Options If You Can't Pay Your Debts

To choose the best options when you can't pay your debts, you must first assess your financial situation. Start by doing the following:

• figure out what types of debts you have
• determine if your financial difficulty is short or long term
• decide which of your debts you should repay
• determine whether exemptions protect your property, and
• learn about your state's wage garnishment limits.

At that point, you can evaluate the various alternatives and choose the best one for you.

What Kind of Debt Do You Owe?

The type of debt you owe will determine what collection actions your creditors are allowed to take and how much time it will take.

What Is Secured Debt?

Secured debts, like mortgages and car loans, give the creditor special rights to collect from property that you've pledged as collateral for the loan. If you don't pay a secured debt, the lender can take steps to collect from the pledged property through foreclosure or repossession.

What Is Unsecured Debt?

Unsecured debts, such as most credit card debts, generally require the creditor to file a lawsuit against you and obtain a judgment before it can take drastic collection actions. Once the creditor has a judgment, it might be able to garnish your wages, levy your bank account, or place liens against real estate you own.

Government Debt

Government debt, like taxes, domestic support, or student loans, are unsecured, but they give the creditor special collection rights. In most cases, the government can take your tax refunds to pay the debt, and it can garnish your wages or Social Security without first getting a lawsuit judgment.

Is Your Financial Situation Temporary or Long Term?

If your financial difficulties are temporary, you might be able to get back on your feet with more time to catch up on payments or a temporary reduction in payments. But if your situation is permanent or long term, you'll need a more permanent solution to reduce or eliminate your debts entirely. Debt settlement or filing for bankruptcy might be appropriate for your situation.

Which Debts Should You Repay?

It's more important to pay some debts than others. If you're having trouble keeping up with all of your bills, figure out which ones are high-priority debts and be sure to make those payments first.

High-priority debts are secured by collateral that you want to hang onto, like a house or a car. Certain unsecured debts are also high priority, like utility bills, child support, and federal student loans in some cases. After all, if you don't keep up with these kinds of debts, a creditor might foreclose on your home, repossess your car, or shut off the utilities. The IRS can intercept your income tax refund to collect a defaulted federal student loan. You could potentially go to jail for unpaid child support. Don't pay low-priority debts unless you've already paid the high-priority ones, even if your creditors insist that you do so.

High-Priority Debts

High-priority debts ordinarily include:

• Mortgage. You'll likely lose your home to a foreclosure if you don't make the mortgage payments. If you're having trouble staying current, you might be able to work out a loan modification and get a more affordable monthly payment. If you've lost your job or had another financial setback, carefully consider whether you should sell your house and rent a moderately priced place. You can then use what's left over to pay your other essential bills.
• Child support. Failing to pay child support can land you in jail. What's more, a child support debt never goes away—it doesn't expire, and you can't wipe it out in bankruptcy.
• Utility bills. Being without gas, electricity, heating, water, or a telephone is not safe. Put these bills near the top of your list.
• Car payments. If you need your car to keep your job, it's best to keep up with these payments. If you don't need a car to get to work, consider selling the vehicle or voluntarily turning it over to avoid repossession. You might be able to use any leftover money to buy a cheaper car.
• Other secured loans. If you don't pay a secured debt back, the creditor might be able to come and get the property without first suing you in court. If the item is something you can't live without, make the payments. Otherwise, don't be too concerned about missing a payment or two. (Keep in mind, though, that a default or repossession will show up on your credit report for seven years and will affect your ability to get credit in the future.)
• Student loans. Paying your student loans is sometimes essential, like when the IRS is about to intercept your tax refund, the holder of your loan threatens to garnish your wages, or you're making payments under a "reasonable and affordable" repayment plan to rehabilitate your loan and get out of default.
• Unpaid taxes. If the IRS is about to take your paycheck, bank account, or other property, immediately contact the IRS to work out a repayment plan.

Medium-Priority Debts

Some debts straddle the line between high and low priority. When deciding whether to pay these debts, consider various factors, like your relationship with the creditor and whether the creditor has initiated collection efforts. Medium-priority debts generally include:

• Medical insurance or bills. If you're currently under a physician's care, you'll want to continue making payments.
• Credit cards. If you don't pay your credit card bill, the worst that will happen before the creditor sues you is that you'll lose your credit privileges. But penalties and interest add up quickly. And falling behind in payments will damage your credit.
• Court judgments. Once a creditor gets a judgment against you, the creditor can generally collect it by garnishing your wages or levying your bank account. If a particular judgment creditor is about to grab some of your money, the fact that the debt was originally low-priority doesn't matter.

Low-Priority Debts

A low-priority debt is one that doesn't have immediate or devastating effects if you don't pay. While paying these debts is a desirable goal, they're usually not a top priority. (Remember, though, that failing to pay a debt causes it to stay on your credit report for seven years.)

