No matter who you are, or your best set financial plans, anyone can fall into financial trouble for nearly any reason imaginable.
Although there are a lot of affordable ways to work through financial hardships, some situations can create even more problems. And that’s an understatement!
1. Believing that a debt collectors plan is the only plan
There comes a time in everyone’s lives where paying credit card bills may become difficult. After missing several payments, your credit cards could be closed by the financial institutions and the debt could be sold off to collections agencies. As a result, a fast-talking debt collector could try to lure you into a fast deal to settle your payment. Should you accept their offer?
Unfortunately, debt collectors will often use several underhanded tactics in order to get payments. According to the Federal Trade Commission, debt collectors cannot tell you legal action will be taken against you unless they have the authority to do so. They also can not threaten to take your property or garnish wages if you don’t agree to make a payment at that very moment.
If you decide to work with debt collectors on paying some of the debt and discharging the rest, it’s critical to look at your budget and come up with a proposed repayment plan. When presenting it, the Consumer Finance Protection Bureau recommends that you record the call where you make an agreement and get the agreement in writing before making any payments. Even though some of the discharged debt may be taxable, getting it paid off and out of the way is the first step towards rebuilding your credit.
2. Credit card debt settlement programs
When credit card debt begins to become overwhelming, you may be tempted to look for any possible way to get out from underneath it. Credit card debt settlement programs may present a very easy method to negotiate lower rates with credit card providers – but do they actually work as they advertise?
The FTC warns that credit card debt settlement companies don’t always work in your best interest. For instance, they may suggest that you stop paying credit card bills while they “negotiate” on your behalf with the companies you owe. Not only can this create a negative mark on your credit reports, as your accounts potentially go delinquent, but there is no guarantee that they will successfully negotiate a payment program.
Instead of turning to a credit card debt settlement company, it may be wise to consolidate credit card debt on a balance transfer credit card, allowing you to get caught up with a lower promotional interest rate.
Otherwise, you could contact your credit card issuers and negotiate with them directly to get back on track with your payments. If that is unsuccessful, you may be able to discharge your debts through credit counseling or bankruptcy instead.
3. Student loan forgiveness from “pay as you earn” plans
After graduating college, you may feel like the world is your oyster as you make the transition from “student” to “professional.” However, once you walk the stage and turn the tassel, one of your first big financial challenges may be dealing with and paying down student loans.
There are several ways you can pay off your student debt, including income-based repayment plans or “pay as you earn” plans. This method adjusts your monthly payment based on how much you are earning from your job, with the goal of increasing payments as your earning potential grows. After a certain amount of time, any remaining debt could be forgiven by the lender.
While this may seem like a smart strategy, it comes with some pitfalls. First, because you are extending a 10-year repayment plan to 20 years or more, you may end up paying significantly more in interest. Furthermore, any debt that is forgiven may be counted as taxable income, which will leave you with a higher tax bill at the end of your loans.
Instead of immediately rushing towards an income-driven plan, consider all of your options. Public Service Loan Forgiveness plans can help you get some of your student loans forgiven tax-free if you work in the public sector or for a non-profit. Additionally, consolidating your student loans could also get you a better rate and help you repay loans faster.
4. Seeking an “offer in compromise” on federal taxes
Every year, tax season can leave individuals and families uncertain as to how much they may owe the federal government. If you didn’t estimate your quarterly taxes correctly or didn’t withhold enough tax from your paycheck, you could find yourself with a large bill come April. What if you can’t pay it off?
If you ignore the balance due, you may end up underneath a mountain of tax debt. Not paying it could make things even worse, as the federal government has many different ways to collect on that debt.
Although it is possible to have your tax debt forgiven through an “offer in compromise,” getting one is incredibly difficult. If you have not filed all your required tax returns or attempted to make a required estimated payment, the Internal Revenue Service will return your application. Even if you submit your application correctly, there is no guarantee that it will be accepted.
Instead of going straight for an “offer in compromise,” start by negotiating a payment plan with the IRS. Setting up manageable payments can be a much easier path towards getting out of tax debt than having liens placed on your property.
5. Hiring a tax relief company to settle tax debt
If you do decide that seeking relief through an “offer in compromise” is your best option, there are two ways of going about it. You can either file the application on your own and hope for the best, or you can work with an attorney or tax relief company to help you file and negotiate forgiveness on your behalf. Do tax debt relief firms offer the best path towards getting out from federal and state tax obligations?
Unfortunately, some of their claims may be too good to be true. Some firms may make verbal guarantees to get you out of your tax obligation or require you to pay a “retainer” upfront for their services. After making payments, there is no guarantee that the IRS will accept their proposal – potentially leaving you in a much worse position than before.
If you do decide to work with an attorney to deal with your tax obligation, be sure to get upfront information on their fee schedule and success rate. If an attorney or company charges fees before settling debts or promises any other kind of forgiveness, it is best to avoid them.
