One of the main reasons why people struggle with any “get out of debt” plan is that they fixate on the big picture. Instead, they should be taking baby steps and expect the process to take a while. If you’re trying to find a way out of Debt, remember that you didn’t get in that situation overnight. You are not going to get out of it overnight either.

If you want to be successful at getting out of debt, you’re going to have to:

• properly assess how deep in the hole you are (by getting your credit reports),
• evaluate your options (by listing your assets), and
• develop a budget (and stick to it).

You’ll also need to know the possible consequences of each of the debt-busting options that are available to you.

Again, this bears repeating: this is a long-term goal. Set smaller milestone goals that you can celebrate achieving – such as paying off each individual creditor, or seeing your balance go down by $1,000 over 3 months. Reward yourself when you reach your milestones. It shouldn’t be extravagant, but you’ll absolutely need it if you want to stay motivated!

I realize that few people will be interested in reading the entire post. My goal is to be as thorough as possible. At the same time I have to keep the post to a (somewhat) manageable length. To improve readability, I’ve included a table of contents. Feel free to jump to any section that interests you:

Big Ticket Debt Busters

Just like it’s easier building an emergency fund if you can jumpstart it to several hundred dollars (as opposed to $50 per paycheck deposits), it’s easier paying off debt if you can throw a couple hundred (or thousand) dollars at it at a time. With this in sight, I’m going to focus first on what I call the big-ticket debt busters. If any of these options are available to you, you might find out that you’re able to make a sizable dent into your debt. This will motivate you even more to keep up the good work. So make a list of your assets. Here’s what you can probably do:

> Cash Out Your Savings And Investments

You could cash out your savings and investments and use the proceeds toward debt repayment. When I first read about this, my first thought was “NO WAY!”, because I know about the power of compounding. But then I remembered that compounding works FOR you when you invest, but AGAINST you when you’re in debt. Since your debt’s interest rate is most likely higher than your investments’ return, your debt will rise faster.

Even when debt interest is at 12%, your investments would have to pay more than 18% before federal and state taxes to equal that outflow of dollars. The dollars in your savings account are earning nowhere near that rate of interest. Pay off the debt, and it’s the same as getting that 18% return without any risk on your part. The higher the interest rate on your debt, the more attractive repayment versus investment becomes.

I have one caveat though. Should you go that route, don’t get carried away. Keep at least a $1,000 emergency fund stashed away. There is an ongoing debate over how much you should have in your emergency fund. Bottom line, whichever amount you settle on, keep it, and only cash out the rest.

> Borrow Against Your Life Insurance

If you have life insurance with a cash value, borrow against the policy. It’s like you’re borrowing your own money but the interest rate is typically well below commercial rates. You can also take your time repaying the loan. Do repay it though! If you die before it’s paid off, the outstanding balance plus interest will be deducted from the face value of the policy payable to the beneficiary.

> Borrow Against Your 401(K)

Do you participate in a 401(k) qualified retirement plan at work? Most 401(k) plans have a loan feature. You can borrow up to 50% of the account’s value, or $50,000, whichever is smaller. Interest rates are usually cheaper than that found on credit cards. On top of that, when repaying the loan, you pay that interest to yourself.

But there are some drawbacks. You must repay this loan in five years or less. But in my eyes the biggest risk is that if you leave your job before you’ve paid off the loan, the outstanding balance becomes due and payable immediately. If it’s not repaid, that amount will be treated as a distribution (income) to you. You’ll be taxed on that amount at ordinary rates. And if you’re under the age of 59 & 1/2, you will also be assessed an additional 10% excise tax as a penalty for an early withdrawal of retirement funds. As a consequence, you’d better make sure any 401(k) loan can be repaid before you leave your job.

> Debt Consolidation

You may be able to lower the cost of your credit by consolidating your debt through a second mortgage or a home equity line of credit. You’ll typically get lower rates and tax advantages, but you’re putting up your home as collateral. If you can’t make the payments — or if your payments are late — you could lose your home. The danger here is falling into a common trap. Many get a home equity loan to pay off existing debt, and then max out the credit cards all over again. Now they have the loan to repay on top of the credit cards, putting them in an even deeper hole.

What’s more, the costs of consolidation loans can add up. In addition to interest on the loans, you may have to pay “points,” with one point equal to one percent of the amount you borrow. Still, these loans may provide certain tax advantages that are not available with other kinds of credit.

If you do have any of the aforementioned options, you can at the very least make a sizable dent into your debt and at least give yourself some breathing room.

