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Credit Repair

NOLO

Chapter One

A. Take Care of Financial Emergencies 1/2

B. Face Your Debt Problems 1/2

C. Understand Your Options for Dealing With Your Debts 1/3 1. Do Nothing 1/3 2. Find Money to Pay Your Debts 1/3 3. Negotiate With Your Creditors 1/8 4. Get Outside Help to Design a Repayment Plan 1/8 5. File for Chapter 7 Bankruptcy 1/9 6. Pay Over Time With Chapter 13 Bankruptcy 1/10

If your debt problems are behind you and you're only concerned with cleaning up your credit report, skip ahead to Chapter 4, Cleaning Up Your Credit File. Also read Chapter 2, Avoiding Overspending.

Before you jump into rebuilding your credit, take care of any financial emergencies. Then you should tally up your debt burden and assess your options for handling what you owe.

A. Take Care of Financial Emergencies

A financial emergency is any situation that may leave you homeless or without some very important property or service. A pending eviction, a letter threatening foreclosure, an IRS seizure of your house, a utility cut-off and possibly a car repossession are financial emergencies. A nasty letter or threatening phone call from a bill collector, while unpleasant, is not an emergency. If you are being hassled by a collection agency, see Chapter 3, Section D.

If you face an emergency, acton it at once. Begin by contacting the creditor. You may be able to work out a temporary solution that will keep you off the street or on your wheels. If that doesn't work, you may need to get in touch with a lawyer to help you negotiate with your creditors. One option is to file for bankruptcy, assuming your overall debt burden justifies it. Currently, bankruptcy filing immediately stops all your creditors in their tracks and can buy you some valuable time. This may change, at least for eviction proceedings, if the bankruptcy legislation contemplated by Congress becomes law. (See Sections C.5 and C.6, below, for more information on bankruptcy and the pending bankruptcy legislation.)

B. Face Your Debt Problems

Some people with debt problems believe that the less they know, the less it hurts. They think, "I'm having trouble paying a lot of my bills. I can't stand the thought of knowing just how much I can't pay." But you must come to terms with your total debt burden. You cannot take steps to rebuild your credit without knowing exactly where your money goes-or is supposed to go.

Figuring out what you owe may result in a pleasant surprise. Most debt counselors find that people tend to overestimate-not underestimate-their debt burden. This may bring little comfort to those of you who find out that you owe more than you thought, but there is always a benefit: knowing what you really owe will help you make wise choices about how you spend your money.

Use Form F-1: Outstanding Debts (in Appendix 3 or on the CD-ROM) to tally up your total debt burden. Look at the most recent bills you've received. If you've thrown out your bills without opening them, you can probably find out the balance by calling the customer service department of the creditor. If you've long been avoiding your creditors and fear they'll hassle you when you call, ask for balance information only. If the customer service representative turns into a bill collector, explain that you are exploring your options and need to know how much you owe before you proceed. Let the representative know that you will contact the company as soon as possible, but for now you need only to know how much you owe. If the representative still hassles you, hang up and use your best guess as to how much you owe that creditor.

Total up both your past due installment bills, such as credit cards and loans, and any regular monthly obligations that are overdue, such as your utility bill.

C. Understand Your Options for Dealing With Your Debts

You normally have about a half dozen options for dealing with your debts-probably more than you imagined. Read this entire section before taking action.

1. Do Nothing

Surprisingly, the best approach for some people deeply in debt is to take no action at all. If you have very little income and property, and don't expect this to change, you may be what's known as "judgment proof." This means that anyone who sues you and obtains a court judgment won't be able to collect simply because you don't have anything they can legally take. You can't be thrown in jail for not paying your debts. And state and federal laws prohibit a creditor-even the IRS-from taking away such essentials as basic clothing, ordinary household furnishings, personal effects, food, most Social Security benefits, disability benefits, unemployment or public assistance.

So, if you don't anticipate having a steady income or property a creditor could grab, sit back. Your creditors may decide not to sue you because they know they can't collect. Many will simply write off your debt and treat it as a deductible business loss on their income tax returns. In several years, the debt will become legally uncollectible under state law. (See Chapter 3 for information on how to stop communications from collection agencies.)

