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Credit Debt Basics

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Understanding Credit Debt | Recognizing Financial Warning Signs | Debt Management Options | Common Debt Terms | Simple Mistakes that Effect Your Credit

Understanding Credit Debt

By knowing the answers to a couple of basic questions about your debt, you will be better equipped to handle the financial difficulties you may be facing.

Who is involved in my Debt Situation?

Debtor

Any person currently using credit cards, holding a personal loan, paying on a home mortgage, or borrowing money from another party with an arrangement to repay credit or loans over a period of time, usually with interest.

Creditor

Any bank, mortgage lender, credit company, retailer or other business extending credit or issuing loans to consumers.

Debt Collector

Any person who regularly collects debts owed to others, including attorneys who collect debts on a regular basis.

Third-party Financial Assistance

Credit Counseling, Credit Repair, Debt Consolidation, or other Agencies offering financial assistance to consumers. Some agencies are for-profit, while others are not-for-profit, often funded by communities, governments, or even creditors.

What are the Two Types of Debt?

Secured Debts

Secured debts are typically tied to an asset, like a car for a car loan, or a house for a mortgage. If payments are missed, the lender can repossess the asset. Secured debts are usually not included in credit counseling and debt management plans.

Unsecured Debts

unsecured debts are not tied to any asset. Examples of unsecured debts include credit card debt, medical bills, signature loans, and debts for other types of service.

What are my Debt Options and Resources?

If you are facing financial difficulty, there are a number of options and resources available to you. These options can range from simple solutions, like budgeting, to the last resort option of bankruptcy. Based on your level of debt, your level of discipline, and your prospects for the future, you'll have to determine which is the best option for you.

Self-Help

Self-help may be your best option when dealing with debt and credit problems. Develop a budget to help realistically assess your income and expenses, and to help curb excessive spending. Your public library has information about budgeting and money management techniques. Low cost financial counseling services are also available in most communities. You may be able to contact your creditors directly to negotiate modified payment plans. If your credit history is less-than-perfect, time and responsible money management are your best resources. Be sure to contest any incorrect or out-dated information which may be negatively affecting your credit.

Credit Counseling

Debt Consolidation

You may be able to lower your cost of credit by consolidating your debt through a second mortgage or home equity line of credit. These loans may add up cost-wise, but may alternatively provide certain tax advantages not available with other kinds of credit. This option requires careful consideration, however, as these loans may require your home as collateral.

Credit Repair Services

Credit Repair companies offer help in cleaning up your credit report. For a fee, they can help you dispute incorrect or inaccurate information in your credit history which may be damaging your credit rating. Be aware, however, that no one can legally remove accurate and timely negative information from your credit report. Also, keep in mind that everything a credit repair clinic can do for you legally, you can also do for yourself at little or no cost. Ultimately only time and a conscientious effort to repay your debts will improve your credit report.

Bankruptcy

Personal bankruptcy is usually considered the last resort of debt management because results are long-lasting and far-reaching. A bankruptcy stays on your credit report for 10 years, which makes it difficult to acquire credit, buy a home, get life insurance, or sometimes get a job. However, it is a legal procedure that offers a fresh start for people who can't satisfy their debts. You'll probably need to seek financial and/or legal counsel before deciding whether this option is appropriate for your situation.

Turning to a third-party or business that offers help in solving debt problems may seem like a perfect solution when your bills or credit become unmanageable, but you need to be cautious. Before you commit to anything, be sure to:
- find out exactly what services the business provides and what it will cost
- get everything in writing; never rely on oral promises alone
- check out any company with your local consumer protection office and the Better Business Bureau in the company's location. They may be able to tell you whether other consumers have registered complaints about the business.

What are my Consumer Rights?

Federal laws, such as the Fair Debt Collections Practices Act are in place to protect your rights as a consumer. Educate yourself about your rights before submitting to the demands of a creditor or debt collector, or before making any major financial decisions.

Fair Debt Collection Practices Act (FDCPA)

Prohibits debt collectors from engaging in unfair, deceptive, or abusive practices while collecting debts. Fair Credit Billing Act (FCBA); Electronic Fund Transfer Act (EFTA) - establishes guidelines for resolving mistakes on credit billing and electronic fund transfer account statements.

Equal Credit Opportunity Act (ECOA)

Prohibits creditors from discrimination on the basis of sex, race, marital status, religion, national origin, age, or receipt of public assistance when deciding whether or not to grant credit.

