This is article one of Part One of the “Conquering Debt Series.”
Nothing is more important than developing a long-term strategy when you are dealing with debt problems. A good plan might include figuring out which debts to repay, understanding the consequences if you cannot pay certain debts, and deciding the best beneficial course of action you should take.
The first step and to get started on your long-term debt strategy, you will need to take a hard look at your overall debt picture. To some, this can seem scary. Trust me; I know what's it like to not know how much you owe and who you owe it to. But you can't start working on your debt without knowing your entire debt picture.
- Resource: Vertex42 Debt Reduction Calculator
Knowing your debt picture involves writing down your expenses (all of them) and income and keeping track for a few months.
When starting a financial journey, some people believe that a budget can fix everything. Don't get me wrong, a budget is crucially important, but it doesn't solve all of your problems.
For example, a budget can't tell you which debts you should pay first if you can't afford to pay all of them at once. A budget can't tell you where you should spend your money if you have any leftover at the end of the month.
In this article, I am going to help you figure out which debts are your highest priorities. This is the first significant step on a long journey, but it's vital because you might determine that you can't afford to pay all of your debt, and you will have to make hard choices about which obligations to pay first.
Making these hard choices might mean the difference between keeping or losing valuable property. I will be the first to admit that there is no magic list for the order in which debts should be paid. Keep in mind, that everyone's situation is different and the following information should be used a guide as you start to make these critical decisions.
COLLATERAL DEBTS ARE YOUR TOP PRIORITY
What is a collateral debt? Collateral is a property that a creditor has the right to take if you do not pay a particular debt.
For example, the most common types of collateral debts are your home in the form of a mortgage and your car in the form of a car loan. But keep in mind, creditors might also have the right to household goods, business property, bank accounts, or even your wages.
Mainly, if a creditor has taken collateral for your loan or debt, they have a “lien” on your property. Another name for this is “secured” debt. The purpose of collateral is to act as an insurance policy. The creditor knows that if you don't pay the debt, they can take your property and sell it to get their money back.
If the creditor does not have collateral on your debt, this is called “unsecured” debt. In most cases, it is tough for them to collect what they are owed if you don't pay voluntarily. Some examples of “unsecured” debts include credit cards, legal or medical bills, loans from friends or relatives, and store or other merchant credit cards.
No matter what, debts that have collateral are almost always your top priority. How you decide to repay other short-term debts depends a lot on your individual circumstances.
So just remember, the creditor making the most amount of noise, might not be your most important debt to pay off. The amount of noise they are making is only because they have no better way to get their money.
THE SIXTEEN RULES YOU SHOULD KNOW
The following sixteen rules on how to set debt priorities are best used when you find out you can not pay all of your high-priority debts. If you are just getting started on your debt-payoff journey, it's a great place to start!
1) Family necessities come first. Food, shelter, clothing and any other form of expenses to survive are number one. This may also include medical expenses if your medical provider requires pre-payment (this DOES NOT include old medical bills).
2) Pay your housing-related bills next. Try to keep up with your mortgage or rent payments if possible. Real estate taxes and insurance should need to be paid if you own your home unless they are included in the monthly payment. This might also include things like condo fees or manufactured home lot payments. All of these payments should be considered a high priority. If you do not keep up with these payments, it could result in loss of your home.
One thing I want to mention; if you are having severe financial problems and find yourself moving to a cheaper residence, you might decide to stop paying your mortgage or rent altogether.
If you make this decision, do not use the extra money from not paying your mortgage to pay off other debts. Instead, save it to use for moving expenses.
3) Keep essential utility service by paying the minimum required. At the very least, make sure you are paying enough to avoid disconnection. What's the point of putting in all the effort to keep your home if you can't live there because you don't have running water or lights?
4) If you need to keep your car, you should focus on paying your car loan next. If your car is a necessity to get to work or if you need it for other essential transportation, you should make it your next priority after food, housing costs, unavoidable medical expenses, and utilities. If you could lose your job if you don't have a car, this might become an even more important priority.
Make sure to also keep up with your car insurance. If you don't, the creditor might buy expensive insurance with less coverage for you at your expense. Yes, they can do this! It's also illegal in most states not to have auto liability coverage.
If you can afford to get rid of your car or one of your cars, you can save money on not only the car payment itself but gas, repairs, insurance, and taxes as well!