Keeping exempt property. A complete list of property you get to keep even if your creditors sue you or you file for bankruptcy, called exempt property, is found in Money Troubles: Legal Strategies to Cope With Your Debts, by Robin Leonard and Deanne Loonin (Nolo).

2. Find Money to Pay Your Debts

If you can come up with a chunk of cash to pay off some of your debts, your financial woes may lessen. But even if you feel desperate, don't jump at every opportunity to get cash fast. If you make a bad choice, you'll get yourself into deeper debt. This section discusses some of the options you should consider to raise money and options you should avoid, if possible. It's not a complete list. Unfortunately, new scams and bad deals crop up every day. So, proceed cautiously, whatever you are considering.

a. Sell a Major Asset

One of the best ways you can raise cash and keep associated costs to a minimum is to sell a major asset, such as a house or car. This is a particularly good idea if you can no longer afford your house or car payments. You will almost always do better selling the property yourself rather than waiting to get cash back from a foreclosure or repossession. With the proceeds of the sale, you'll have to pay off anything still owed on the asset and any secured creditor to whom you pledged the asset as collateral. Then you'll have to pay off any liens placed on the property by your creditors. You can use what's left to help pay your other debts. But before you take this step, be sure you have affordable alternative housing or transportation available. If not, you'll be in worse shape than before-without a roof over your head or a car to get to work.

b. Cut Your Expenses

Another excellent way to raise cash is to cut your expenses. It will also help you in negotiating with your creditors, who will want to know why you can't pay your bills and what steps you've taken to live more frugally. Here are some suggestions:

• Shrink food costs by clipping coupons, buying on sale, purchasing generic brands, buying in bulk and shopping at discount outlets.

• Improve your gas mileage by tuning up your car, checking the air in the tires and driving less-carpool, work at home (telecommute), ride your bicycle, take the bus or train, and combine trips.

• Conserve gas, water and electricity.

• Discontinue cable (or at least the premium channels) and subscriptions to magazines and papers. Most cable companies offer a low rate basic service that they don't advertise. Be sure to ask.

• Instead of buying books and CDs, borrow them from the public library. Read magazines and newspapers there, too.

• Make long distance calls only when necessary and at off-peak hours. Also, compare programs offered by the various long distance carriers to make sure you are getting the best deal.

• Carry your lunch to work; eat dinner at home, not at restaurants.

• Buy secondhand clothing, furniture and appliances.

• Spend less on gifts and vacations.

c. Withdraw or Borrow Money From a Tax-Deferred Account

If you have an IRA, 401(k) or other tax-deferred retirement account, you can get cash to pay off debts by withdrawing money from it before retirement-but in most cases you'll pay a penalty and taxes. Or, with a 401(k) plan, you may be able to borrow money from it (instead of withdrawing it). There are serious disadvantages to both options-you should only consider doing either to pay off debts if you have other substantial retirement funds or you are truly desperate. And even then, this should be a last resort. Always look to raise money from nonretirement resources first.

Different plans have different requirements for borrowing and withdrawing money. Withdrawing money early from a tax-deferred account is expensive. Generally, any money that you take out of your 401(k) plan before you reach age 59 1/2 is treated as an early distribution. The one exception to the early distribution penalties and income taxes applies to Roth IRAs.

Instead of withdrawing money, you can usually borrow up to half of your vested account balance, but not more than $50,000. Then, you pay the money back, with interest, over five years. If you can't pay the money back within five years (or immediately, if you leave your job), your "loan" will be treated like an early withdrawal and you'll pay both an early distribution tax and income tax.

If you're seriously considering using the money in your retirement plan or IRA to pay off your debts, get a copy of IRAs, 401(k)s and Other Retirement Plans: Taking Your Money Out, by Twila Slesnick and John C. Suttle (Nolo).

d. Obtain a Home Equity Loan or Credit Line

Many banks, savings and loans, credit unions and other lenders offer home equity loans, also called second mortgages, and home equity lines of credit. Lenders who make these loans establish how much you can borrow by starting with a percentage of the market value of your house-usually between 50% and 80%. Then, they deduct what you still owe on it.

