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Updated on Friday, March 1, 2019
Does it feel as if you’re drowning in debt? Do you consistently run out of money before the month is over?
You do have options when you’re unable to pay your debt, whether you’re behind on high-interest credit cards, a car loan, a personal loan, tax debt or even your mortgage.
First, remember you are not alone in accruing massive amounts of debt. Total consumer credit outstanding in the U.S. exceeded $4 billion in December 2018, up 5% year-over-year, according to a report from the Federal Reserve.
It’s important to take a step back, breathe and strategize a plan. You’ll want to create a budget to calculate your monthly expenses so you know how much you have left over to pay your debt. Consider ways you can cut costs or earn more money, perhaps with a part-time job or side gig. Do you have a hobby that can earn you extra cash?
If you study the numbers and realize you don’t have the money to pay your debt, there are steps you can take to get your financial life back on track.
What to do when you’re unable to pay your debt
Staring at a stack of unpaid bills can be stressful for sure. It’s important to open those envelopes so you know where you stand. Ignoring your debt is the worst thing you can do because the interest will continue to accumulate.
It’s also not a good idea to open a new credit card if you can’t pay your existing balances. This may be only a temporary solution to your outstanding debt. And you could face penalties, fees, collections calls and even a lawsuit if your new credit card debt goes unpaid. In a worst-case scenario, creditors can place a lien on your property or garnish your wages.
Instead, consider these six options you could take to better deal with your debt:
Communicate with your lender. Often, lenders are amenable to a payment arrangement if you can explain your circumstances, such as a serious illness, job loss or unplanned expenses resulting from the loss of a loved one. They may also waive late fees.
Check with your creditors to see if one or more of your cards carries credit protection. For instance, protect your total balance up to $20,000, American Express via Assurant®. This insurance allows you to stop payments temporarily while keeping your balance the same following job loss, loss of a spouse or disability. Terms may apply.
Make your payments late. A late payment of fewer than 30 days usually will not be reported to the credit bureaus or affect your credit score, although you will be charged late fees. Your credit score may drop again if an account is 60, 90, or 120 days late. At 150 days late, it could go into collections, which creates a significant event in your credit file. It could take a while for your credit score to recover and that account won’t be reported as “current” even if you pay off the debt. However, late payments may be better than no payments.
Prioritize certain debts over others. While it’s not ideal, juggling payments so that no bill is ever more than 30 days late can help prevent severe delinquencies on your credit report. It’s important to make sure that secured loans, such as a car loan or your mortgage is never more than 90 days late, because this could result in repossession or foreclosure.
Consolidate your debt. If you’ve managed to maintain a decent credit score, it may be possible to get a personal loan at a lower interest rate than your credit cards. With fixed monthly payments and a lower interest rate, you may be able to get out of debt faster. You might also transfer high-interest credit card balances to a card with a 0% introductory offer.
Consider a home equity loan, home equity line of credit (HELOC) or cash-out refinance. Forty-four percent of Americans say they would consider using their home’s equity to consolidate high-interest credit card debt. Using a home equity loan or HELOC to pay off credit card debt can be a smart solution if you make sure not to charge up your credit cards again and continue to make on-time mortgage payments. This can be especially beneficial if you can refinance your home at a lower interest rate so that your mortgage payments stay the same or even go down.
How to handle different kinds of debt
Not all debt is equal, and defaulting on some loans may be worse than others. Consider these different types of debt and how you may manage them.
- Secured debt: Make every effort to keep secured debt, including mortgages and auto loans, current. If you fall behind, call your lender immediately. The U.S. government offers several programs to help homeowners avoid foreclosure.
- Student loans: Some student loans may not be considered in default until they are 270 days, or nine months, late. However, going into default on a student loan is serious, and your lender may garnish your wages, tax refunds and any federal benefits to help cover the loan. It is important to take student debt seriously.
- Tax debt: Tax debt can lead to wage garnishment, property seizure and even arrest. But the IRS has several programs established that could waive fees and help you make a payment arrangement. You should always continue filing your taxes on time and speak to the IRS or a tax professional for help.
- Other unsecured debt: Your credit cards and other unsecured loans may rack up late fees and interest if you don’t make your payments, but you aren’t in danger of losing your home or vehicle if you can’t pay on time. This debt may not be as high of a priority as other types of debt. However, you should reach out to your creditors to try to negotiate a payment arrangement. It may not be as bad as you think.
If you are able to keep current on your payments, the order you pay down your debt could be reversed. For example, you may follow these three steps:
- Tackle high-interest debt first to reduce how much you pay in interest each month and to get your debt under control
- Focus on paying the minimum each month on lower interest loans, such as auto loans.
- Put more toward savings or other debts when your higher-interest debts are repaid.
The above steps are part of the Avalanche plan of debt repayment, and is one way you can work on your existing debt.
However, you may find that repaying your debts with the lowest balances first keeps you motivated in repayment. This is known as the snowball method and works well if you are the type of person who wants to see small victories along your road to financial freedom.
Budgeting may be your key to long-term financial success
Once your debt is paid off, you’ll need a plan to maintain your financial health.
Track your expenses for a month to see how much you usually spend. Look for areas where you can cut back, perhaps by eating at home more often instead of dining out.
Create a list of your fixed expenses, such as mortgage and utilities. It’s easy to stay on top of these payments if you have the money available.
Be cautious of your discretionary spending. Allocate specific amounts for items like clothing, groceries and entertainment. Start building an emergency savings fund by stashing away a set amount — even if it’s only $10 or $20 — each paycheck. Then, stick to your budget.
If you use credit cards to take advantage of cashback rewards, make sure to pay off your cards at the end of each month so you won’t get hit with interest charges.
Paying off debt is not easy and it can be overwhelming. Take steps to get your debt under control, take the time to pay it off and then future-proof your financial future with a budget and an emergency savings account.