I recently got an email from a reader, Brenda. She’s worried about her family members who found themselves under a mountain of credit card debt.
Originally they were able to keep them current and had good credit ratings. Unfortunately, when the husband lost his job last summer, they fell behind on the credit cards and the penalties are piling up. Now they are considering bankruptcy. Brenda wants to help, but doesn’t know how.
Meet My Brother-in-Law
I thought this would be a great time to share with you the story of my brother-in-law. He was in a similar situation, racking up credit card debt.
When he found himself without a job, he stopped paying on the cards. Collection agencies, phone calls, sky high penalties and interest made it almost impossible for him to recover, even when he found a new job.
Back in 2004, he called me for some help. After a very open and frank discussion about how we would need to handle this, he gave me power of attorney and access to all his accounts.
Getting Out of Debt
Once I took over, here’s what I did:
- Get organized. The first step was to try and figure out how much he even owed and to whom. He gave me a box of papers and unopened mail, and I pieced together his financial world for the first time.
- Make a list. I listed every credit card and debt, the amount owed, if it was past due (or in collections), and the interest rate.
- Figure out a budget. I put my brother-in-law on a strict budget, giving him only enough money each week to keep food in his stomach. Until we could get things under control, there wasn’t any money for entertainment or frivolous spending. It was rather harsh, but it was temporary. The rest of his incoming money was earmarked for getting the debts under control.
- Keep paying on current cards. Any card or loan which was current, keep it that way. It’s one less account that will have a negative history on your credit report. If all the cards are current, you can use How to Pay off Credit Card Debt as a resource.
- Call on past due accounts. For the accounts that hadn’t gone into collections, but were a month or two late, I called to find out how much it would take to bring the account current and paid it immediately, if he had enough money. If he didn’t have enough I asked how many days we had before it would be turned over to collections.
- Forget about bankruptcy. He wanted to declare bankruptcy, and even saw a lawyer. I told him that wasn’t going to happen, so forget about it. The long term repercussions from declaring bankruptcy would be much more harmful; in addition, it wouldn’t have taught him anything about the responsibility for his actions.
Dealing with Collections
Once an account went into collections, it seemed I was playing a whole new game. Here’s how I handled that part.
- Do your research. I spent a lot of time doing research at the Credit Boards forum, specifically the beginner index (you need to register to access the index). The transcripts are a little difficult to follow, but there is a “Cliff notes” for each transcript that helped summarize the information. Since I hadn’t ever been in a similar situation myself, I needed all the help I could get.
- Calculate Actual Charges. For each debt that was in collections, I calculated the actual charges versus the interest, late fees, and over-limit fees. He felt that he was responsible for paying what he actually bought. What I found was that many times the actual purchase was less than half the total debt. It was sad to see that a $900 purchase could turn into a debt over $2,000 in just a few months.
- Save Up. Each month I took all his leftover money after paying the current accounts and put it into a savings account at ING Direct. Once I had saved enough to cover the actual charges, I called the company and offered to pay that amount in full that day to settle the account. Every single time, they were more than willing to accept it. One by one, we settled each account.
- Wait it Out. It takes time. A lot of time. It took time to build up the debt, and it takes time to repay it. At the end of the year, when I turned his accounts back over to him, we’d made a huge dent, but he still had a long way to go.
Taxes and Retirement
Taxes. Taxes are a big part of settling debts because the forgiven debt is considered taxable income. It’s something a lot of people don’t realize when they settle accounts.
Retirement. I felt is was very important that my brother-in-law not only pay off his debts, but begin saving for his retirement. At the same time that he was aggressively paying off the debt, I enrolled him in the government TSP program and opened a Roth IRA.
The contributions to the retirement accounts allowed him to lower his tax bill substantially, because he was able to qualify for the the saver’s credit.
I’ll be back later with Gettin’ Out of Debt: Part II in my brother-in-law’s gettin’ out of debt story!