If you have a credit card or a loan, making monthly payments by their due date is important for your credit and financial well-being. But sometimes, life can get in the way of your best-laid plans. A death in the family or a big life transition, like going through a divorce or having a baby, can make keeping up with bills difficult.
Whatever the reason, you might be facing significant credit card debt, are in danger of defaulting on a loan, or are currently in default, hoping to regain your bearings. Read on to learn how to handle defaulting on a loan and other types of debt.
How to manage significant credit card debt
If your loan payments are starting to feel out of reach, it can be a scary time. Dealing with a ton of credit card debt isn’t easy, especially given the high interest rates that many credit cards have.
The first step is tallying how much you owe in credit card debt. This might seem like a simple step, but it’s easy to stay in denial by sticking your head in the sand. Looking at your credit card debt head-on can help you create a plan to get out.
As you look at your credit card balances, write down their APR as well. Your list might look similar to this:
- Credit card 1: Balance – $5,000 at 18% APR
- Credit card 2: Balance – $12,000 at 19% APR
- Credit card 3: Balance – $3,000 at 17% APR
This will help you later when it’s time to figure out a repayment strategy. Once you have these numbers, assess the underlying problem. Reasons you’re in credit card debt typically fall into a few categories:
- You’re not earning enough income to make ends meet.
- You’re spending beyond what you can truly afford.
- You’ve experienced an unexpected event but don’t have an emergency fund.
Knowing why you’re in debt helps you understand what to do to get out of debt. It also helps you understand whether this is a chronic issue or a one-time unfortunate event.
Transfer your balance or consolidate your debt
You might consider transferring your debt onto a balance transfer card to score a lower APR (potentially even a 0% APR) or take on a personal loan to consolidate the debt at a lower rate. Be aware that balance transfer cards generally charge a 3% to 5% fee, and the 0% rate is for a limited time, typically six months or more. With a personal loan, ensure that you actually can obtain a lower interest rate.
These options lend the advantage of saving money on interest and might help you chip away at your principal balance. However, the reality is that you’re opening another credit card or taking out another loan which could be sticky territory. If you haven’t addressed what really got your finances in this situation, you could end up even deeper in debt.
Contact your credit card company
If your situation isn’t that dire, but you need a bit of relief to get your finances in order, try calling your credit card company. Ask if it’s willing to reduce your interest rate or offer a manageable repayment plan for your budget.
You might also be able to get free or low-cost financial counseling through a nonprofit credit counseling agency. A good place to start for legitimate help is the National Foundation for Credit Counseling (NFCC). A credit counseling agency can work with you on a debt management plan by negotiating lower rates or lower fees with your creditors.
How to repay multiple types of debt
If you’re tackling a large sum of credit card debt, you might have other types of debt you’re repaying as well, like an installment loan. Figuring out which payments you need to prioritize can feel challenging. In this situation, figuring out a plan of action is essential.
Although everyone’s list order might vary slightly, generally, you’ll want to tackle your debt in the following order to save the most money:
- Mortgage or rent payments. Keeping your housing safe is crucial.
- High-interest credit cards. Refer back to your list of credit card debt and APRs. Consider paying them off using the Debt Avalanche method (more details below). You can also speak to your creditors and see if it’s possible to negotiate and come up with a payment plan or lower rates.
- Installment loans. If you have a personal loan, talk to your lender to see if it’s possible to obtain a lower rate.
- Medical bills. You might be able to negotiate this type of debt with your creditor or healthcare provider. Be sure to check for errors, see what your insurance covers and ask about financial assistance programs. You can check out this guide on negotiating medical bills.
If you’re struggling to make any payments, contact your creditor right away to see if they can work with you to find a viable solution.
Debt Avalanche vs. Debt Snowball method
There are two common ways to approach debt repayment: the Debt Avalanche method or the Debt Snowball method.
The strategy that offers the most savings is the Debt Avalanche plan. It involves funneling any extra money toward the debt account with the steepest APR first. The faster you rid yourself of high-interest debt, the less you’ll spend on interest charges over time. Meanwhile, you’ll pay the minimum amounts for each loan or credit card balance.
Once you’ve repaid the highest-APR account, you’ll repeat the process for the debt with the next-highest rate.
