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| The Basics | 5 tales from debt hell
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If you use credit foolishly or naively, the consequences can dog you for years -- as these readers have learned for themselves.
By Liz Pulliam Weston
There are a few ways that credit can help you build a better life. Most of us, for example, couldnt buy a home without a mortgage, and a house is normally an excellent way to build wealth.
But there are many, many other ways in which the misuse of credit can lead to a hellish nightmare of stress, empty wallets and bankruptcy. Ive chosen a few stories from my e-mail bag to illustrate some of those paths to perdition, along with cautionary words on how to avoid these fates.
Here, then, are five stories from debt hell:
The heavy risks from co-signing a loan
I was the co-signer on a vehicle for my sister-in-law. I got the whole "You're the only one who can help me. If I don't have a car, I can't get to work. Then, I can't pay my bills . . ." and so on. Being soft-hearted, I gave in and co-signed for her. To make a long story short, she defaulted on the payments, had the vehicle voluntarily repossessed and is currently filing bankruptcy on the balance, which is about $18,000. I by no means have the resources to pay for the defaulted portion, so I am in the process of starting the bankruptcy process.
My credit rating before this incident was flawless, and I scored around 850.
(The last time I checked my report) about a year ago, it's at 650. I am so bummed out.
What can I do, besides grin and take it, to show creditors that I am not a risk -- that this is the only blemish on my report? I am looking to trade in my car soon to get a new one before the bankruptcy is finalized because I'm sure after it goes through, I won't be able to get a nickel on loan, let alone a car.-- Doug Punchak, Brookpark, Ohio Its probably already too late to get a decent rate on a car loan. By now your sisters bankruptcy is showing up on your credit report, along with the defaulted payments and the repossession. Thats almost certainly driven your score below 620, which means youll pay pretty high rates on any loans you manage to get.
You learned a tough lesson: that co-signing a loan puts your credit in the hands of someone else -- a someone else whose credit is so poor that no regular lender will take a chance on her. Unless youre in a position to make sure that every payment gets made and that you can pay off any balance owed, you should never co-sign a loan.
Both bankruptcies will stay on your credit report for up to 10 years. Thats the bad news. The good news is that you can rehabilitate your credit over time by:
- Paying your bills on time, all the time.
- Paying down your existing debt.
- Keeping balances on your credit cards low -- below 30% of your available credit.
- Not applying for credit you dont need.
This rehabilitation isnt going to happen overnight. Youll probably pay for this mistake for several years. But if you use credit responsibly from now on, you should be able to bounce back eventually.
The balance-transfer backlash
Over the past year or so, my wife and I have taken advantage of several balance transfer offers at very attractive rates. In the process, we used most of our available credit on the cards to which we transferred balances. Although this debt load is manageable for us, apparently some of the very companies that promoted the activity have since chosen to turn the tables, so to speak. For instance, Fleet has chosen to increase our rate from one that was well below 10% to one that is somewhere around 23%. Bank One took the liberty to increase my rate from 14.15% to 24.99% despite my having been a customer for some 15-plus years and only having a $1,000 credit limit on the card.
We have not defaulted or been late on any payments. The only explanation that we have received is that people with high balances tend to default more often. (If thats true, then how is raising the rates going to stop (these people) from defaulting? I would venture to say that this kind of conduct by these well-to-do institutions is what causes many people to indeed default.
We have credit lines with some companies up to $20,000, and (the lenders) know that most people don't have the ability to pay it off when these rate hikes are implemented.-- Mark from Michigan In the mid-1990s, lenders started noticing an unusual trend: an increase in the number of people filing for bankruptcy who had never been late on a single payment.
These so-called sudden bankruptcies wreaked havoc at the banks and credit card companies, which started looking for other clues to predict defaults. Running up big balances proved to be one of those clues -- it is a pretty good indicator that people are getting in over their heads.
Youre quite correct that raising rates for this behavior creates a Catch-22 by making debt repayments more expensive. But lenders insist higher rates are the only way they can adequately cover their risk so that low rates are still available for the people who use credit responsibly.
To preserve your credit score, you never want to max out any credit card. In fact, you should try not to charge more than 50% of your available credit limit; keeping your charges below 30% is even better. Paying off your credit cards in full every month is the smartest choice, since carrying balances just puts you at the credit card companies mercy.
Overdosing on good debt
My wife is 53 and is studying for her Ph.D. She has about $138,500 in subsidized and unsubsidized loans from the federal government. She also has about $14,000 in private education loans. This will cause payments to be about $800 a month for 30 years at today's low interest rates.
My wife wants to be an instructor at a college. Currently, there are no openings. A starting salary would be around $50,000 a year.
Liz, this is clearly an example of a big investment (with) a poor return. When I called Sallie Mae, one counselor raised the issue of (the) high debt and pointed out that almost a quarter of a million dollars will have been spent once this loan is paid off (if this loan gets paid off)!! And with the relatively limited time (left) in my wife's work life, there will not be much time to earn the benefits of higher education. Also, imagine paying student loans into your 60's, 70's and possibly 80's?
