John Vaughan (Financial Advisor) @ Lucid Living
People struggling to repay debt often hear the same advice — budget better, make more money, negotiate debts, get professional help — but what happens when repayment is difficult even after following that guidance?
It’s a question more consumers are asking themselves. The rate of serious delinquencies (90+ days late) on consumer debt is 17.8% as at Q4 2010 and total household consumer debt has risen from just over R53 billion in Q3 2009 to R75 billion in Q3 2010, according to the latest figures released by the National Credit Regulator.
Now, many people – even those who had stellar debt repayment records in the past – are faced with picking which debts to repay.
To be sure, it’s unwise to stop paying bills or skirt debts altogether. Most financial advisers recommend that consumers pay at least the minimum on all debts, especially those that affect your credit score, like homeloan, credit cards, vehicle and other loans.
But if you can’t cover everything and have exhausted other possibilities, here are some guidelines to help determine which debts you might consider setting aside.
Prioritize paying the essentials
Pay for the things that have the most impact on your life first, experts advise. Make payments on the debts you can go to jail for not repaying — like maintenance, taxes and child support, says Ted Connolly, a bankruptcy and finance lawyer at Edwards Angell Palmer & Dodge and the co-author of “The Road Out Of Debt.”
Determine which debts have the least favorable terms
It is important to consider the interest rate (how much of each payment is interest; whether the rate is fixed or variable) and the tax benefits (homeloan interest can be deducted on taxes; vehicle loan interest cannot) to determine which debts have terms that are least favorable.
Weigh the cost of non-repayment
Once you have funded the essentials and negotiated the best terms possible on your existing debts, it’s time to examine what remains. Connolly recommends first deciding which non-repayments would hurt the least. First, examine secured debts — those backed by collateral — and assess what you’ll be giving up if you don’t repay, such as a house or a car.
Consider the potential hit to your credit score and how that would negatively affect your ability to get loans in the future. Delinquencies on almost all debts – both secured and unsecured – will have a similar effect on your credit score.
“What matters is the delinquency’s recency, severity (how many months the payment is delinquent), and frequency (how often has the person been reported delinquent on this and any other accounts),” says Craig Watts, a spokesperson for the Fair Isaac Credit Organization.
A recent repossession (home or vehicle), for example, can “inflict severe pain to your credit,” says Tristan Powys, a Credit Manager at Lucid Living.
Scores usually fall between 100 and 175 points after a repossession, according to Craig Watts.