Fair Credit Reporting Act (FCRA)

Ensures that consumer reporting agencies furnish correct and complete information to businesses. Designed to promote accuracy and ensure the privacy of information used in consumer reports.

Recognizing Financial Warning Signs

Many times we don't see the signs of a financial trouble until it's too late. But a financial crisis doesn't occur overnight. There are many warning signs that may indicate that your financial situation may be getting out of control. Following are a list important warning signs:

Do you pay only monthly minimums or occasionally miss payments on charge accounts and credit cards? Are your cards nearing or over your available credit limit? Do you depend on overtime or multiple jobs to cover monthly bills? - Do you often borrow from friends and relatives or depend on cash advances to cover basic expenses or pay your credit obligations?
Do you find it impossible to save money or find yourself exhausting savings as a way of supporting your debts?
Do you often float or bounce checks, hoping that checks you've written don't clear the bank before payday?
Can you account for the total amount of debt that you owe? Do you avoid adding up the total of the amount of your outstanding debt or purposely hide credit card bills from family members?
Are you considering, or have you consolidated debts by borrowing from a high-interest lender?
Do you panic when faced with an unexpected expense, such as car repairs?
If you find yourself struggling with any or all of the items listed above, you may be living beyond your income, depending on credit, cash advances, or loans to maintain your lifestyle. If you're stretched to the limit financially, you may find that when unexpected expenses arise, you can quickly lose control of your already shaky financial situation.

What you can do

If you or someone you know is facing financial difficulty, there are a number of options to consider. These options can range from the simple solutions, like budgeting, to more involved solutions such as credit counseling or debt consolidation, to the last resort option of bankruptcy. Based on your level of debt, your level of discipline, and your prospects for the future, you'll have to determine which is the best option for you.

Develop a Budget

Your first step toward improving your financial situation is to realistically assess your income and your expenses. By prioritizing your expenses, identifying those that are necessary and cutting back on the rest, your can start to track and control your spending.

Contact Your Creditors

Contact your creditors right away if you are having trouble making your payments. Explain the difficulty and try to work out a modified payment plan that reduces your payments to a more manageable level.

Deal with Debt Collectors

Federal laws, like The Fair Debt Collection Practices Act, dictates how and when a debt collector may contact you. Know your personal rights regarding debt collection.

Credit Counseling

If you're unable to resolve debt problems on your own, consider contacting a credit counseling service; they can help eliminate much of the stress of dealing with financial problems on your own. These services will help you establish a debt repayment plan and may help you reduce payments with creditors. Auto and Home Loans - If you see default approaching with your auto loan, consider selling the car yourself and paying off the debt, thus avoiding the added costs of repossession and a negative entry on your credit report. If you fall behind on your mortgage, contact your lender immediately to avoid foreclosure. Most lenders are willing to work with you if they believe you're acting in good faith and the situation is temporary.

Debt Consolidation

You may be able to lower your cost of credit by consolidating your debt through a second mortgage or a home equity line of credit. These loans may add up cost-wise, but may alternatively provide certain tax advantages not available with other kinds of credit. This option requires careful consideration, however, as these loans require your home as collateral.

Bankruptcy

Prevent Future Problems

The best way to deal with debt and other financial problems is to avoid them - prevention is the best cure! Develop positive financial habits and build a good personal credit history by following a few simple rules:

Pay all your bills on time

This will prove your reliability and ensures that you are a consistent and responsible consumer, not to mention saving the expense of costly late fees.

If you can afford to, make more than your minimum payments

Paying more than the minimum balance will help you to eliminate the principle debt more quickly. Otherwise you may be paying mostly on interest.

Keep an eye on your debt

Your creditors assign a credit limit based on your credit history, outstanding indebtedness, and income. If you are at or near your limit it is a good sign that you're headed for trouble.

Keep an eye on your available credit

Multiple accounts and high credit limits could result in excessive debt in the future.

Stay informed about your credit

Check your credit report regularly and dispute any inaccuracies.

Start and maintain your personal savings

Savings are an important way to protect yourself in the event of an unexpected financial situation.

Be honest with yourself about your financial situation

Only personal effort, prudence, and planning can repair problems and ensure a healthy financial future.

Create a budget (and follow it!)

Make sure that your style of living and your income are in complete agreement. Regularly analyze your budget and make adjustments as necessary.