I am so glad I am not responsible for these loans.-- Steve from California The love of learning is a wonderful thing. But if youre borrowing money for an education, try to make sure that the payoff will be worth the investment.
Unfortunately, many people blindly assume that student loans are always good debt -- like mortgages or business loans. In truth, all these loans can, in moderation, leave you better off by increasing your wealth or earning power.
But an overdose on good debt can be just as fatal to your financial health as taking on too much bad debt, like credit cards.
A general rule of thumb is that your student loan debt shouldnt exceed two-thirds of your expected first-year salary. In your wifes case, that means she should have stopped about $120,000 ago.
There are plenty of other ways to afford an education besides borrowing. Going to a cheaper school is one of them. So is working part time, or alternating study semesters with work semesters. It may take longer to get your degree, but you wont emerge with a crushing load of debt that puts you behind the financial eight-ball for the rest of your life.
My thinking here applies to undergraduate degrees, too. For more details on college debt, see my column How much college debt is too much?
Speaking of which, you will be paying for this debt, one way or another. If you live in a community property state like California, debts incurred during marriage are generally considered joint debts. Even if you live in a common-law state, the money your wife pays towards her loans is money that wont be available for other, joint goals, such as a comfortable retirement or vacations.
Choosing the wrong credit counselor
A little over five years ago I contacted AmeriDebt to see if they could lower the interest rates on my credit cards. (I owed more than $12,000.) Within 30 minutes, I had received a call back from a representative from AmeriDebt stating that they (lowered the rates). I was amazed at the speed in which they had done this.
I started paying them $500 a month, and they were to disburse the funds to my creditors. The problem was they never paid my creditors. They had $2,500 of my money that the creditors should have received. This sent my credit into a tailspin.
I was not in trouble with my creditors and had never missed a payment of any kind until I started dealing with (AmeriDebt). Bottom line: My credit is now ruined. I went from a 750 (FICO credit) score to a 520 within four months.
I paid everyone off immediately, and it has taken almost five years to get my credit score to just below 700. The funny part is that AmeriDebt decided to finally pay out that $2,500 to my creditors after I already paid them off.-- Jeff Davis, Cincinnati, Ohio Youre not the only person to suffer at the hands of a credit counselor. The Federal Trade Commission filed a lawsuit last year against AmeriDebt, saying the company lied to its customers, misrepresented the fees it charged and misled people about the services it offered and the very nature of its business. Although claiming to be a nonprofit, the company funneled most of its business through a for-profit arm owned by an AmeriDebt principal. Since then, AmeriDebt has closed its doors to new clients.
AmeriDebt often touted its ability to lower interest rates for clients, but credit counseling has never been a good solution for people who are current on their debts. Many lenders react negatively when a customer signs up for a credit counselors debt management plan. The late payments that sometimes result can do much more damage to a credit report thats pristine (as yours was) than to a credit report thats already troubled.
Thats why if you have good credit and you want lower interest rates, you would do much better by contacting your creditors yourself and negotiating with them directly. Many credit card companies are willing to lower rates for their best customers, particularly if those customers promise to otherwise take their business elsewhere.
Going for broke -- twice
My husband and I have been married for 11 years this July and hope to buy a house soon. We do face a huge stop sign, however. We have filed bankruptcy twice since we have been married. Both times were due to major medical problems within the family and having to live off of credit cards in order to buy groceries.
My question to you is this. Can we ever hope to buy a home with our credit so out of shape? I have been told by several people in the lending business that we might as well try to swim the Atlantic Ocean, because we will get it done before anyone will loan us money. Our most recent bankruptcy was discharged in December 2002.
We have always paid our rent on time. Will that be a determining factor when we go to apply for a loan?-- Amy from Tulsa Interestingly, yours is not an isolated case, on any level.
Although there are no hard statistics, bankruptcy officials in many states say there seems to be a rise in multiple filers -- people who have declared bankruptcy at least once before doing so again.
Medical bills are also a big factor in bankruptcies. Two large-scale studies indicate that unpaid hospital and doctor bills contribute to one out of five filings.
The good news, for you, is that buying a home isnt totally out of reach and may even be in your near future. If you demonstrate youve learned your lesson and maintain perfect credit after a bankruptcy, you can get a federally-backed FHA loan two years after your discharge. That means youll be eligible to apply in less than a year. But youre going to have to get your finances in better shape before you try. For more details, check out my column 4 steps to great credit.
Your rent payments probably arent helping to build your credit history, since many landlords dont report payment histories to credit bureaus. (If, on the other hand, you were evicted or sued by your landlord, that would show up and harm your credit score, so it is important to continue paying your rent on time.)
Youll also want to build up an emergency fund so that financial setbacks dont force you to use your credit to eat. And, if at all possible, find jobs that include health insurance. Your twin experiences with medical debt should have convinced you how essential it is to have this coverage.
Liz Pulliam Weston's column appears every Monday and Thursday, exclusively on MSN Money. She also answers reader questions in the Your Money message board.
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