Obtaining a home equity loan has both advantages and disadvantages. If all of your debts are unsecured and your house is exempt from collection, it's almost never a good idea to put your home into jeopardy by getting a second mortgage or home equity line of credit. If you're behind on your house payment, you'll be better off negotiating a mortgage workout with your lender. (For more on mortgage workouts, see Money Troubles: Legal Strategies to Cope With Your Debts, by Robin Leonard and Deanne Loonin (Nolo).) If you are not able to negotiate a mortgage workout or, for other reasons, decide that you do want a home equity loan, be sure you understand all the terms before you sign on the dotted line. It is extremely important that you find out how much the loan will cost you each month and determine whether you can afford it. If you can't afford it, you'll likely lose your home.

Advantages of Home Equity Loans and Credit Lines

• You can borrow a fixed amount of money and repay it in equal monthly installments for a set period (home equity loan). Or you can borrow as you need the money, drawing against the amount granted when you opened the account; you'll pay off this type of loan as you would a credit card bill (home equity line of credit).

• The interest you pay may be fully deductible on your income tax return.

Disadvantages of Home Equity Loans

• Many home equity loans are sold by predatory lenders at very high rates. Predatory lenders target people in financial trouble or with past credit problems. Often, they sell loans that borrowers have trouble paying off down the line. (For more on predatory lenders and mortgages for people with poor credit, see Money Troubles: Legal Strategies to Cope With Your Debts, by Robin Leonard and Deanne Loonin (Nolo).)

• You are obligating yourself to make another monthly or periodic payment. If you are unable to pay, you may have to sell your house, or even worse, face the possibility of foreclosure (the lender forcing a sale of your house to pay off what you owe). Before you take out a home equity loan, be sure you can afford the monthly payment.

• While interest may be deductible, it's often high-19% per year or more.

• You may have to pay an assortment of upfront fees for an appraisal, credit report, title insurance and points. These fees can be as much as $1,000 or more. In addition, for giving you an equity line of credit, many lenders charge a yearly fee of $25 to $50.

e. Use the Equity in Your Home If You Are Elderly

A variety of plans help older homeowners make use of the accumulated value (equity) in their homes without requiring them to move, give up title to the property or make payments on a loan. The most common types of plans are reverse mortgages.

Reverse mortgages are loans against the equity in the home that provide cash advances to a homeowner and require no repayment until the end of the loan term or when the home is sold. The borrower can receive the cash in several ways-a lump sum, regular monthly payments, a line of credit or a combination.

There are pros and cons to reverse mortgages. In general, a reverse mortgage works best for older people with a lot of equity in their homes. In most cases, the reverse mortgage lender will look at your age, the amount of equity you have in your home and current interest rates to determine the amount it will lend you. All reverse mortgages cost money-closing costs (title insurance, escrow fees and appraisal fees), loan origination fees, accrued interest, and in most cases, an additional charge to offset the lender's risk that you won't repay. Almost every state allows lenders to offer reverse mortgages.

The most widely available reverse mortgage plans are the FHA's Home Equity Conversion Mortgage Program and Fannie Mae's Home Keeper Mortgage Program.

f. Borrow From Family or Friends

In times of financial crises, some people are lucky enough to have friends or relatives who can and will help out. Before asking your college roommate, Uncle Paul or someone similar, consider the following:

• Can the lender really afford to help you? If the person is on a fixed income and needs the money to get by, you should probably look elsewhere for a loan.

• Do you want to owe this person money? If the loan comes with emotional strings attached, be sure you can handle the situation before taking the money.

• Will the loan help you out or will it just delay the inevitable (most likely, filing for bankruptcy)? Don't borrow money to make payments on debts you will eventually discharge in bankruptcy.

• Will you have to repay the loan now or will the lender let you wait until you're back on your feet? If you have to make payments now, you're just adding another monthly payment to your already unmanageable pile of debts.

• If the loan is from your parents, can you treat it as part of your eventual inheritance? If so, you won't ever have to repay it. If your siblings get angry that you're getting some of mom and dad's money, be sure they understand that your inheritance will be reduced accordingly.

g. Options to Avoid

• Borrowing From a Finance Company

A few finance companies lend money to consumers. These companies make secured consolidation loans, requiring that you pledge your house, car or other personal property as collateral. The loans are just like second mortgages or secured personal loans; you'll usually be charged interest between 10% and 15% and if you default on the loan, the finance company can foreclose on your home or take your property.

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Excerpted from Credit Repair by Robin Leonard Deanne Loonin Copyright © 2002 by Nolo
Excerpted by permission. All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.

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