5) Pay your child support payments. No matter what you do, these payments will not just go away. If you do not pay them, it could result in severe consequences such as loss of wages, and even prison time.
6) Income tax debts. You must always pay any income taxes you owe that are not automatically taken from your wages, and no matter what, you must still file your federal income tax return, even if that means you can't pay the balance due.
Remember, the government has a lot of different rights that creditors do not have. If you have changes or your income has been reduced to living circumstances, this might mean your tax obligation has changed also. Make sure to pay what is necessary.
7) “Unsecured” loans are the low priority debt. Remember, unsecured loans means the debt does not have collateral. So the creditors can not take property due to nonpayment. In the short-term, creditors can't hurt you.
8) Debts with ONLY household goods as collateral are also low priority. Mostly, you should treat these debts as unsecured debts for priority purposes. Creditors don't usually collect household goods because they have little market value. They can't take the goods without going to court (which is expensive), and it's time-consuming for them.
9) Never move a debt up on your priority list because the creditor threatens you. A lot of threats to sue are not carried out. Why? Because it's expensive to the creditor. Threats over rent, mortgage, and car debts should be taken more seriously since it could mean the immediate loss of your home or car.
10) Figure out if you have good legal defenses. What do I mean by legal defenses? This might mean making a case that the property the creditor is trying to seize is defective or damaged. Is the creditor asking for more money than what is owed? If you have a defense, it might make sense to get legal advice to see if your argument will hold up. Never be afraid to fight back.
11) You should move a debt up on your priority list if there is a court judgment. If a collector obtains a court judgment, the creditor can enforce that judgment by asking the court to seize certain assets or property. How high of a priority should it become? It depends on your individual circumstance (value of your property, income, etc.) and your state's law. If all of your property and income is protected by state law, you become “collection proof.” Make sure you find out before deciding on the priority of the debt.
12) Government student loans are a medium-priority. That means these type of debts should be paid before low-priority debts but after top-priority debts. Failing to pay for your government student loans could mean seizure of your tax refunds, wage garnishments, denial of new student loans, or even seizure of Social Security benefits.
Make sure to research all of your options when making payments on your government student loans. There are laws in place that provide special solutions for people who are looking at getting out of default. Look into affordable repayment options, student loan consolidation, or even student loan forgiveness.
Government student loans should be treated more like unsecured debt.
13) Never determine a debt's importance based on debt collection efforts. Always make sure to be polite and respectful to debt collectors, but it's up to, and you need to make your own choices about which debts you need to pay based on what is best for your family. Debt collectors rarely give you good advice, and sometimes they are aggressive. Even if they are trying to get you to pay a debt, you should really pay last.
14) Credit record threats should never move up a debt's priority. There are times when a debt collector may threaten to report your missed payments to a credit bureau. If they are threatening you with this, they probably have already reported it.
15) Cosigned debt is still YOUR debt. If you cosigned for someone else or put YOUR home or car as collateral for someone else's debt, you are still responsible. If the person responsible for the debt is not making payments, you need to treat this debt as high-priority because it's your assets that are in jeopardy. If there is no collateral on a co-signed debt, then you should treat it as unsecured debt with a lower priority.
16) Never make refinancing your first choice. When deciding to refinance, you should always proceed with caution. It can be expensive, and it could mean giving the creditors even more opportunity to take your assets. It is a short-term fix for a long-term problem.
The rules listed above should be used as a guide. If you find yourself in a situation where you can't even maintain payments on your high-priority debts, it might mean getting a second job or finding additional ways to make extra money.
Whatever you do, do not make the mistake of telling yourself, “If I can't pay my mortgage, at least I can make a payment on my credit cards.” This is a serious mistake that some people make. They attempt to pay smaller (low-priority) debts in an attempt to make an effort, any effort to keep up.
If you want to create a long-term plan to save your home or your car, you will have to start making payments again at some point. If you don't have enough money to make full payments, you can try to talk to your creditor about making partial payments. If they will not negotiate with you, save your money! You can always use it later to make a down payment, to get caught up, or to cover the cost of moving to a cheaper residence.
Although it might be hard, don't make desperate decisions. Sometimes it's best to step back and accept the inevitable changes that come with money problems. That might mean having to move to a cheaper residence, getting rid of a car, or cutting back to only the necessities.
Did you find this article helpful? Let me know your thoughts in the comments below!