Debt Management and Bankruptcy :: Certified Financial Planner : Colorado Springs, CO

Q and A with Denisa - Debt Management and Bankruptcy

1. Debt Management and Bankruptcy

Today, I want to talk to you about credit card debt forgiveness. When I worked with Jim and Lisa on their financial plan, it became obvious that in order for them to save more money, they needed to get rid of some of their credit card debt. So, they decided to negotiate with creditors. They owed a total of $48,000 and they managed to settle it for a lump sum payment of $30,000. They were thrilled to have $18,000 of their debt cancelled! However, several months later they received a 1099 notice showing that they would owe a tax on the forgiven debt.

So, here is what you need to know:

First - the forgiven credit card debt we are talking about is NOT the same as a cancelled mortgage debt under the Mortgage Debt Forgiveness Act.
The cancelled credit card debt is almost always taxable as income, EXCEPT when you are insolvent or if your debt was erased in bankruptcy. IRS defines being insolvent when "your debts exceed your total assets".
Finally...very important...while settling your credit card debt for less may give you some breathing room, it will negatively impact you credit score.

As always, I would love to hear from you. Tell me what has worked for YOU to successfully negotiate with creditors. You can email me through the KRDO’s website.

Senate Passes Credit Card Reform Full of Consumer Friendly Provisions:

The bill prevents card issuers from increasing interest rates in the first year after an account is opened, and requires promotional rates to last at least six months.
For existing cardholders, the bill puts an end to fees charged for paying off a debt via mail, telephone or electronic transfer, but fees will be allowed for live services on expedited payments. When timing card payments, issuers must mail statements 21 days before the bill is due, rather than 14.
Specific provisions were made for responsible cardholders, including eliminating so-called double-cycle billing. Card companies can no longer charge interest on debt paid on time during a grace period. And when issuing new cards or increasing credit limits, companies will be required to consider a customer's ability to pay the debt. If issuers plan to increase interest rates, fees and finance charges, cardholder must be notified 45 days in advance.
This bill will make it tough for a 21-year old to get a credit card. When issuing credit cards to people under 21, credit card issuers have to get a parent's signature, or co-signer older than 21. Otherwise, the applicant has to document that it has independent means of repaying the debt. And issuers must get approval from a parent or guardian before increasing the credit limit on accounts for which they are jointly liable.

Essentially, these are mostly protections to prevent abuse and stop the downward spiral that occurs to a person if they make a late payment. For many consumers this will be a positive change and it will offer more transparency in rate change. However, on the other side are banks, complaining that putting on additional restrictions will raise the price of credit for everyone and make credit less available.

The Credit Card Reform went into effect yesterday. It’s a major credit card makeover, so let me make it simple to understand and highlight some of the benefits:

They simplified the fine print, which means that your statements will now show how long it will take you to pay off your balance.
New cards cannot hike up your interest rate on existing balances unless your introductory teaser rate expires or you are at least 60 days late. And they must give a notice 45 days before they can increase your interest rate.
One of the biggest changes will impact your under age kids. They will either have to show proof of income or you will have to co-sign their credit card application. But when you do, it will become your debt also. So, better option for them may be a prepaid debit card. Remember, this is about helping young people becoming responsible with credit card debt.
All of these things are supposed to keep money in your pocket but keep in mind that these changes are only for consumer credit, not business credit cards. Despite the simplified fine print you still want to read it very carefully and understand exactly what you are signing up for.

"I work with people who have a lot of medical bills and are considering medial bankruptcy. Is there a way to prevent this? Is bankruptcy a solution?"

ANSWER:

62% of personal bankruptcies are in fact related to medical bills and majority of the filers had health insurance coverage. (Source: American Journal of Medicine).

Some things that people can do to reduce the risk of medical bankruptcy is looking at supplementing their health insurance policies. The two types of supplemental plans are dread-disease insurance and catastrophic health insurance.

Dread Disease Insurance covers against specific diseases such as cancer. The money can be paid directly to the policyholder, regardless how much the individual actually spends on the care. These plans are typically offered through a payroll deduction at work.

Catastrophic or Secondary Health Insurance is a form of insurance coverage that keeps deductibles very high, with lower and more affordable premiums. With this type of plan, you pay for almost all medical care until you reach the annual deductible amount. After that, traditional health insurance coverage begins.

Obviously, if you are currently sitting on pile of medical bills, try to negotiate with the hospitals. Often times you will receive a good size discount for lump sum payments. If bankruptcy protection is inevitable, make sure to consult bankruptcy attorney.

"Denisa, Christmas shopping is thankfully over, but now the financial reality sets in. I have a lot of credit card debt! I feel like I already live paycheck to paycheck and I know that I need to save for retirement. Should I pay off my credit cards first and then save, or do both?"

ANSWER:

I applaud you for your commitment to fiscal responsibility. There is a theory that due to the volatility of the stock market, people are better off paying off their high interest credit cards instead of investing. I believe differently. In reality, as life throws curve ball at us, we dust off that credit card that we just paid off and use it again. The saving for retirement then becomes postponed indefinitely while we find ourselves in more credit card debt.

