Eliminate debt and rebuild your credit

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How to eliminate debt and rebuild your credit
2 years ago
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Debt is a problem for many people, and can lead to devastating consequences if ignored. The current precarious state of the economy, and the resulting lack of job security in this country, has resulted in increasing debt by large numbers of Americans. With so much emphasis on Social Security, investments, and saving for retirement, many people are putting themselves at greater financial risk by rushing to make unwise investments instead of paying off the debt they have already accumulated.

Before you can prepare for the future, you need to build a solid financial foundation. This involves reducing the amount of debt you currently have, developing a strategy to prevent future debt accumulation, and repairing or building your credit.

Unfortunately, there is nothing you can do to dramatically improve your financial situation overnight. However, by making sound financial decisions from this point on, you can gradually decrease your debt and get your finances back on track. Financial recovery is not easy, but it is obtainable. Determine what your short and long-term financial goals are, develop a realistic plan, and then stick to that plan.

Debt accumulation happens gradually, and the problem is often critical before most people are even aware that a problem exists. If you are unable to afford your regular monthly expenses, especially if the problem becomes worse each month, you need to step back and take a long look at your expenses. Are your credit card balances increasing, or are you missing due dates and paying additional fees because of it? Both of these issues can cause an already extended monthly budget to slip into the red, and are excellent examples of how minor financial problems can increase exponentially in a short period of time.

If you find that you are unable to pay more than just the minimum payment on your credit cards, or are forced to use one card to pay the bill for another, you need to concentrate on paying off those cards and discontinuing your accounts. Additionally, if one small financial setback, such as a car repair or unexpected medical bill, requires you to borrow money, you should consider taking steps now to reduce your debt and protect your credit rating.


Develop a Plan - Track and Reduce Spending:

Your first step in taking control of your finances should be to determine your goals. If your financial goal is to pay off your credit cards and save some money for your retirement, you will need to figure out a way to achieve that goal while still being able to put food on the table right now.

If you are like most people, you probably have no idea where most of your money goes each month. Before you can develop a budget, you need to track your spending. There are many methods of tracking your outgoing money, and one of those methods may work better for you than another. The simplest approach is to create a list of all of your expected monthly expenses, such as utilities, mortgage or rent payments, and food costs. You can do this on paper, on a spreadsheet on your computer, or with help from any of the software packages designed for this purpose that are currently on the market.

You need to pay careful attention to your miscellaneous expenses. If you currently spend more than you make, you have likely become accustomed to a lifestyle that you cannot afford. Cutting back on unnecessary or overpriced items, even if the amount of each seems insignificant when considered separately, can quickly add up to a large savings over time. You may also want to consider eliminating any extras that you can live without for a while, such as cable television or meals away from home.

Make a list of all your debts, including balances and interest rates, and then prioritize which debts should be paid off first. Credit cards, especially those issued by department stores, typically charge the highest rates.


Eliminate Credit Card Debt:

Credit card debt is extremely difficult to eliminate due to high interest rates and monthly payments. A credit card is essentially a loan that requires repayment just like a car loan or mortgage. Many people view credit card balances as free money, but interest rates on credit cards are often considerably higher than rates on other loan types. This makes it easy to fall further into debt each month as you attempt to pay off your existing balance, while continuing to add charges to your card due to lack of money.

Paying off your credit cards should be a priority if you have made the decision to climb out of debt. Always pay more each month on your balance than is required, and pay off any new charges immediately. If possible, discontinue using your cards completely and pay for all future purchases with cash. Pay off the cards with the highest interest rates first, and do not be afraid to ask your lender for a rate reduction. Many lenders are willing to reduce their rates in order to retain your business.

Balance transfers might seem like an easy way to reduce your interest rates and pay your card balances off more quickly, but you must be careful when choosing a new card. Often, low balance transfers expire after a short period of time, which can leave you paying an even higher interest rate than you were paying initially. Additionally, most credit cards that offer low rates for balance transfers will still charge you a standard rate for new purchases. Payments made are then applied to the portion of your balance with the lower interest rate.

