the end.”

Christopher Razo, 22, who this month will begin classes at Chicago’s John Marshall Law School, plans to take advantage of PSLF while working toward his dream of becoming a state attorney. (Photo courtesy of Christopher Razo)

Harrell has also dealt with confusion from loan servicers and other experts — and based on incorrect advice, she nearly consolidated her loans in a way that would have reset the clock on her years of payments.

Christopher Razo, 22, who this month will begin classes at Chicago’s John Marshall Law School, is relieved that he is enrolling before the 2018 uncertainty begins. Razo is one of Orsolini’s clients, and he plans to take advantage of PSLF while working toward his dream of becoming a state attorney.

“[PSLF] is complex as it is, so my initial thought was, ‘Wow, great timing for me that I’m starting in 2017,’” Razo says. “But I understand the program affects way more than just me. [PSLF] gives you comfort to pursue public-service goals without having to make your employment about the money. I’m optimistic that [lawmakers] will see the good in the program so it can continue.”

When in doubt: Follow the ‘3 phone call rule’

While borrowers may think their loan servicer has all of the answers, Harrell’s situation isn’t uncommon, says Orsolini. He recommends “the three phone call rule”: Call three times and ask the same question, documenting whom you spoke to and when.

“These programs are complicated — which is one of the issues that critics [of PSLF] bring up — and you don’t always get the right information,” Orsolini says. “Before you plan your whole life around the [first] answer you get, you have to double- and triple-check that it’s right.”

If you’re taking out your first qualifying loan on or after July 1, 2018, Orsolini says “there’s not much to do besides hurry up and wait” to see what happens with the White House budget as it relates to PSLF.

“The important thing to remember is that a proposal is just a proposal, and these don’t always see the light of day,” Orsolini adds. “It doesn’t do any good to be overly worried, but you’ll want to keep a close eye on the news.”

Other types of loan forgiveness, cancellation, or discharge:

PSLF isn’t the only option. But not all types of federal student loans offer the same forgiveness, cancellation, or discharge options. See the chart below and check out StudentEd.gov pages here and here for more details.

Still, borrowers should know Trump’s desire to streamline federal programs into a single option means some of these loan types and forgiveness plans could be changed or canceled as well.

Julianne Pepitone
Julianne Pepitone |

Julianne Pepitone is a writer at MagnifyMoney. You can email Julianne here

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Older Americans Are Getting Crushed by Debt, New MagnifyMoney Analysis Shows

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

More American seniors are shouldering debt as they enter their retirement years, according to a new MagnifyMoney analysis of data from the latest University of Michigan Retirement Research Center Health and Retirement Study release. MagnifyMoney analyzed survey data to see whether debt causes financial frailty during retirement. We also spoke with financial experts who explained how seniors can rescue their retirements.

1 in 3 Americans 50 and older carry non-mortgage debt

The Health and Retirement Study from the University of Michigan Retirement Research Center surveys more than 20,000 participants age 50+ who answer questions about well-being. The survey covers financial topics including debt, income, and assets. Since 1990, the center has conducted the survey every other year. They released the 2014 panel of data in November 2016. MagnifyMoney analyzed the most recent release of the data to learn more about financial fitness among older Americans.

In an ideal retirement, retirees would have the financial resources necessary to maintain the lifestyle they enjoyed during their working years. Debt acts as an anchor on retiree balance sheets. Since interest rates on debts tend to rise faster than earnings from assets, debt has the power to destroy the balance sheets of seniors living on fixed incomes.

We found that nearly one-third (32%) of all Americans over age 50 carry non-mortgage debt from month to month. On average, those with debt carry $4,786 in credit card debt and $12,490 in total non-mortgage debt.

High-interest consumer debt erodes seniors’ ability to live a quality lifestyle, says John Ross, a Texarkana, Texas-based attorney specializing in elder law.

“From an elder law attorney perspective, we see a direct correlation between debt and institutional care,” Ross says. “Essentially, the more debt load, the less likely the person will have sufficient cash assets to cover medical care that is not provided by Medicare.”

Even worse, debt leads some retirees to skip paying for necessary expenses like quality food and medical care.

“The social aspect of being a responsible bill payer often leads the older debtor to forgo needed expenses to pay debts they cannot afford instead of considering viable options like bankruptcy,” says Devin Carroll, a Texarkana, Texas-based financial adviser specializing in Social Security and retirement.

Some older Americans may even be carrying debt that they don’t have the capacity to pay.

According to our analysis, 40% of all older Americans have credit card debt in excess of $5,000. More than one in five (22%) Americans age 50+ have more than $10,000 in credit card debt. On average, those with more than $10,000 in credit card debt couldn’t pay off their debt even by emptying their checking accounts.

Over a third of American seniors don’t have $1,000 in cash

It’s not just credit card debtors who struggle with financial frailty approaching retirement. Many older Americans have very little spending power. More than one-third (37%) of all Americans over age 50 have a checking account balance less than $1,000.

Low cash reserves don’t just mean limited spending power. They indicate that American seniors don’t have the liquidity to deal with financial hardships as they approach retirement. This is especially concerning because seniors are more likely than average to face high medical expenses. Over one in three (36%) Americans who experienced financial hardship classified it as an unexpected health expense, according to the Federal Reserve Board report on the Economic Well-Being of U.S. Households in 2015. The median out-of-pocket health-related expense was $1,200.

