debt

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What debts do I have?

If you're just getting started with your debt repayment plan, make a list of all the debts that you have. On that list, also note the interest rate or any other fees that you may be paying (for example: overdraft fees). If you are not sure what you owe and to whom:

  • Get a free copy of your credit report. Check out the FAQ on Credit report for more information.

  • The National Student Loan Data System has data about your Title IV loans and/or grants. The site displays information on loan and/or grant amounts, outstanding balances, loan statuses, and disbursements.

What are my rights, as someone who has debts?

In the US, debt collection agencies have to adhere to the Fair Debt Collection Practices Act. That means that you have some rights. Know the basics so that you can take advantage of them, if necessary.

Are these debts mine to pay?

Sometimes people claim you owe debt that you don't actually owe.

  • Mistakes. Sometimes honest mistakes are made, and someone charges you for something that you shouldn't have been charged for. You should try to resolve the issue with the vendor first. If the initial point of contact can't help, you may ask to speak with a supervisor. Make notes of the conversation, including the names of the people you talked to. If that doesn't help, you can often contact a regulating agency and complain about the company. For example: the FTC can sometimes help, your local Better Business Bureau can sometimes be effective, and the Consumer Finance Protection Bureau is a good option.

  • Identity fraud. Sometimes, identity fraud happens and someone used your information to get money - and left you to pay the bill. Check out the FAQ on identity theft for guidance on dealing with identity theft.

  • Parent PLUS loans. These loans are held in the parent(s) name and cannot be transferred to the student under any circumstances. You have no legal obligation to pay Parent PLUS loans if you are the student, although you may feel an emotional obligation to do so.

  • Very old debts. There's a statute of limitation on most debts in the US. The term depends on the kind of debt and on what state you are in. Debt collectors are allowed to try and collect debts that are past the statute of limitations, but you are not obligated to pay these debts once the statute of limitations has passed.

  • "Inherited debt" - Debt is not inherited from generation to generation. If someone tells you that you need to pay on a deceased family member's debt, this is generally untrue. Debts of the deceased that aren't cosigned are paid out of the deceased's estate. If you feel you are being held responsible for a deceased family member's debt that you aren't responsible for, please create a post on the /r/personalfinance subreddit to describe your specific situation. You should also consult an attorney.

Can I reduce the principal of my debts, or the interest rates?

You can always try! Some ideas:

  • Negotiate the amount that you need to pay. This can work for medical debts, especially if you can prove that you have a low income or offer to pay a reduced amount in full. It can also work for other debts. For example you can ask if there's a discount when you can pay the full amount within a few days. It can also work for older debts, because sometimes the debt collector will know that it's better to get $500 from a $900 debt from you now, than to keep fighting to get the full amount from you.

  • Negotiate the interest rate. This can work with credit card companies. You can call them and ask for a lower interest rate. However, you should always pay your credit card bills off in full, every month, no exceptions. If you do this your effective interest rate is 0%.

  • Refinance or transfer your debt(s). 0% introductory interest rate credit cards and balance transfers can help you manage your credit card debt (note: there's often a fee for transferring the balance, so make sure the fee is worth it). The caveat is that if you miss a payment or don't pay off the entire balance by the end of the promo period you will be charged back interest as if the promo period never happened. Other options that may give you a lower interest rate, are: a personal loan with your bank, a HELOC on your house, a loan with a P2P-lending agencies (Prosper, Lending Club, etc), or refinancing student loans through a third party.

  • Some student loan servicers offer a slight discount on the interest rate if you set up auto-pay.

Please be aware that these tactics may help you pay down the debts quicker, but some use these tactics as an excuse to borrow more money. Please use these tactics to reduce your debt burden as much as you can, but after you've paid up stay out of debt for good.

I need more money to be able to pay off these debts

Check out our FAQ on budgeting. Look at all of your assets: are you able to sell some to make some more money? Can you increase your income? There may be options to get financial aid from the government or from charities. If so, take all the help that you can get. You may be able to pay it forward later, if you want to.

What's the best way to pay down my debt?

  • In the avalanche method, debts are paid down in order of interest rate, starting with the debt that carries the highest interest rate. This is the financially optimal method of paying down debt, and you will pay less money overall compared to the snowball method.

  • The snowball method, popularized by Dave Ramsey, debts are paid down in order of balance size, starting with the smallest. Paying off small debts first may give you a psychological boost and improve one's cash flow situation, as paid off debts free up minimum payments. The downside is that larger loans (that may be at higher interest rates) are left untouched for longer, costing more in the long run.

In both cases you should make the minimum payments on all of your debts before choosing which method to devote extra money to. As an example, Debtor Dan has the following situation:

  • Loan A: $1100 with a minimum payment of $100/month, 5% interest
  • Loan B: $3300 with a minimum payment of $300/month, 10% interest
  • Sudden windfall: $1300

Dan needs to first pay $100 + $300 = $400 to make the minimum payments on loans A and B so the payments are recorded as "on time." The extra $900 can either go towards Loan A (smallest balance, snowball method) or Loan B (highest interest rate, avalanche method).

What's the best method? /r/personalfinance tends to default to the avalanche method (The avalanche method is always the financial optimum), but do not underestimate the psychological side of debt payments. If you think that the psychological boost from paying off a smaller debt sooner will help you stay the course, do it! You can always switch things up later. The important thing is to start paying your debts as soon as you can, and to keep paying them until they're gone. You can use unbury.us or PowerPay to help you get an idea of how long each method will take, and how much interest you'll be paying overall.

If you struggle with understanding why the avalanche method is optimal, consider that you should not be comparing which loan is currently costing you the most interest total. It is not a question of "shall I pay off this $1,100 loan or shall I pay off this $3,300 loan?" . You don't have a magic fairy who says she will pay off one of your loans, no matter its size. The right question is: "Given a specific amount of money that I can put towards the loans, which loan(s) should I pay down/pay off to save me the most on interest". So if Debtor Dan has got that extra $900, putting it towards towards the 5% loan will save him $45 per year in interest, while going to the 10% loan will save him $90 per year.

Should I be in a hurry to pay off lower interest loans? What rate is "low" enough to where I should just pay the minimum?

Depending on your attitude towards debt, you may want to stop paying off loans with low interest rates once you have paid all other loans above that threshold. A common argument is that the long-term return from investments in the stock market will likely exceed the interest rate from a low-interest loan. While this has been true in the past, keep in mind that paying down a loan is a guaranteed return at the loan's interest rate. Stock performance is anything but guaranteed. Fairly common consensus is that loans above 4% interest should be paid off in the debt reduction phase, while anything under that can be stretched out.


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