Large Monthly Expenses:

Mortgage payments and auto loans are two examples of large monthly expenses that are extremely difficult to eliminate. Because these items have investment value, they can be viewed as good debts. Being unable to pay them off completely, however, does not mean you cannot reduce the amount you are required to pay monthly.

To reduce your monthly house payment, speak with your lender about refinancing for a better interest rate. It may also be possible to reduce your payments by extending the term of your mortgage. This option only makes financial sense when lowering your payments is vital to reducing your other debts.

If you own more than one home, renting one of them is an easy source of additional income. You will not be required to sacrifice the financial investment you made in the property, and will have the option of selling it later if needed. Extra rooms in your main home can also be rented out for additional income.

Like home loans, some auto loans may be eligible for refinancing. Depending on your individual circumstances, you may benefit financially by taking out a separate, lower-interest loan and using it to pay off your car loan in full. Another option is to sell any extra vehicles you own, or to downsize to a cheaper vehicle. If public transportation is available in your area, owning a car may be a luxury and not a necessity.


Filing for Bankruptcy:

If you have tried every other possible solution, and are still unable to pay off what you owe, you have the option of filing for bankruptcy. Declaring bankruptcy should be used only a last resort, as it can severely affect your credit and future ability to qualify for financing of any type. You should never attempt to file bankruptcy without first consulting with an attorney.

Declaring bankruptcy has become more complicated since the introduction of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. In addition to the increased paperwork and limitations, you are now required to receive financial counseling from a non-profit credit counseling service before you can file for any of the three types of bankruptcy.

In Chapter 7 bankruptcy, you must surrender your property to the court, and it will then be divided up and passed on to your creditors. For giving up your property, the court will erase your debts and outstanding financial obligations. Qualifying for Chapter 7 requires you to pass a "means test," which is an evaluation of your income and total expenses. Your results must show that your discretionary income falls below 100 dollars a month. If your results show an amount higher than 100 dollars a month, you may need to file for Chapter 13 bankruptcy instead.

Chapter 13 allows you to pay off your debts over several years, but does not eliminate any of them. This type of bankruptcy will help keep creditors from harassing you while you work out a repayment schedule in court.

Chapter 11 bankruptcy is typically reserved for businesses, and is designed to enable a business to continue operating in order to allow the debtor to keep any income earned after the filing. Only assets that the debtor possessed at the time of filing for bankruptcy are used to pay off past debts.

Regardless of which type of bankruptcy you qualify for, you should first exhaust every other option available. Bankruptcy remains in your credit file for at least seven years from the date you filed, and may prevent you from obtaining any new credit until after that amount of time has passed.

Rebuild and Protect Your Credit:

Your credit is one of the most valuable resources you will ever have. Good credit lowers your risk profile and enables you to receive better interest rates on loans. Poor credit will make it nearly impossible for you to purchase a car or home in the future, and may even prevent you from finding employment.

It is important to check your credit report frequently for errors and fraudulent charges or claims against you. The major credit companies are required to provide you with a free copy of your credit report once each year. You are also entitled to receive a free copy if you have recently been denied credit, if you are unemployed and looking for work, on welfare, or believe your report contains errors that need to be corrected.

Once your high-interest consumer debt is eliminated, or has become manageable, you can begin saving and investing the money you would have been spending on your monthly credit card payments or other debt. Before making any investments, you should set aside enough money to cover all of your monthly expenses for a period of 90 days. This cushion will help prevent you from falling right back into debt in the event that you lose your job or experience some other type of financial hardship.

Even if you are currently deep in debt, there is hope for your financial future. By developing good financial habits and learning to budget your money, you can stretch your income, build your credit, and even put some money aside for your retirement.

by Sketcham
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