Before we go down this rabbit hole, let’s make one thing clear: the steps we suggest in this section are a last resort for individuals whose debt burden/total debt are too high for them to feasibly pay off. These steps come with consequences, and should not be followed by individuals who have a sub-50% debt burden/total debt. With that said, we want those individuals who do have a high debt burden/total debt to know that there is a way out, and that you absolutely can recover from this and rebuild yourself financially.
If your debt burden/total debt are above 75%, you may be best suited by skipping ahead to the subsection on Bankruptcy. For everyone below this threshold, we’re going to start by exploring how you can negotiate with lenders in order to improve your financial situation.
How we approach this will ultimately depend on your exact financial situation: whether you are up-to-date on your payments, delinquent, or your account has been transferred to a collection agency. Remember that these strategies only apply to unsecured debt, and do not include accounts moderated by separate federal laws (like student loans or taxes.)
You’re Up-to-Date, but Struggling
First, let’s look at this from the bank’s perspective: if you are still making adequate payments to your account then why would they want to lose you? Of course, it’s likely that these payments are barely covering interest, and you’re struggling to make ends meet in other areas of your life because of this financial burden.
You’ll need to reach out to your bank at this point. If you can speak to someone in-person, that’s great, but you may have to rely on the customer service line provided by your bank. Explain that you are unable to continue meeting the minimum payments on your account (if there is some relevant circumstance, like a lost job, it would be appropriate to mention this) and that you would like to explore your options. It’s likely that they will just offer a temporary forbearance on your account’s principal, but always push for a more permanent solution. If they concede, great! But if not, you do have other options.
The next step will be a little scary, but it will open up these other options – you’re going to stop making payments. This will put your account into delinquency, and will do serious damage to your credit score to the point where you will likely be unable to borrow anything for several years. However, it will give you the opportunity to rebuild from this point instead of continuing to spin your tires. Once you have completed this step, you can move on to the techniques outlined in our next section.
If you allow your account(s) to go into delinquency, and the bank feels you CAN afford to continue paying, there is a chance you will be sued. If the bank wins this case, up to 25% of your take-home income may be garnished and put toward your debt. Proceed at your own risk.
Your Account is in Delinquency
Once you have stopped making payments, your bank will typically hold onto your debt for 6 months before selling it to an outside collection agency. During this time, you’ll have a chance to convince your bank to agree to a settlement regarding your debt balance.
During the first couple months of delinquency, your bank probably won’t be overly eager to settle with you – in their eyes there is still a chance that you will resume payments. After two or three months, this glimmer of hope will likely disappear, and they will begin considering ways to cut their losses.
Now it’s a waiting game on your end: calculate how much you are able to contribute to your debt and present this number to the bank. Stick to this number and don’t agree to one you can’t realistically pay. They may not accept it the first time but they likely will in the future, and if they don’t a collection agency will.
Your Account Has Been Transferred to a Collection Agency
Collection agencies have much less at stake than the original lending bank did. When account balances are sold to collection agencies, they typically only pay a fraction of the face value – this gives you much more wiggle room for negotiation.
We recommend aiming for about 50% of the debt’s original value when negotiating, but be warned that debt collectors are known for playing dirty. Do not allow them to threaten you or your family when negotiating, and be sure to read up on your consumer rights before confronting them (you can find this information at www.consumerfinance.gov). Here are some things to watch out for:
If you are being wrongfully harassed by a collection agency for a closed or invalid debt balance, you can file a complaint at www.consumerfinance.gov/complaint. After 7 years of being in collection, an account will no longer appear on your credit report. At this time, collectors will no longer have the same rights when it comes to collecting this debt, and you can start your life fresh.
You may reach a point in your financial journey where bankruptcy is the only feasible option. Before we begin, let’s look at the potential consequences of bankruptcy:
There are two different “types” of bankruptcy: Chapter 7 and Chapter 13. These different chapters are available to you depending on your financial situation, and your particular debt may dictate which type you opt for.
A Chapter 7 bankruptcy will eliminate all of your eligible debt. Most unsecured debt is eligible, except for federally regulated debt like student loans, tax payments, or child support. WIth secured debt, you may have to choose between forfeiting or paying for the property. You may also be forced to sell property that you outright own in order to cover some of your debt obligation, though in most cases your primary home will be exempt. Chapter 7 bankruptcies remain on your credit report for 10 years.
Not everyone will qualify for a Chapter 7 bankruptcy, though. In order to qualify, your family’s income must be below the median for your state, or you must pass a means test. The means test looks at your income and expenses to determine if you’re capable fo repaying your debt. If the test determines that you are not, you may still qualify for Chapter 7 regardless of your income.
With Chapter 13 bankruptcy, your debt will not be automatically eliminated. Instead, you will be required to pay monthly installments toward your debt until it is forgiven. Unlike Chapter 7, Chapter 13 can be much easier to qualify for, and can actually make it easier to keep things like your home or car that would otherwise be repossessed. Chapter 13 bankruptcy will stay on your credit report for 7 years, but the credit bureaus assign this the same severity as Chapter 7 (so while the bankruptcy is on your report it will do the same amount of damage as Chapter 7 would.)
In order to file for bankruptcy, you are required to meet with a non-profit debt counselor first. Even if you are unsure about filing, these counselors can be an important resource when determining what the best course of action for your particular situation could be.
While bankruptcy can be a rough road to go down, it really is the first step to a fresh start. After you have filed for bankruptcy, neither the bank nor a collection agency will be able to collect on the accounts, and after several years you will be able to rebuild your credit score. Bankruptcy could be the difference between owning a home, car, and being financially responsible or continuing to make minimum payments to a stagnant debt 7 years from now.