Managing your credit debt

Char Telkamp

Char Telkamp

Editor’s Note: This is part 2 of a two part series on dealing with credit cards. Last week we looked at the pros and cons of having credit cards and how to compare the different card offers to pick the one right for you.

A 2001 study conducted by Nellie Mae, the nation’s leading student finance firm, revealed that the average undergraduate carries a credit card balance of $2,327. According to the study many students use their cards without anticipating how the bills will be paid off.

While its almost impossible to live debt-free, too many people let debt get out of hand. Ideally, experts say, your total monthly long-term debt payments, including both loans and credit cards, should not exceed 36 percent of your gross monthly income.

It’s far too easy to spend more than you can afford, especially when you pay with credit cards. Of course, avoiding debt at any cost is not smart either, if it means depleting your cash reserves for emergencies. The challenge is learning how to wisely manage the money you borrow.

The problem most students have is that they carry a lot more than one credit card, and often only carry small balances on many of them. The goal here should be to identify the easiest card to pay off – and pay it off.

For the next three to six months, put all your extra debt-busting cash toward paying down that single card. The resulting feeling from eliminating that single debt will give you a sense of accomplishment – and the momentum you need to perhaps pay down your second smallest card balance, and third and etc.

Understanding the ins and outs of your debts is critical. Which one carries the largest balance?, which has the highest APR?, etc. Then decide, using your budget, how quickly you would like to pay it all back. Set a feasible time goal, of say, 18 months, and stick to it at all costs.

Where to turn when the hole is too deep

The human reaction to extreme financial difficulties due to debt are unfortunate, but fairly consistent. Feelings of panic or desperation are often underlined by feelings of depression that come with the debt trap.

What’s worse is that there are always going to be people who are there to take advantage of your desperation to offer you a quick fix. What they always neglect to mention, however, is that this quick fix comes with a high price. Some companies literally profit off of other people’s misery, either by dressing up a bad deal to appear good, or by charging you for what amounts to nothing but fraud.

Guaranteed Low Interest Loans

If ever you encounter an offer for a loan at an extremely low rate, “no matter your credit history”, beware. This is not likely the offer of a legitimate company. There are numerous fraudulent scams currently being practiced where these loans are “guaranteed”, and all you need do is submit a “small application fee” (often $200 or more) to be approved. Avoid these offers altogether. No established financial firm would demand a fee up front simply to apply for a loan.

Payday or Title Loans

When times are tough, many people turn to what are termed “payday loans” in order to meet their obligations. The way this process works is the borrower shows the lender recent pay stubs, and the lender advances cash based on a guarantee of payment.

The key fact of these loans is that they are intended to be short-term. The real problem here is that the interest rates and fees are often more than 500 percent, depending on the loan and the time it takes to pay it off.

In many states, investigations of firms offering this type of loan have been launched, mainly because what this basically amounts to is legalized loan-sharking.

Title loans have typically been under even greater scrutiny than payday loans, mainly because they use loopholes in state laws to charge annual interest fees, which may be higher than 1000 percent! Collateral for title loans is always your car, hence the term “title loan.”

Avoid these loans at all costs.

Credit Repair Practitioners

You’ve probably seen ads for companies that claim they can fix your credit, qualify you for a loan or get you a credit card. Their pitches are tempting, especially if your credit is bad and you desperately want to buy a new car or house.

You should avoid these outfits, however. Many of their practices are illegal. Some have been caught stealing the credit files or Social Security numbers of people who are under 18, have died or live in out-of-the-way places like Guam or the U.S. Virgin Islands, and substituting these for the files of people with poor credit histories. Others have been identified as breaking into credit bureau computers and changing or erasing a bad credit file.

But even assuming that the credit repair company is legitimate, don’t listen to its come-ons. These companies can’t do anything for you that you can’t do yourself. What they will do, however, is charge you between $250 and $5,000 for their unnecessary services.

Credit counseling agencies are a necessary part of the debt industry. One of the things you should be careful of is the confusing nature of Credit Counseling agencies’ use of the term “non-profit” or “not-for-profit”.

What many people do not understand is that the term “not-for-profit” is simply just another type of business organization. Many assume that these agencies are not interested in profit, when this is simply not the case. In fact, many of the largest organizations in the credit counseling industry managed to grow from humble beginnings fueled by their profits.

The key to not-for-profit credit counselors is that your creditors primarily pay for their services. Typically, this means they organize a plan for you in which interest rates are lowered, but at which your debt level remains the same.

They basically extend the length of your debt payment plan to ensure smaller payments. This is exactly what your creditors want, as they lose very little over the long term. As a result, credit-counseling agencies typically are paid a 10-15 percent commission by your creditors. Obviously, this can mean upwards of several thousand dollars over the life of your debt plan.

The worst point about credit counselors is that despite what they may lead you to believe, they are actually working for your creditors. This means that they benefit by extending your debt payment plan because every time you make a payment, they pick up a commission.

What credit repair clinics claim to be able to do:

– Remove incorrect information from your credit file.

You can do that yourself under the Fair Credit Reporting Act.

– Remove correct, but negative, information from your credit file.

Negative items in your credit file can legally stay there for seven or ten years (depending on the type of information), as long as they are correct. No one can wave a wand and make them go away.

One tactic of credit repair services is to try and take advantage of the law requiring credit bureaus to verify information if the customer disputes it. Credit repair clinics do this by challenging every item in a credit file – negative, positive or neutral – with the hope of overwhelming the credit bureau into removing information without verifying it.

Credit bureaus are aware of this tactic and often dismiss these challenges on the ground that they are frivolous, a right credit bureaus have under the Fair Credit Reporting Act. You are better off getting your file and selectively challenging the outdated, incorrect and ambiguous items.

Even if the credit bureau removes information that a credit bureau had the right to include in your file, it’s no doubt only a temporary removal. Most correct information reappears after 30-60 days when the creditor that first reported the information to the credit bureaus re-reports it.

– Get outstanding debt balances and court judgments removed from your credit file.

Credit repair clinics often advise debtors to pay outstanding debts if the creditor agrees to remove the negative information from your credit file. This is certainly a negotiation tactic you want to consider, but you don’t need to pay a credit repair clinic for this advice.

– Get you a major credit card.

Credit repair clinics can give you a list of banks that offer secured credit cards. While this information is helpful in rebuilding credit, it’s not worth hundreds or thousands of dollars – you can find this information yourself for little or nothing.

Many states and the federal government regulate for-profit credit repair clinics, or even prohibit them from doing business. Some dubious credit repair clinics have tried to get around these regulations by setting themselves up as nonprofits, but still take your money and provide poor results.

Before using any organization that claims to be a nonprofit, carefully check the company’s fees, claims of what it can do and its reputation. Call the Better Business Bureau or ask for the names of satisfied customers.