05_084861 ch01.qxp 12/21/06 10:42 PM Page 9 Chapter 1 The Basics of Managing Too Much Debt In This Chapter ᮣ Figuring out where you stand financially ᮣ Knowing what to do when you owe too much ᮣ Dealing with debt collectors ᮣ Handling your most important debts ᮣ Building your financial future oing into debt is as American as Mom’s apple pie and fireworks Gon the Fourth of July. It’s the American way! Unfortunately, if it’s also your way, you may be so deep in debt that you live paycheck to paycheck, using credit cards and home equity loans to make ends meet and pay for unexpected expenses. Maybe you despair of ever being able to buy a home, have a comfortable retirement, or take a vacation with your kids. (Are we hitting a nerve?) You’ve probably just about given up on the American Dream. Many creditors claim that consumers owe too much because they’re irresponsible spenders, but recent studies tell a different story. For example, a 2006 study based on information from the Federal Reserve Board reveals that U.S. wages have been flat (after adjustments for inflation) since 2001, while the costs of such basics as housing,COPYRIGHTED medical care, food, and otherMATERIAL household essentials have increased. In other words, not all U.S. consumers are in debt because they’re spendthrifts; instead, we’ve all taken a national pay cut. Okay, so consumers at all income levels are being stretched to their limits — including you, which is undoubtedly why you picked up this book. But chances are that you haven’t yet taken decisive action to improve your financial situation. Maybe you haven’t even acknowledged the state of your finances, much less changed your lifestyle and become more careful about your spending. Even if 05_084861 ch01.qxp 12/21/06 10:42 PM Page 10 10 Part I: Getting a Grip on Your Finances you’re well aware that you’re in financial jeopardy, chances are you don’t know what to do about your situation. You may be frozen by fear and confusion. If you’re trying to keep up with your financial obligations but you feel like poor Sisyphus, struggling to keep the boulder he’s pushing uphill from rolling over him, you’re in the right chapter. Starting here, we give you the information you need to take control of your finances and turn them around. Taking Stock of Your Finances You need a clear idea of the current state of your finances in order to figure out the best way to deal with your debts. Here’s how you can begin to take stock of your finances (a topic we discuss in detail in Chapter 2): ߜ Compare your monthly spending to your monthly income. Prepare yourself for a shock. Most people underestimate the amount that they actually spend relative to what they earn. By doing this comparison, you may quickly realize that you’re using credit to finance a lifestyle you can’t afford, and you’re spending your way to the poorhouse. If that’s the case, you must reduce your spending to meet your financial obligations, and you may need to do a lot more than that depending on the seriousness of your financial situation. ߜ Order copies of your credit histories from the three national credit-reporting agencies: Equifax, Experian, and TransUnion. We provide the contact information in Chapter 2. Your credit history is a warts-and-all portrait of how you manage your money: to whom you owe money, how much you owe, whether you pay your debts on time, whether you are over your credit limits, and so on. Being charged higher interest rates on credit cards and loans is a direct consequence of having a lot of negative information in your credit history. ߜ Find out your FICO score. Your FICO score, which is derived from your credit history information, is another measure of your financial health. These days, many creditors make deci- sions about you based on this score rather than on the actual information in your credit history. See Chapter 2 for instruc- tions on ordering this score. We understand that things beyond your control — like bad luck and rising prices — may be partly to blame for your debt. We also know that chances are you’re at least partly responsible as well. For example, you may 05_084861 ch01.qxp 12/21/06 10:42 PM Page 11 Chapter 1: The Basics of Managing Too Much Debt 11 ߜ Pay too little attention to your finances. You forget to pay your bills on time; you don’t pay attention to the balance in your checking account so you bounce checks a lot; and/or you have a lot of credit accounts. ߜ Maintain high balances on your credit cards. As a consequence, you can afford to pay only the minimum due on the cards, you pay a lot in interest on your credit card debts, and all that debt has lowered your FICO score. ߜ Have little (or nothing) in savings so you have to use credit to pay for every unexpected expense. ߜ Mismanage your finances because you don’t know how to manage them correctly. The National Foundation for Credit Counseling surveyed its member credit counseling agencies in early 2006 to determine the key reasons consumers were filing for bankruptcy. The survey showed that 41 percent of consumers blamed their bankruptcy on poor money management skills; 34 percent attributed it to lost income; and 14 percent cited an increase in medical costs. If compulsive spending is the cause of your financial problems, get help from an organization like Debtors Anonymous (www. debtorsanonymous.org) or from a mental health therapist. Compulsive spending is an addiction just like alcoholism, and you can’t beat it on your own. You’ll always have debt problems if you can’t control your spending. Using a Budget to Get Out of Debt After you assess the seriousness of your financial situation, you need to prepare a plan for handling your debt, including keeping up with your creditor payments — or at least keeping up with payments to your most important creditors. One of the first things you should do is prepare a household budget (or spending plan, as some financial experts euphemistically call it). Whether your annual household income is $20,000 or $100,000, living on a budget is probably the single most important thing you can do to get out of debt and to avoid debt problems down the road. A budget is nothing more than a written plan for how you intend to spend your money each month. It helps you ߜ Make sure that your limited dollars go toward paying your most important debts and expenses first. ߜ Avoid spending more than you make. 05_084861 ch01.qxp 12/21/06 10:42 PM Page 12 12 Part I: Getting a Grip on Your Finances ߜ Pay off your debts as quickly as you can. ߜ Build up your savings. ߜ Achieve your financial goals. In Chapter 4, we walk you through the budget-building process from start to finish. Reducing your spending and making more money often go hand in hand with creating a budget. We provide lots of practical sugges- tions for doing both in Chapter 5. Getting out of debt usually requires that you change your spending habits. Because those changes may affect everyone in your family, if you have children (especially preteens or teens), you and your spouse or partner should invite them to help you create your household budget. They can suggest expenses to cut and things they can do to improve your family’s financial situation. By involv- ing them, your kids will be less apt to resent the effects of budget cuts on their lives. Also, you’ll be giving your kids the education they need to become responsible money managers as adults. Taking the Right Steps When You Have Too Much Debt If you don’t owe a ton of money to your creditors, living on a budget may be all that it takes for you to whittle down your debts and hold on to your assets. If you owe a lot, living on a budget is only the first step in the get-out-of-debt process. You may also need to do some or all of the following: ߜ Cut deals with your creditors. Ask your creditors to help you keep up with your debts by lowering your monthly payments on a temporary or permanent basis, reducing the interest rate on your debts, or letting you make interest-only payments for a limited period of time. Before you approach any of your credi- tors, you’ve got homework to do. For example, you need to • Create a list of all your debts and the relevant informa- tion pertaining to each debt. In Chapter 6, we explain the specific information to include on your list. • Review your budget to figure out how much you can afford to pay on your debts every month, starting with the ones that are the most important. Don’t allow a cred- itor to pressure you into agreeing to pay more than you think you can afford. 05_084861 ch01.qxp 12/21/06 10:42 PM Page 13 Chapter 1: The Basics of Managing Too Much Debt 13 Whenever you talk with a creditor, explain why you’re calling and exactly what you’re asking for. If the first person you speak with says no to your request, politely end the conversa- tion and ask to speak with a manager or supervisor.