Debt pushes seniors further from retirement goals

Seniors carrying credit card debt exhibit other signs of financial frailty. For example, seniors without credit card debt have an average net worth of $120,000. Those with credit card debt have a net worth of just $68,000, 43% less than those without credit card debt.

The concern isn’t just small portfolio values. For retirees with debt, credit card interest rates outpace expected performance on investment portfolios. Today the average credit card interest rate is 14%. That means American seniors who carry credit card debt (on average, $4,786) pay an average of $670 per year in interest charges. Meanwhile, the average investment portfolio earns no more than 8% per year. This means that older debtors will earn just $4,508 from their entire portfolio. Credit card interest eats up more than 15% of the nest egg income.

For some older Americans the problem runs even deeper. One in 10 American seniors has a checking account balance with less than $1,000 and carries credit card debt. This precarious position could leave some seniors unable to recover from larger financial setbacks.

Increased debt loads over time

High levels of consumer debt among older Americans are part of a sobering trend. According to research from the University of Michigan Retirement Research Center, in 1998, 36.94% of Americans age 56-61 carried debt. The mean value of their debt (in 2012 dollars) was $3,634.

Over time debt loads among pre-retiree age Americans are becoming even more unsustainable. Today 42% of Americans age 50-59 have debt, and their average debt burden is $17,623.

Credit card debt carries the most onerous interest rates, but it’s not the only type of debt people carry into retirement. According to research from the Urban Institute, in 2014, 32.2% of adults aged 68-72 carried debt in addition to a mortgage or a credit card, and 18% of Americans age 73-77 still have an auto loan.

Even student loan debt, a debt typically associated with millennials, is causing angst among seniors. According to the debt styles study from the Urban Institute, as of 2014, 2%-4% of adults aged 58 and older carried student loan debt. It’s a small proportion overall, but the burden is growing over time.

According to the Consumer Financial Protection Bureau, in 2004, 600,000 seniors over age 60 carried student loan debt. Today that number is 2.8 million. Back in 2004 Americans over age 60 had $6 billion in outstanding student loan debts. Today they owe $66.7 billion in student loans, more than 10 times what they owed in 2004. Not all that student debt came from seniors dragging their repayments out for 30-40 years. Almost three in four (73%) older student loan debtors carry some debt that benefits a child or grandchild.

Even co-signing student loans puts a retirement at risk. If the borrower cannot repay the loan on their own, then a retiree is on the hook for repayment. A co-signer’s assets that aren’t protected by federal law can be seized to repay a student loan in default. Because of that, Ross says, “We never advise a person to co-sign on a student loan. Never!”

How older Americans can manage debt

High debt loads and an impending retirement can make a reasonable retirement seem like a fairy tale. However, an effective debt strategy and some extra work make it possible to age on your own terms.

Focus on debt first.

Carroll suggests older workers should prioritize eliminating debt before saving for retirement. “Several studies have shown a direct correlation between debt and risk of institutionalization,” he says. Debt inhibits retirees from remodeling or paying for in-home care that could allow them to age in place.

Downsize your lifestyle

As a first step in eliminating debt, seniors should check all their expenses. Some may consider drastic measures like downsizing their home.

Cut off adult children

Even more important, seniors with debt may need to stop supporting adult children.

According to a 2015 Pew Center Research Poll, 61% of all American parents supported an adult child financially in the last 12 months. Nearly one in four (23%) helped their adult children with a recurring financial need.

Wanting to help children is natural, but it can leave seniors financially frail. It may even leave a parent unable to provide for themselves during retirement.

Work longer

Older workers can also eliminate debt by focusing on the income side of the equation. For many this will mean working a few years longer than average, but the extra work pays off twofold. First, eliminating debt reduces the need for cash during retirement. Second, working longer also allows seniors to delay taking Social Security benefits.

Working until age 67 compared to age 62 makes a meaningful difference in quality of life decades down the road. According to the Social Security Administration, workers who withdraw starting at age 62 received an average of $1,077 per month. Those who waited until age 67 received 27% more, $1,372 per month.

Retirees already receiving Social Security benefits have options, too. Able-bodied retirees can re-enter the workforce. Homeowners can consider renting out a room to a family member to increase income.

Consider every option

If earning more money isn’t realistic, a debt elimination strategy becomes even more important. Ross recommends that retirees should consider every option when facing debt, including bankruptcy. He explains, “A 65-year-old, healthy retiree would be well advised to pay down the high-interest debt now. Alternatively, an 85-year-old retiree facing significant health issues is better off filing bankruptcy or just defaulting on the debt. For the older person, their existing assets are a lifeline, and a good credit score is irrelevant.”

Don’t take on new debt

It’s also important to avoid taking on new debt during retirement. “The only exception,” Ross explains, “[is taking on] debt in the form of home equity for long-term medical care needs, but then only when all other reserves are depleted and the person has explored all forms of government assistance such as Medicaid and veterans benefits.”

Every senior’s financial situation differs, but if you’re facing financial stress before or during retirement, it pays to know your options. Conduct your research and consult with a financial adviser, an elder law attorney, or a credit counselor from the National Foundation for Credit Counseling to choose what is right for your situation.

Hannah Rounds
Hannah Rounds |

Hannah Rounds is a writer at MagnifyMoney. You can email Hannah at hannah@magnifymoney.com

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