Debt Management Options

If you or someone you know is facing debt problems, there are a number of options to consider. These options can range from the simple solutions, like budgeting, to more involved solutions such as credit counseling or debt consolidation, to the last resort option of bankruptcy.

First Steps to Recovery

Develop a Budget

Contact Your Creditors

Deal with Debt Collectors

Federal laws, like The Fair Debt Collection Practices Act, dictates how and when a debt collector may contact you. Know your personal rights regarding debt collection.

Credit Counseling

Auto and Home Loans

If you see default approaching with your auto loan, consider selling the car yourself and paying off the debt, thus avoiding the added costs of repossession and a negative entry on your credit report. If you fall behind on your mortgage, contact your lender immediately to avoid foreclosure. Most lenders are willing to work with you if they believe you're acting in good faith and the situation is temporary.

Debt Consolidation

Bankruptcy

Common Debt Terms

As you learn more about credit and debt management you'll begin to run across terminology you may be unfamiliar with. Below is a primer on a few important definitions you should know.

Debtor

Creditor

Any bank, mortgage lender, credit company, retailer or other business extending credit or issuing loans to consumers.

Debt Collector

Any person who regularly collects debts owed to others, including attorneys who collect debts on a regular basis.

Third-party Financial Assistance

Secured Debts

Unsecured Debts

Unsecured debts are not tied to any asset. Examples of unsecured debts include credit card debt, medical bills, signature loans, and debts for other types of service.

Simple Mistakes that Effect Your Credit

To a lender or merchant your credit score is the barometer of financial health and credit-worthiness. Pay close attention to simple mistakes that can lower your credit score and reduce your loan eligibility. The FDIC Consumer News has compiled the following list of common mistakes that can significantly affect your credit history and credit score.

Paying bills late

One of the biggest factors in the determination of your credit score is your past payment history. While one or two late payments on your mortgage, credit card or other important obligations over a long period of time may not significantly damage your credit record, if at all, making a habit of this can count against you.

Solution

Consistently pay your bills on time because this indicates you're a responsible money manager and likely to take your future commitments (such as a loan) seriously. Be especially careful with payments in the months before you apply for a loan, because lenders put more emphasis on your recent payment history.

Not paying the minimum amount required

"If you don't make at least the minimum payment on your credit card or other bills, your creditors will eventually report your account as past due, and that's a bad mark on your credit history," says Janet Kincaid, a Senior Consumer Affairs Officer with the FDIC. "Not only that, but paying less than the minimum can result in late fees and additional interest charges, which can add up quickly." Consistently pay your bills on time because this indicates you're a responsible money manager and likely to take your future commitments (such as a loan) seriously.

Solution

Make the minimum payment to avoid negative reports. Pay more than the minimum to reduce interest charges and improve you credit score.

Keeping debt levels too high

Potential creditors will be concerned if there are indications you already owe a lot of money on credit cards and other obligations because additional debt could stretch your ability to repay. One way creditors evaluate whether to approve a loan or charge a higher interest rate (which is done to compensate for higher risk) is to look at how much you owe compared to your income. Creditors also consider how much of your credit card limit you typically use. If you are "maxing out" your credit cards or otherwise keeping a high balance in relation to your credit limit, a lender could question your ability to make payments on additional debt.

Solution

Different lenders and credit scoring services may use different calculations when evaluating you—for example, some may include your monthly mortgage payment in their debt-to-income ratio, others may not. So, in general, try to keep your debt level low. How? Don't spend more than you can afford. Don't max out or charge near the limit on your credit card. Also, if possible, try to pay off that credit card balance each month. Follow this strategy and you'll build a good credit history, reduce debts and save on interest payments, too.

Owning too many credit cards

You may not think twice about offers to "sign up today" for a credit card to receive a percentage off your first purchase, get a free T-shirt or to have no payments for six months. Depending on your personal situation, these promotions may be good deals. But beware. "If you open a number of credit accounts with retailers just to get the discounts or freebies, these seemingly harmless accounts may linger in your credit file and end up costing you money the next time you get a loan or insurance," warns David Lafleur, an FDIC Policy Analyst on consumer matters. Here's why.

If you have a stack of credit cards and department store cards—even if you rarely use them or don't carry a balance on them—each card represents money that you could borrow. According to the Kincaid, "A potential creditor will look at each card and its $10,000 or $20,000 credit limit and say, 'We don't know when or if you'll access this amount, but if you do, that means you'll have less money available to repay any new obligation'." The result could be that, if you apply for a mortgage, a car loan or some other important loan, you may qualify for only a smaller loan amount or perhaps face increased costs or fees.