Lifestyle Change

Now if you’ve used up the previous options (or they weren’t available to you in the first place), a lifestyle change is in order if you want to achieve you goal of getting out of debt.

> Get Organized

Have your bills organized so you know when they are due. This will help you avoid late payments that can damage your credit and cost you money in late fees and higher interest rates.

> Assess Your Current Situation

Unless you’re ready to take radical steps like downsizing your lifestyle, there’s not a lot you can do about fixed expenses such as housing or a car payment. However, many of us have opportunities to cut back on incidental expenses. If it’s been a while since you made your last budget (or you haven’t gotten around to making one!), you need to start by tracking your spending to have a realistic idea of where your money is going.

Start by listing your income from all sources. Then, list your “fixed” expenses — those that are the same each month — like mortgage payments or rent, car payments, and insurance premiums. Next, list the expenses that vary — like entertainment, recreation, and clothing. Writing down all your expenses, even those that seem insignificant, is a helpful way to track your spending patterns, identify necessary expenses, and prioritize the rest. The goal is to make sure you can make ends meet on the basics: housing, food, health care, insurance, and education. No matter how painful this exercise, don’t cheat on the every day regular expenses that you normally don’t notice. They can really add up and turn out to be quite an eye-opener. Saving on them could go a long way towards paying down debt.

The Internet is chock-full of money saving tips, here are some of the very best I’ve come across:

How to Save Money: 53 Clever Ways to Pocket More Cash

25 easy money-saving tips that will help you cut the monthly bills

Free (Or Nearly Free) Entertainment For Every Week of the Year

Once you’ve identified the weaknesses in your budget and the habits that are causing you to waste money, it’s relatively easy to come up with a solution that will allow you to save money and use it towards paying off your debt.

Depending on your current situation, you’re now going to have to do one of two things. If your accounts are still in relatively good standing, you will be calling your creditors. Otherwise, you’re going to have to deal with the debt collectors.

Contact your creditors

Contact your creditors immediately if you’re having trouble making ends meet. Tell them why it’s difficult for you, and try to work out a modified payment plan that reduces your payments to a more manageable level. Typically, your debts are either unsecured or secured. Secured debts usually are tied to an asset, like your car for a car loan, or your house for a mortgage. If you stop making payments, lenders can repossess your car or foreclose on your house. Unsecured debts are not tied to any asset, and include most credit card debt, bills for medical care, signature loans, and debts for other types of services.

> Negotiating Credit Card Debt

Most credit card companies are not willing to talk to consumers until they are 60-90 days down.

Also, if you are current on everyone but the creditor you are trying to settle with, they are not going to be willing to reduce your debt.

If they see (by looking at your credit report, which is legal) that you are paying everyone else but them, they will feel that since you are able to pay everyone else, you really do have the ability to pay them.

If you’ve been paying on time and all of a sudden call up the credit card company and tell them you can’t pay, they are going to be suspicious and less likely to make a deal. So in this case, asking for a lower interest rate (to lower your payments) may be the only option available to you.

If you have a history of paying late, however, they probably will not be willing to lower your interest rate.

On the other hand, if you’re late on your payments, especially if you’re more than three months behind, you may have some negotiating leverage: you may be able to negotiate a lump-sum settlement for your outstanding balance, where the credit card company accepts a portion of your debt and writes off the rest.

They’re often willing to do this instead of turning your debt over to a collection agency, as it’s cheaper just to settle. The credit card company will settle:

• if they believe it is in their best interest (you have convinced them that this is their only chance to receive anything),or
• if they don’t think that you have many assets (if they do sue, they won’t be able to collect much from you even if they win)

The settlement amount will vary, depending on your interest rate, your balance and your payment history, but the big drawback is that you have to have the money to settle all at once. After all, if you’re having trouble making your payments, odds are you don’t have a lump sum lying around to settle your debt.

Additionally, the amount of your debt that gets written off will show up on your credit report as bad debt, and that will stay there for seven years.

In recent years, the credit card companies have adopted a common stance on your account rating if you settle (meaning you pay less than you owe). They will agree to list your account as “Settled”, but that’s it. You can try to get a better rating, but your chances of success are slim. “Settled” is an inherently negative listing but not as negative as “Paid Charge-off.”

> Settlement Options For Your Auto Loan(S)

Most automobile financing agreements allow a creditor to repossess your car any time you’re in default. No notice is required. If your car is repossessed, you may have to pay the balance due on the loan, as well as towing and storage costs, to get it back.

