Vanessa and David were swimming in financial debt. They bought real estate at the height of the market and were in over their heads. They owed credit card debt to numerous banks, had significant student loan debt, monthly daycare costs for their 2-year-old twins and owed a $20,000 personal loan to David’s parents (currently paying interest only, with full knowledge of the upcoming “balloon payment” they’d hope to have paid off five years ago).
Vanessa did everything she could to make ends meet. She shopped with coupons at the cheapest grocery store in their town, and made home-cooked meals daily. Their previous weekly ritual of dinner out had ended long ago, and the only meals they ever ate out were at the homes of family and friends.
The recent holidays were particularly tough. Vanessa and David refused invitations to most parties to avoid the costs of host presents and grab bag gifts. Although depressing, it was cheaper to stay home and watch TV- strange how the characters on TV never seemed to have any money problems. David often thought how unrealistic TV was. How did everyone live seamlessly, without constant money worry?
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David thought about getting a second job, and sometimes Vanessa encouraged that he do so. Other times, she really wanted him around, as she was exhausted from her long work hours and taking care of the babies. If they were always working to earn money for the old bills, and they were sinking, what would be the point of living like a single parent, too?
While Vanessa tried to be logical about their finances in her waking hours, she often had a hard time sleeping. When she fell asleep from sheer exhaustion, she would often wake in the middle of the night with the dread of how she and David would get through the next round of bills. The two were always sure to pay the mortgage and daycare costs on time out of fear that they would either lose their home or that their sons would not be admitted to their program, respectively. But the credit cards and student loan debt were often paid late or in an amount less than the minimum due.
There was nothing they could do; at least, that is how he felt.
David had called a few of the credit card banks to see if they would negotiate a lower interest rate or the actual balance, but he was unsuccessful. When he received “hate mail” from the bill collectors, he would toss it in the garbage before Vanessa got home because he knew letting her see it would upset her. There was nothing they could do; at least, that is how he felt.
David calmed himself with thoughts of receiving a big bonus to pay down the debt and sometimes fantasized that one of his elderly relatives would die and his inheritance would free up some money to get them out of this predicament. Although he chided himself for thinking so morbidly, he simply could not come up with an alternative to get out of their financial predicament.
Vanessa and David wanted to know what they could do. They were looking for advice on which debt to attack first or what would happen to them when their house of cards collapsed. While every situation is unique, Vanessa and David are not alone in their struggle. These are some tips I shared with them:
1) Understand the difference between secured and unsecured debt.
Secured debt is collateralized by an asset. For example, if you owe money on a note which is secured by a mortgage on your house, and you don’t pay the debt, the mortgage holder will have the right to start a legal proceeding to take your home. There are many laws out there to protect homeowners, so even if Vanessa and David stop making mortgage payments, they will not be out on the street tomorrow. The legal proceedings would take some time, and while those proceedings take place Vanessa and David should be preparing for the time when they will be evicted and forced to find alternative housing.
This is a drastic change. Since they are managing to pay the mortgage now, they should continue to do so if at all feasible once their total household expenses are analyzed.
Secured debts can also include a vehicle which was purchased with a lien against the title, and household items, such as furniture, purchased “on credit.”
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Unsecured debts are generally those owed through debts incurred on credit and gas cards, legal and/or medical bills, and loans from friends or relatives. There is no security attached to the money that was extended on the borrower’s promise to repay. If you fail to repay, those creditors would be forced to take legal action, much like the secured creditor.
However, the unsecured creditor will have a more difficult time collecting the amount due (which will likely include interest and legal fees), as there are no specific assets securing the debt. This means that once the creditor successfully obtains a judgment, the creditor would then have to locate the defendant’s bank account to “attach” the judgment and or his or her employer to “garnish” a portion of the debtor’s wages.
While the “what ifs” can certainly feel alarming, when analyzed in the light of day, there are generally always solutions.
While the “what ifs” can certainly feel alarming, when analyzed in the light of day, there are generally always solutions. These answers to prioritizing debt range from discomfort and embarrassment when facing personal losses, to the more serious determination to file a bankruptcy and obtain relief from some debt (generally, the unsecured debt) and somewhat of a “fresh start.” A bankruptcy is drastic and mainly beneficial to discharge, or wipe out unsecured debt, as it will not resolve secured indebtedness up to the value of the collateral, most student loan debt or certain tax liabilities.
2) You must pay your necessities first.
In analyzing where to start prioritizing debt, a pen and paper are always good to get a clear visual of where things stand, namely your net income versus actual debt. In Vanessa and David’s case, that covers the payments they have been making: their mortgage and their daycare costs. They must also be prepared to pay for their daily living expenses, including food, fuel and necessary medical expenses. Of course, there may be ways to minimize these expenses.
3) Pay at least the minimum amount due
I next suggested that Vanessa and David keep their minimum payments up to keep their utilities in working order and to avoid disconnection. Since they need both cars to commute to work, those payments, along with state-required insurance, were the very next priority (and maybe even first priority because without the cars the income streams will cease). If a car is not necessary, selling it could save a lot more than the car payment (including gasoline, insurance, parts and repairs).
Although not an issue for Vanessa and David, I would caution that if child or domestic support obligations are a part of your financial equation, making sure those payments are made must also be very close to the top of your priorities. Failure to make those payments could result in prison time. At the very least, if there is a change in your financial circumstances, seek approval from the court to reduce the expected payments. The courts will generally not consider issues that far predate your modification request.
4) Put tax debt next on the list.
Make sure to pay your tax debt and file your tax returns. The government has rights well beyond those of your other creditors, including the ability to seize your tax refunds, special wage garnishment rules, and seizure of federal benefits (including Social Security down the line). For the same reasons (although there are some special remedies potentially available), student loan debt should be the next consideration on your list of payment priorities.
Loans without collateral- the unsecured debt- are low on the priority list and by the time creditors take legal action to obtain a judgment, many are inclined to accept a settlement at a fraction of the original amount of the debt. Oftentimes, accepting some money is better than receiving none at all (if the debtor chooses to file a bankruptcy, that unsecured debt will be fully discharged and thus, completely uncollectible).
Creditors have rights, but so do the consumers. Do not change the priority of a debt just because a creditor threatens to sue or does sue you. That means if you owe money to a creditor for an unsecured debt, do not refinance or take out a home equity loan to pay off that debt. That route could be a short-term fix, which leads to long-term problems and allows access to your otherwise protected assets.
And, on that note, do not use your retirement funds (which creditors cannot legally get to) to pay off that debt. Those funds are “exempt” from seizure. Finally, while it may be tempting, do not take advice from debt collectors – or promise payments on recorded phone lines. Those debt collectors are often the most aggressive when trying to convince you to pay debts that should be lowest on your priority list.
While Vanessa and David’s debt at first seemed insurmountable, once they sat down and mapped out their finances, we came up with a logical and manageable plan of attack, that fortunately, did not require a bankruptcy or the loss of their home, but did negatively impact their credit. Negative marks on your credit stay there for up to seven years, while a chapter 7 bankruptcy will remain there for 10 years.
“All of the problems we’re facing with debt are man-made problems. We created them. It’s called fantasy economics. Fantasy economics only works in a fantasy world. It doesn’t work in reality.”
Although it may not be pretty, figuring out which debt to pay and how to attack your financial problems is doable and required for your financial health as well as your sanity.
I’m a debt settlement and bankruptcy attorney who negotiates resolutions between clients and their creditors. I am also a real estate attorney involved in both sides of purchasing and selling distressed real property. I am passionate about teaching people about money and helping individuals of all ages achieve financial independence and success in a "no…
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