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Cleaning up your credit
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July 2, 2001: 2:00 p.m. ET
Steps include checking your credit report, opening a deposit account
By Staff Writer Alexandra Twin
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NEW YORK (CNNfn) - Kathleen Law is a 26-year old publicity assistant at a book publisher. She makes $33,000 a year. She is also $40,000 in debt. And she's not alone.
Personal debt is at an all-time high. Federal Reserve figures show the national balance on credit cards, auto loans and other consumer loans hit a record $1.58 trillion in April 2001. Mortgage debt is at about $5.2 trillion.
"Retail sales figures are up 7 percent and pay increases are up only 2.6 percent," said Scott Dengwald, director of consumer credit services, at the National Foundation for Credit Counseling in Silver Spring, Md. "People of all ages, across the board are over-spending, failing to budget themselves, failing to pay off student loans or mortgages."
But it's not only irresponsible spending that gets people into trouble.
"A lot of debt results from unexpected emergencies, like illness or divorce," Dengwald said.
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Personal debt figures are at an all-time high. | |
"Between car payments, getting married, buying property, having children, dealing with deaths, most people walk a very tight rope with debt," said Howard Dvorkin, president of Consolidated Credit Counseling Services in Ft. Lauderdale, Fla. "They make the huge mistake of only making minimum payments. Once something goes wrong in their lives and they need money fast – they are at a major loss."
Fed figures show that people are spending about 14.3 percent of their take-home pay on debts, the highest amount since 1986.
But that's not all.
Bankruptcy cases filed in the first quarter of 2001 were at about 367,000, up 17.5 percent from the year-earlier period. Some people may be jumping the gun, nervous about Congress changing bankruptcy laws in the next few months. There is currently a bill in the Senate that makes it more difficult to file for bankruptcy. It prevents anyone making over a certain amount from being able to wipe the slate clean by filing under Chapter 7.
Experts say regardless of potential changes in the law, bankruptcy should be an absolute last ditch response to debt. Before you consider such a move, you should take aggressive steps to clean up debt.
Click here for a quick credit check-up
When debt is a done deal
Keep in mind that personal bankruptcy filingsl stay on your record for seven to 10 years. This can push up health and auto insurance rates and make it almost impossible to get good mortgage rates. You'll have a tough time renting a car, for example, following a bankruptcy, said Mike Kidwell, president of Rockville, Md-based Myvestra.org and co-author of the book "Get out of Debt."
Still, if you are forced to declare bankruptcy, there are ways to repair your credit. The best way to reassure both potential creditors and yourself that you can maintain financial security is to actually create that security, piece by piece.
Kidwell offers a few tips:
Check your credit report. You'll first want to make sure everything on your credit report is accurate. If you've been denied credit for anything, you can get a free credit report for up to 30 days. Call credit agencies Equifax (800-685-1111), Experian (800-682-7654) or Transunion (800-916-8800).
Make sure your credit report includes your positive account history. Often, your credit report includes mostly defaults or delays, rather than the credit you handled responsibly. Did you have a car loan and pay for it on time? A gas card that you were always up to date on? Have that information added to your report.
Also include other information that is not required on a report, but shows stability to potential creditors, like your current and past jobs and salaries, your bank account number or balance and any car or home you own.
Visit the bank. Open a deposit account. No matter how small, the account is like a symbol of proof to potential creditors that you have a specific means of repaying whatever credit they extend you. A preventative measure to safeguard against sudden financial disaster is to build up enough money in a savings account to sustain you for six months.
You may also be able to get a secured line of credit at the bank, but you'll probably have to back it up with some collateral. The same is true for a loan.
Department stores. Department stores are a little looser with their requirements than traditional credit card companies, so you may find it easier to initially get a credit card through them. Make small purchases each month and pay for them promptly. This improves your standing in the eyes of bigger credit providers.
Traditional credit cards. Get a co-signed or guaranteed account. Remember when you were 19 or 20 and needed a parent or someone else to co-sign your first apartment lease to reassure the landlord that in case you flaked out, someone else would be sure to pay for you? This is the same idea.
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 NEED A CREDIT CARD?
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Get a co-signed or guaranteed account
Become an authorized user on someone else's account
Get a secured credit card
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You can also become an "authorized user" on someone else's credit card account. All they need to do is tell the company to add you to the list and you will get a card that falls under their account.
Another option is to get a secured credit card where you give a bank a set amount and the bank gives you a credit card with a limit lower than the amount you've already given them. Banks are usually willing to do this because there is no risk for them of you defaulting on your loan.
The cash advantage. Pay for as much as you can with cash in the beginning. Credit cards can sometimes feel imaginary, like Monopoly game money. Paying in cash as much as you can is a good way to remind yourself of exactly what your financial resources are.
Your best bet for repairing credit is to get off on the right foot right away: this time out, pay your bills punctually, stick to your budget and be attentive enough to catch yourself early if you are starting to slip into debt again.
Get back on the good foot
Once your credit is repaired, it's time to get grip on your spending – so you don't fall into that trap again.
(Click here for a more detailed look at the steps to eliminating debt.)
Experts say you should:
Assess, budget. "Sit down, collect all your information, all your bills and write out exactly what you owe," Dvorkin said. "Then, you need to put yourself on a budget."
Stop spending. It seems like an obvious dictum, but far too few people follow it. "Make a commitment to stop," Kidwell said.
"Don't keep borrowing, freeze the credit cards, if you haven't already," Kidwell said. "Don't get a second mortgage on the house."
Call the creditors. "A common mistake is to avoid calling the people you owe," Dengwald said. "But some creditors will be willing to help you. Explain to them why you are having a hard time paying. They may put you on a hardship plan, they may waive late fees. Auto companies may give you a forbearance."
For Kathleen Law, the bulk of her debt was from graduate school student loans.
One way she was able to avoid filing for bankruptcy was by getting her series of loans from different holders consolidated into one loan. She then sent detailed evidence of her salary and monthly personal expenses to the loan holder. With this evidence in hand, it was clear to the loan holder that her monthly payments of $378 were impossible in light of all her other expenses. The loan holder reduced her monthly payments to a much more manageable $265, a 30 percent reduction on the original figure.
"It took several phone calls and a lot of insisting, but they were eventually willing to work with me," Law said. "They knew that if I filed for bankruptcy, they wouldn't get any of their money back. So it was in their best interest, as well as mine, to find a compromise."
Transfer balances, consider savings. You may want to consider transferring a balance from one credit card to a new one with lower interest rates. However, some credit cards have a low APR rate only for a short initial period. So only consider this option if you can pay off the debt before the rate changes, Dvorkin said. Also, be careful to avoid the common mistake of many debtors, who have four or more credit cards at once.
Although you're probably loathe to dip into your savings, depending on interest rates, sometimes it is to your advantage to pay off the debt -- with its high-interest rate -- first and then rebuild your savings account -- with its low interest earnings -- afterwards.
Remember, there may be no second acts in American history, as the saying goes, but there can certainly be a second act in your financial history. 
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Five steps to dumping debt - July 2, 2001
Keeping your secrets - June 29, 2001
Bankruptcy: The road to recovery - May 24, 2000
Credit mania, killer debt - May 19, 2000
Debt, a health hazard? - Apr. 13, 2000
Mortgages with bad credit - Apr. 5, 2000
Don't fall prey to lenders - Mar. 15, 2000
Bank says no, then what? - Mar. 1, 2000
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