If you can’t do this, the creditor may sell the car. In case the proceeds of the sale can’t pay off the loan, you will still be liable for the difference. If you see default approaching, you may be better off selling the car yourself and applying the proceeds towards the debt: You’ll avoid the added costs of repossession and a negative entry on your credit report.

Most of the time, lenders insist that the first step toward resolving the problem is to come clean. Call and discuss your options; you may have more than you think.

> Avoid Foreclosure On Your Home Loan(S)

If you fall behind on your mortgage, contact your lender immediately to avoid foreclosure. Most lenders will work with you if they believe you’re acting in good faith and the situation is temporary. Some lenders may reduce or suspend your payments for a short time.

When you resume regular payments, though, you will have to pay an additional amount toward the past due total. Other lenders may agree to change the terms of the mortgage by extending the repayment period to reduce the monthly debt. Ask whether additional fees would be assessed for these changes, and calculate how much they total in the long term.

If you and your lender cannot work out a plan, contact a housing counseling agency. Some agencies limit their counseling services to homeowners with FHA mortgages, but many offer free help to any homeowner who’s having trouble making mortgage payments.

Call the local office of the Department of Housing and Urban Development or the housing authority in your state, city, or county for help in finding a legitimate housing counseling agency near you.

Dealing With Debt Collectors:

The Fair Debt Collection Practices Act is the federal law that dictates how and when a debt collector may contact you. A debt collector may not call you before 8 a.m., after 9 p.m., or while you’re at work if the collector knows that your employer doesn’t approve of the calls. Collectors may not harass you, lie, or use unfair practices when they try to collect a debt. And they must honor a written request from you to stop further contact.

If you’re negotiating with debt collectors, though, here’s a list of tips:

• Learn your rights. Check out this resource page on fair debt collection from the Consumer Financial Protection Bureau.
• Prioritize your bills. Providing necessities for your family comes first. Dave Ramsey calls it the 4 walls: food, utilities, shelter, and transportation
• Estimate how much you can pay and offer less. Don’t do anything you can’t afford to do. Avoid sending postdated checks to a debt collector or agreeing to automatic electronic payments from your checking account.
• Don’t tell them your life story. Don’t go into a lengthy explanation of why you can’t pay
• Keep private information private. Don’t give a debt collector personal information
• Stay calm and focused. The more in control you sound and the less you fall apart, the more likely you are to get what you want out of the negotiation
• Tape the call if you can. Flicking on a tape recorder is a great way to keep a debt collector in line. Plus, you get a record of the call. Just make sure you get consent before you record the conversation. Yes, I know that there are many states with a “one-party consent” requirement, but it’s just simpler to abide by the more stringent requirement.
• Take notes. Make sure there’s a record. If you’ve made a deal with them, get proof.
• Get proof of payment agreement in writing. If they told you half of it satisfies the obligation and that’s what you want to do, have it in writing.
• Wipe your credit clean. Ask a debt collector to remove any negative information they’ve placed on your credit report. At the very least, insist that they list your account as paid in full rather than paid in settlement. Once they agree, get it in writing
• Don’t let them rush you. A debt collector will push and push for you to send them money immediately. Don’t do anything until you have confirmation of a payment agreement in writing.
• Negotiate at the end of the month. Because commissions for debt collectors are based on what they do each month, you may want to try negotiating near the end of the month. You could land a really good deal.

~

Tax Consequences Of Debt Settlement

One common objection to debt settlement is that if your debt is partially canceled outside the bankruptcy system, you will need to report the canceled portion of the debt as taxable income.

The Internal Revenue Service considers forgiven debt as taxable income. The creditor that settles with you must provide you with a 1099-C tax form.

However, the IRS will not require you to report forgiven debt if you were insolvent at the time the creditor forgave the debt. You’re insolvent when the amount you owe is greater than your assets (how much money and property you own). But the IRS adds that “you cannot exclude any amount of canceled debt that is more than the amount by which you are insolvent.”

For example, if you owe $10,000 in debt and own $3,000 in assets, you cannot exclude more than $7,000 of forgiven debt from your income tax. Any forgiven debt over $7,000 that year must be reported as taxable income. Many people decide to settle, not knowing that if they’re, say, $20,000 in debt and don’t own much, they’re going to have to report almost that entire amount as taxable income at the end of the year.

Conclusion

Wow, that was a lengthy one! And to think that I haven’t included everything I wanted to. There are two very interesting concepts that everyone who’s focusing on paying off their debt should get familiar with: snowballing, and snowflaking. I am not going to make this post any longer, so I’m just giving you the link to those additional resources.

Debt Snowball

Snowflaking Primer

To think that I’ve only scratched the surface of “getting out of debt” options…

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