This is the time when you can have the cake and eat it too by setting money aside for rainy days and retirement while paying off your credit card debt. However, it is important to have a disciplined plan for both your savings and for reducing your debt.

For your debt, you will need to make more than a just a minimum payment. Once you pay off one card, make sure to add this money toward the payment of another card, and repeat until they are all paid off. Simultaneously, for your savings, make sure to place a portion of this money into a money market or savings account for rainy days, then invest the rest each month toward retirement.

Now more than ever, when I meet with a client, we always talk about how to improve their credit score. So, here is the 4-1-1 (information) as to what impacts your credit:

YOUR Payment history accounts for 35% of your credit score! So, pay those bills on time.

The second most important thing is your Outstanding Debt. A high balance against your credit limit can harm your credit.

Here’s a tip-- aim for balances under 30%. For example, if you have a credit card with $1,000 limit, keep the balance below $300, or spread the balance among multiple cards.

Your credit history accounts for 15% of your score. A longer history makes you a less risky borrower. Don’t close old accounts.

When a lender checks your credit, it causes a slight "ding" to your credit score. Apply for new credit in moderation.

Here are types of inquiries that will not mess up your score: Job Related, Insurance, Utilities or Promotional - for pre-approved offers in the mail.

In Summary:

Bring your Past Due Accounts Current
Pay Down those Credit Cards
Don’t Close your Old Accounts
and, Have a Mix of Accounts: mortgage, auto and 2-4 credit cards

As always, I enjoy hearing from you--let me know how you have been able to improve your score.

I receive many questions on the topic of bankruptcy and that is what I will talk about tonight.

The two main types of BK are chapter 7 and chapter 13

Chapter 13 will allow you to restructure your debts at better terms, such as a lower interest rate. But it will not delete your debts. This may be a suitable option for a business-owner who took a dive with his income and he can no longer afford to make the regular payments to his creditors. He will have generally up to 5 years to repay his debts. Again the key here is to have some regular income.

Chapter 13 will stay on the credit report for up to seven years.

Let’s talk about Chapter 7. It will discharge most of your debts. But some will not be eliminated, like tax claims, alimony, child support, most student loans, and fraudulent debts.

Chapter 7 is for people in real financial hardship - who barely have enough to cover their mortgage and food and they are getting sued by their creditors.

You will have to show your hardship but you will be able to keep certain things, such as your retirement plans and certain amount of equity in your home.

Chapter 7 BK will stay on your credit for 10 years. During this time, you will most likely qualify for loans but with higher interest rates.

As you can see it, it has the ability to provide you with some relief but with a price to pay in a long run. Approach this with caution and consult a BK attorney before you dive in.

Last week I emphasized that the key to improving your financial health was changing your behavior and also finding a partner who will hold you accountable to your plan.

The only way you can get out of your financial struggle and build a successful future is by sticking to a written cash flow plan. Notice that I did not call it budget.

Here are simple things that will make a huge difference.

In your cash flow plan, create an expense called "Emergency Fund Savings" and list it as your very first bill. Even if you feel that you live paycheck to paycheck and there is no room for savings, you can’t afford not to have it. It is critical that you assign some dollar amount here and stick to it.
When you subtract your expenses from your monthly take home pay and you see that you don’t have enough money to cover all of your expenses, don’t automatically assume that you will just cover the hole with your credit card. That is a self-destructive behavior and you need to stop right here. Instead cut up your credit cards, pretend that they are all maxed out, and pick one expense that you are willing to live without.

By following these steps, you will eliminate the two most disastrous things that get people into the financial crisis, which is spending more than you earn and adding to your existing credit card debt.

If you follow these steps for 6 months, coupled with a debt repayment plan, which we will cover next time, I can promise you that you will sleep much better at night.

Over the past year, you have heard economists using terms like "overleveraged" and "lack of capital" as being some of the causes of the financial crisis. Plain and simple, these words mean "not having an emergency fund" and "having tons of debt". Whether you are an individual, a bank or the Government, the financial fundamentals apply to everyone.

So, in order to get out your personal recession, you will have to stop following the herd and get a debt repayment plan in place. Here is how you snow ball your debt.

Write down all debts (except your mortgage), listing them from the smallest balance to the largest, regardless their interest rate. For example if you have a medical bill for $600, Visa card with the balance of $5,000, and a Master Card with $10,000 balance, you would list the medical bill first, Visa second and Master Card last.
Paying off the smallest debt first will give you an instant gratification. So the key is to add to your minimum payment on your medical bill and pay it off as fast as you can while you make ONLY minimum payments on the other credit cards. Once you pay off you medical bill, apply this payment to the minimum payment on your Visa and pay that off. Repeat these steps until you pay off the Master Card and any other credit cards, car loans and student loans.

Yes, this may take you a while but trust me you will get fired up as you see your debt getting smaller. So, post the list somewhere where you can see it and make sure to reward yourself each time you cross off another debt from your list.

As always, you can send me your questions through KRDO’s website.