6. Getting a cancellation of debt on a mortgage
As unfortunate as it is, foreclosures happen. If a house ends up being too much for you to handle, one of the traps you could fall into is a cancellation of debt. Upfront, this may sound like a good option: you could get out of the home payments and move somewhere more affordable, while a portion of your debt goes away. However, the IRS warns that cancellation of debt can be considered taxable income, which could increase your tax bill next year.
Instead of choosing to do nothing, homeowners should take action to protect their property and credit history. Homeowners can request a loan modification from their lender, which could create a plan to catch up on payments and stay in the home. Other options include short-selling the home to get out of debt.
7. Discharging home loan debt through a foreclosure
If you are forced to go through the full foreclosure process, there are additional tax implications that could hurt you later down the line. There are two different ways you could end up owing more in taxes if the bank forecloses: through taxable cancellation of debt, or a reportable gain from the disposition of a home.
Unlike a cancellation of debt, foreclosures are considered the same as sales for tax purposes. If you end up having a gain from the foreclosure, that sum could be added to your taxes at the end of the year. Moreover, if you lose money as a result of the foreclosure, it doesn’t provide a benefit because you can’t claim losses from a sale of personal property.
Before giving up on the “American Dream”, it’s important to work in good faith with your lender to see if a mortgage forbearance or deferment could apply to your loan. Through programs offered to help troubled borrowers get back on solid ground, you can potentially keep your family safe and sound in your home.
8. Voluntarily surrendering your vehicle to forgive auto loans
There’s nothing quite like the freedom that comes with car ownership. Through the right combination of auto financing and affordable payments, anyone can own a car, truck, or van that fits their lifestyle perfectly. However, in uncertain times, those easy payments can get tough – and if you miss several payments, your credit may not only get hurt, but you could be at threat of repossession.
One option to avoid repossession is to voluntarily surrender the vehicle to the lender. While this presents an easy way to get out from under the debt, the lender could still report the loan as delinquent, and the “voluntary” surrender could still be reported as an involuntary repossession.
Before you hand the keys back to the bank, start by calling the lender to see if you can work out an agreement to keep the vehicle and adjust payments to get caught up on the loan. If you do decide to voluntarily surrender the vehicle, it is recommended that you get all the provisions in writing, including if the surrender will satisfy the loan, and if it will be reported as a repossession.
By making an agreement with the lender to soften the blow, you may have the opportunity to help rebuild your credit faster with fewer penalties, which could help you get another vehicle down the line.
9. Using overdraft protection programs to cover checking accounts
As a convenience feature, some banks and credit unions offer overdraft protection programs as a way to ensure clients don’t spend beyond their account balance. On the surface, these programs are attractive as a way to avoid expensive overdrafts or insufficient fund fees and help ensure you will have just enough to cover whatever may come next.
However, overdraft protection programs might not be the best way to protect your account from being over-drafted. In addition to making you pay back your overdraft, your bank can also charge high fees per overdraft instance, or charge you per day for as long as you have an overdraft balance in your account. These fees can add up quickly, especially if you don’t check your balance for a couple of days.
Overdraft protection programs aren’t the only way to ensure you don’t accidentally overspend out of your account. Before you sign up for anything, check with your bank or credit union to see if you can link a credit card or savings account as a safety net for your checking account. If you don’t want any sort of overdraft protection, your bank must give you the option to opt-out entirely, which means your debit card can be declined if you have insufficient funds.
10. Refinancing debt with payday or auto title loans
Hard times happen to everyone, no matter your background or who you work for. As you try to balance everything, taking a short-term loan to cover groceries or make a payment towards a debt may seem like an easy way to balance the budget. Payday loans or auto title loans often advertise themselves as quick and easy ways to get a little extra cash at an affordable rate.
What they don’t tell you is that these loans are written to benefit the lender, instead of the borrower. These loans can charge as much as 300% in interest, with very strict terms on payment dates. If you miss a payment, it could result in high per-day penalties, a spike in interest, and a never-ending attempt to recover the debt. If you secure a loan with an auto title, missing a payment could result in losing your vehicle.
Instead of refinancing debt with a payday loan or auto title loan, consider applying for a personal loan instead. Personal loans are unsecured debt offered by reputable lenders to help borrowers get back on their feet, with terms that are much fairer.
Even with the best of intentions, it’s easy to fall into a number of different debt forgiveness and refinancing traps. These could cost you more than you realize and catapult you into a debt spiral. Without reading the fine print and making sure everything makes sense, what appears to be a good opportunity to get out of your debt could end up as an even bigger problem.
Before starting on any plan to get debt forgiven or refinanced, be sure to understand all the terms and conditions. Always get the final details you agree to in writing and don’t make payments until you have done so. By making a plan and being sure the terms are clear, you can ensure that you won’t fall into these common traps while continuing your plan towards debt payoff.