Also, when you apply to a bank for a credit card or a loan, it will look at the "inquiries" section of your credit report to find out if you've recently applied for loans elsewhere. Several such inquiries on your credit report could indicate to a lender that you may be having financial troubles or that you could be on the verge of getting too deeply in debt. These inquiries remain on your credit report for two years and can be a factor in your credit score.

Solution

Don't own or apply for credit cards you really don't need. Two or three general-purpose cards and a few (if any) cards issued by stores or oil companies probably are enough for the average family. Cancel and cut up the rest. If necessary, transfer any balances from these cards onto the few you plan to keep. Also important: "Notify the card issuer in writing that you want the account closed at your request, and with no balance remaining, and save a copy for your files," says Kincaid. "This letter can be very valuable if, as it sometimes happens, the account is inaccurately reported as still open and available, or if it's shown as being closed by the card issuer, which is considered a negative in the credit world."

Note: Under some credit scoring systems, canceling credit cards can lower your credit score, not raise it. For example, canceling cards you've owned for many years could lower your credit score because those older cards can establish a long history of responsible credit use. Even so, we still generally favor the idea of canceling cards you rarely or never use, for reasons already mentioned, plus others (including the fact that you'll have fewer cards that can be lost to a thief, and you are more likely to notice problems with cards you use regularly). As one possible strategy, Kincaid suggests this: "Review all the cards you have. Keep only the cards you've had for a long time and handled well by always paying on time."

Not periodically checking on your credit report

Many people never or rarely look at their credit report until they apply for a loan or they have been denied a loan or other request based on information in their report. Among the concerns: Inaccurate or missing information in your credit report could raise your borrowing costs or cause delays when you're in a rush to make a major purchase, such as a home.

Solution

Many experts say you should review your credit report from all three major credit bureaus about once a year, but especially before you apply for a home loan or seek some other benefit where your credit report could affect the outcome. If you find an error in your credit report, write to the credit bureau that prepared it and provide copies of relevant documentation. If the matter isn't resolved to your satisfaction, contact the Federal Trade Commission for general information about your rights.

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Not using your full legal name in bank accounts, credit applications and other documents that become part of your credit history

"This may seem like a minor issue but it can be important in terms of the accuracy of your credit report," says Joni Creamean, an FDIC Senior Consumer Affairs Specialist. Here's why.

Credit bureaus obtain data from a variety of sources, not all of which include a person's full name, Social Security number or other identifying factors. As a result, aspects of someone else's credit history—perhaps late payments, loan defaults or other serious problems—could be reported on your credit report and could reduce your credit score. Some situations are more likely than others to create mix-ups, Creamean explains. "It's not uncommon for a child and a parent with the similar names to show up on each other's credit report," she says.

Solution

Always use your full legal name when opening a bank account or applying for a loan or other benefit, such as a job or lease. Never leave off a Junior, Senior or similar designation, and never use a nickname. Or, at the very least, be consistent by always using the same name when you fill out these kinds of applications or documents. Following this advice doesn't guarantee that someone else's credit history won't appear on your credit report, but it will reduce the potential for a mistake.

Not alerting current or potential creditors if you've moved or changed names

Suppose you move and don't notify your existing creditors. If your monthly credit card statement and other bills don't reach you at your new address, you may miss a payment or two, and that tardiness can be reported on your credit report (not to mention the penalties or interest charges from your card issuer). Or, if you change names because of a marriage or divorce, and you apply for a loan without informing the potential creditor about your previous name, the credit bureau's report may show only your recent financial record under your current name. "If you don't inform your creditors of your name change, your credit record may not reflect your previous hard work at maintaining a good credit history," says Kincaid.

Kincaid also says that if your name or address doesn't match what's being reported by the credit bureau or other creditors, "this can prompt a red flag about a potential fraudulent account, and if nothing else, it can slow down your loan application."

Solution

Call each of your creditors to notify them of a name or address change, and keep a record of who you spoke to and when. Also, follow up with a letter to the appropriate department and mailing address. Some creditors may require specific documentation, such as a marriage license or divorce decree, in cases of a name change. "But even if the creditor doesn't require written notification," Kincaid says, "it may be in your best interest to provide it in writing to protect your rights and document that you made timely notification."