Over-indebtedness can lead to stress, family problems, repossessed property, garnished wages and even bankruptcies; however, options exist to help families manage financial challenges when bills pile up and families are unable to manage them.
Develop a Debt Management Plan
If you have more bills than your monthly income can meet, develop a debt-management plan. To do so, follow these steps:
Who Do You Owe?
Check your credit statements and list the following information about each creditor:
Determine How Much You Can Pay
After you have listed all of your creditor information, determine how much you can pay each creditor and how long it will take to pay each debt.
Try to limit your monthly credit payments to no more than 20 percent of your monthly take-home pay; 25 percent should be the absolute maximum. Most families need 75 percent of their income for daily living expenses.
Consider these options to help find money to repay debts while maintaining necessary daily living expenses:
Develop Plan to Pay Debts
After you have a clear picture of how much money you can pay back and when you can do it, determine how much you will pay each creditor and how long it will take to pay off the account. Try to develop your plan so creditors can be paid within three years.
Consider Debt Pro-ration
Debt pro-ration is an arrangement between a debtor and creditor, often made through a credit counselor intermediary, to reduce payments to a portion of the balance due. First, living expenses are reduced to provide as much available income as possible for debt repayment. Next, the pro-ration is calculated using the following formula:
If, for example, the percentage of pro-ration is 50 percent, each creditor is then offered a prorated payment of 50 percent of his regular monthly payment. Pro-ration percentages below 2.5 percent are generally inadvisable.
If a debtor has secured property (such as a car) that cannot be prorated because partial payment would result in repossession, the debt pro-ration formula is:
|Percent of Pro-ration =||Monthly dollar amount available to repay debt|
|- Total of monthly payments for secured items)|
|Total debt balance - Balance on secured loans|
Discuss Plan with Your Creditors
Convincing creditors to accept pro-rated payments may be the biggest challenge to implementing a debt pro-ration plan. Creditors are generally more responsive if you take the initiative to contact them first and express a sincere desire to pay your obligations.
Contact each creditor to explain your plan. A personal visit or letter is better than a phone call. Be sure to include the following:
Make every effort to fulfill your end of the agreement. Failure to do so will harm your chances of getting future credit. Inform your creditor if there are any changes that may affect your payment agreement.
Debt Reduction Strategies
Many factors, including level of compliance to a household spending plan (budget) and the repayment plan, will influence your success. Consider these strategies to help reduce debt:
Monitor your Progress
Look at your plan occasionally to determine if you are keeping up with your debts and meeting daily living expenses. If there is a change in income or expenses, you may need to adjust your monthly payment plan accordingly.
Strategies for Salvaging a Home
When consumers are faced with the loss of a home, financial advisers may suggest:
Bankruptcy: Going for Broke
Bankruptcy has become an increasingly common way to deal with debt. While bankruptcy gives people a fresh start to rebuild their financial lives, bankruptcy is not an easy way out. It is a last resort, to be considered only when all other options have been exhausted. Two types of bankruptcy exist:
Chapter 7. The Chapter 7 discharges most obligations. Filers must surrender all assets that are not legally exempt. Non-exempt assets are sold, with the proceeds divided among creditors. The right to future income is retained. Another Chapter 7 bankruptcy cannot be filed for six years from the date of initial filing.
Chapter 13. With a Chapter 13 bankruptcy, a voluntary payment plan is proposed and approved by the court to repay all or a portion of debts from future earnings within three to five years. Debtors are permitted to keep their property and submit a monthly payment to the trustee, who disseminates it to creditors. Chapter 13 is best suited to those with stable incomes and equity in secured assets like a home or car.
Both forms of bankruptcy remain on an individual's credit report for 10 years.
When debts seem overwhelming and your monthly income is not sufficient to cover your obligations, there are ways to solve your debt problem. The road to financial recovery takes a total commitment. First, decide that you want to be debt free. Discipline yourself to take the necessary action to pay back your debts. Success depends on your determination to make the necessary sacrifices to achieve your goal.
Consumer Credit Counseling Service. (1999). It's All About Money. Baton Rouge, La.
Garman, E.T. & Forgue, R.E. (1997). Personal Finance. Boston: Houghton Mifflin.
Howell, B. R. (undated). How to Get Out of Debt. (Publication No. 1737). Starkville, Mississippi: Mississippi State University Extension Service. [On-line]
O'Neill, B.M. (1995). Dealing with Debt. Unpublished manuscript, Rutgers Cooperative Extension Service.