For example, low-priority debts typically include:

• Department store and gasoline charges. If you fail to pay these bills, you'll probably lose your credit privileges and, if the debt is large enough, you might face a lawsuit.
• Loans from friends and relatives. You might feel like you need to repay these kinds of loans, but your friends and relatives are most likely to understand that you're in a tight spot.
• Other unsecured loans. Again, an unsecured debt is one that doesn't have collateral; a creditor can't take your property without first suing you in court.

Are Your Assets Protected by Exemption Laws?

Each state has exemption laws that protect certain of your assets from creditors. If you file for bankruptcy, exemption laws also protect your assets from the trustee. It's important you know which of your property is exempt so that you understand which items are at risk for collection and which are safe. You can then decide which assets, if any, you want to use to pay your debts.

Can Creditors Garnish Your Income?

Depending on the type of debt you owe and the exemption laws available to you, your income might be protected from creditors in whole or part. Certain income sources, like Social Security, may have special protections that extend to funds directly deposited into your bank account.

Find the Option That's Best for You

Here are some options to consider.

Do Nothing

Generally, doing nothing is only an option if you're judgment proof, which means that your creditors, even if they sue and get a judgment against you, will not be able to collect from you. In most cases, all of the following must apply to you to make you judgment proof:

• your debt is all unsecured
• your situation is likely permanent
• all of your property is protected by exemptions, and
• your income can't be garnished.

Negotiate With Creditors

You might be able to get some relief by negotiating with your creditors directly. Different types of debt have different options. You could be able to reduce or temporarily suspend mortgage payments with a forbearance or loan modification. You might be able to lower your credit card payments or interest rate by reaching an agreement with your credit card lender.

Once you know what you can afford to pay each month, call your creditors. Let them know what's going on—maybe you suffered a job loss, went through a divorce, had medical problems, or other financial troubles—and ask for help. Be aware that, in some cases, if your debt is settled for less than you owe, the amount of the canceled debt is taxable. The IRS generally considers canceled debt of $600 or more as taxable and settling debts for less than what's owed can increase your tax liability depending on your tax bracket and the canceled amount.

If you decide to go this route, be sure to work something out with each of your creditors. If you negotiate a payment plan with only some of your creditors, the other creditors can sue you and essentially negate whatever benefit came out of your successful arrangements. And if you do end up filing for bankruptcy, which is not uncommon, the fact that you paid off some of your debt won't benefit you at all.

You don't need a debt settlement agent to contact your creditors for you.

Seeking Help From a Consumer Credit Counseling Agency

If you're not successful in your efforts to work out realistic solutions with your creditors—or if you feel you can't handle the negotiations yourself—consider getting help from a reputable and accredited nonprofit credit counseling agency. The National Foundation for Credit Counseling website is a good place to start looking for one. Credit counseling agencies can provide money management education, budget counseling, debt counseling, housing counseling, and referrals to other agencies that can help. Credit counseling agencies may also be able to contact your creditors and create a debt management plan.

Remember, though, if you pay an agency to help with your debt problems, you're spending money that you otherwise could have used to repay your debts. Figure out whether the amount the credit counseling agency charges for its services makes sense. If you pay more for debt assistance than you save through reduced interest rates and discounted principal, then you're essentially just adding to your debt load.

Also, before you use a credit counseling agency, do some research. Not all agencies are legitimate and some charge excessive fees, fail to perform promised services, or sign you up for a debt management plan without explaining other options.

File for Bankruptcy

If reaching individual agreements with your creditors is impractical, you need more time to catch up on secured debt, or need to stop a wage garnishment, bankruptcy might be the best solution.

• Chapter 7 bankruptcy overview. With a Chapter 7 bankruptcy, you ask the bankruptcy court to eliminate (discharge) the debts you owe. But keep in mind that not all debts are dischargeable and not everyone qualifies to file for Chapter 7.
• Chapter 13 bankruptcy overview. With a Chapter 13 bankruptcy, you file a plan with the bankruptcy court that details how you will pay back your creditors. You have to repay some debts fully, but other debts might be partially repaid or not paid back at all, depending on what you can afford.

Apply for a Student Loan Payment Plan

If you can't make your student loan payments, a variety of options are available to you. In most instances, you need to take action before you fall too far behind. The options differ based on the type of loan you have. Consolidation might help, but it might also limit your options. Contact your lender or servicer to learn more.

Get Help From Family or Friends

For most people, getting assistance from family or friends is a short-term option. But it might be easier to get help from family or friends if you have a plan to deal with your debt. For example, your family might be more likely to pay your bankruptcy attorneys' fees or help you out with a payment to rehabilitate your student loans, which then enables you to get on a better payment plan, instead of helping you make payments every time you fall behind.

Watch Out for Tricks or Scams

When you're in a difficult financial situation, you're particularly vulnerable to debt relief scams, collection tricks, and bad options.

Consult With a Lawyer

If you need help deciding which course of action is best for you, consider consulting with a debt relief lawyer to get more information. If you're considering filing for bankruptcy, talk to a bankruptcy attorney.