Steps to clearing bad Debt

Debt is not bad, bad debt is bad, to quote Martin Lewis the owner of the UK's http://www.moneysavingexpert.com.

Debt is a risk not to be undertaken lightly. Clearing debt is subversive, perhaps even unpatriotic. Debt is fundamental to Western Capitalism and if everyone paid off their debts and stopped borrowing many banks and finance companies would collapse. If everyone cleared their debt or sat down and justified whether they should go into debt before borrowing there would be a major shakeout in the finance industry. Thousands of wealthy bankers would face relative poverty. They might even end up having to do real jobs.

Assuming you want to be this subversive, read on.

Handling debt involves several steps. Loosely these are, don't get into a hole, stop digging, measure the hole, work out how to get out. More formally, stop borrowing, work out the size of your debts, prioritise your debts, get advice, have a plan, get support.

This is obvious, avoid Bad Debt. Bad Debt is debt for something you do not need and or can afford the time and money to save for. If you have started a job which absolutely needs a car then getting into debt to pay for it is not Bad Debt, but you still have to shop around for the best deal and may have to buy a cheap old car rather than a large new one. Buying a holiday on credit is Bad Debt. You will not die if it takes six months longer than you want for that great break. For times like Christmas, start a savings club where everyone pays in during the year and gets the money back, possibly with interest, just before Christmas

Credit cards are probably the most expensive way to borrow other than possibly a loan shark.

A bank overdraft is probably one of the cheapest ways to borrow money. Some banks also make unsecured loans which are similar to an overdraft but the payments are fixed. You may be able to borrow small amounts from friends and relatives but be sure to pay them back as soon as possible.

Avoid any loan offers that come through the post or on TV. Remember, as Martin Lewis says, it is the job of a company to make money from you.

Check the terms of any loan you intend to take out. Some loans do not let you repay early or charge horrific penalties. Remember their job is to make money from you.

If there is too much month left at the end of the money there are places you can hand over a cheque and get slightly less cash back. They will hold the cheque till the day you get paid. This can be useful. Pawnbrokers no longer have the stigma they used to have and are good for short term loans if the goods you are pawning are of the right quality. I read of a business man who pawned his helicopter to finance a deal and redeemed it a few days later having paid much less than a bank would charge. And it is an excellent way to get rid of that gift you never liked without offending anyone.

These are just a few ideas. Think laterally and pass on any good ideas.

This should be part of a larger budgeting exercise. Write down how much you owe and to whom. Write down your income and expenses including loan payments. Your expenses are either non-negotiable (rent/mortgage/loan payments) or negotiable (Food, Clothing, etc). Your disposable income is the difference between income and expenses. If it is negative you need to make savings or increase your income. You may need to discuss things with your family.

Things you can do easily include buy cheaper clothing – but remember quality lasts longer, cut off the landline and use a prepay mobile, turn the thermostat down two degrees, buy cheaper beer and wine or make your own ( in the UK this is legal as long as you do not sell it. Distilling is illegal and, carelessly done, can be dangerous)

Once you know what your debts are you can decide which is the most expensive. You obviously want to change expensive debts into cheap ones if your credit rating allows.

Whatever this situation knowing the depth of the hole you are in is liberating.

Not all debts are equal. Delaying paying debts to family and friends may be OK if the relationship is good and it does not cause them problems. In the wider world taxes come first as they can put you in prison or remove your property. Mortgages come next followed by credit cards, bank loans and overdrafts. Remember that overdrafts, like all loans can be called in at any time, but ssem more likely to be called in abruptly.

There are a lot of commercial debt counselling services. Some will claim to be able to restructure your debt. Treat these with caution. There are a lot of cowboys out there. If you ARE thinking about one of these google on its name and include “problems” or “complaints” in the query. I recall looking for a plumber and rejecting several when Google revealed masses of complaints about them.

There are also non commercial services that will provide advice. In the UK you can get details from the phone book or the Citizens Advice Bureau and some banks and building societies list a few places in every communication with you. I do not know what is available in the USA

At this stage you know what your disposable income is, and what your debt is costing. You have had impartial advice now you need to make a plan for getting out of debt. If you can clear any debts immediately do so. This will leave more money to service other debts. If you need an incentive then when you clear a debt treat yourself with an amount equal to ONE regular payment of that Debt, IF you can afford to do so. Then use the extra money towards a priority debt.

Write down your plan. Even if it is as simple as “repay overdraft and use the interest you were paying towards the mortgage then rethink my plan”. Lock it in a place safe from prying eyes.

Revise the plan from time to time. I suggest once a month.

You need a professional support team. At the minimum a good INDEPENDENT financial advisor is essential (I use ASK financial  Management Services in Edinburgh 00 44 131 315 2175). They will often be paid by the commission on any products they sell you so be ready to alter your life and home insurance. In the UK they are legally obliged to give best advice and audited regularly for compliance with various regulations. Once you are a client however they can be invaluable in dealing with problems with Mortgages, credit cards etc. You will have to sign papers to say they are authorised to deal with your affairs but they know the way the other side thinks and what not to say. Whoever is on your team should be someone who benefits if you benefit. If they will suffer it you suffer so much the better.

In the UK Mortgages are not, as far as I know, sold on. The rule is TALK TO THE COMPANY. They do not want to repossess. It damages their reputation and costs them money. You may get put onto a special service list and get a lot of unwanted phone calls but it could save your home. Before talking to them write down what to say and what not to say. If possible let someone on your team talk to them. Just knowing you have support may alter the way they treat you.

These are the most expensive form of borrowing. Try to clear them as fast as possible. If they cut your limit, tough. It is doing you a favour. Prepaid credit cards are now available. Sine you are not borrowing there is no need for a credit check. Some require a minimum top up or initial deposit. It may be worth going a bit more into debt to pay this. Just make sure you have a repayment plan. Use the prepay card and put your normal  debt.... sorry credit cards somewhere safe and not too easy to get to.