Instead of focusing on the interest rate, the debt snowball method asks you to focus on the debt with the lowest balance. Continue to make minimum payments on all other debt accounts while throwing extra cash toward the account with the lowest balance. Repeat this process until you’ve repaid all of your debt.
This strategy isn’t as effective in avoiding high interest charges, but offers a bite-sized win as motivation to stay on your debt repayment path.
About federal student loan debt
Federal loans aren’t the first priority when you’re at risk of defaulting on loans and other debt, especially due to federal benefits, like loan forgiveness. If you have federal student loan debt that originates from the U.S. Department of Education, take advantage of the current payment pause. If you’re outside the payment pause time frame, send your loan servicer a request to get on an income-driven repayment plan (IDR).
An IDR plan can help you avoid student loan default by lowering your monthly payments. How much you’re required to pay each month depends on your income, family size, and IDR plan. Under an IDR plan, payments will be 10 to 20% of your discretionary income. And if your income is low enough, your payments might drop to $0 per month, while your loans remain in good standing.
What happens after defaulting on a loan or credit card debt?
Credit card delinquency occurs if you fail to make a payment within 30 days of your due date. Credit card default generally occurs after a period of 180 days or six months after a missed payment. Defaulting on a loan or a credit card can have adverse consequences.
Not only does your credit score drop, but the default also stays on your credit report for seven long years. This can make obtaining additional credit difficult.
After the six-month period, your credit card issuer will likely write off the debt as a loss and sell it to a collections agency. But you’re still not off the hook for the debt.
Debt collectors will then contact you in an attempt to get you to repay the debt. Although there are rules and regulations around what debt collectors can and can’t do, the collection agency will work tirelessly to get the loan repaid. Be aware that a debt collection agency can sue you to try and reclaim the debt.
How to recover from defaulting on a loan or credit card
Defaulting on a loan or credit card can have serious and lasting damage to your financial health and credit. Taking steps to recover from default can help you move forward and move on.
Though unlikely if you’re in default, if you have the option to pay off the debt now, do so to make your life easier. Your other options include:
- Ignoring the debt. This strategy isn’t recommended as it can cause more problems. But if you’ve failed to make payments for a long time, each state has a statute of limitations on how long a creditor or debt collector can legally sue you for an unpaid debt. This period can range from three to six years or more, depending on the state. NOTE: If you make a payment after the debt reaches its statute of limitations, this action might restart the clock on the debt’s statute of limitations.
- Ask if you can settle the debt. If you want to resolve the debt, ask the debt collection agency if they’re willing to settle it for a lower amount. Learn about how to approach this from the Consumer Financial Protection Bureau. There are debt settlement companies out there that claim to help with this process, but many of them charge high fees and might not have your best interest at heart.
- Look into bankruptcy. As a last solution, bankruptcy might get your debt discharged or offer a path toward a debt repayment plan. Be aware that filing bankruptcy costs money and can be on your credit report for seven to 10 years.
Top resources for helping you get out of debt
Dealing with massive debt or defaulting on a loan or credit card can be a major disruption and stressor, but help is available.
The Institute of Student Loan Advisors (TISLA)
If you need student loan support and are financially struggling, you can get help through The Institute of Student Loan Advisors (TISLA). TISLA offers “fair, free, student loan advice” to student loan borrowers. You may be able to get support regarding defaulted loans, learn about student loan repayment options, or get information about loan forgiveness. Find more info here.
Homeowners dealing with a potential foreclosure should talk to a housing counselor from the U.S. Department of Housing and Urban Development (HUD). You can call (888) 995-HOPE (4673) at no cost and access housing counseling services or foreclosure avoidance counseling.
Nonprofit credit counseling agencies
There are both credit counseling services and also debt settlement services. To avoid potential scams, consider nonprofit credit counseling with a company that has an established history and reputation. One top option is the National Foundation for Credit Counseling which has been around since 1951.
Additionally, read Better Business Bureau (BBB) reviews and customer reviews online.
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You’re not alone after defaulting on a loan or credit card
Feeling financially trapped due to credit card debt or defaulting on a loan can feel stressful. If you feel unsure of where to even start, use the resources provided in this guide.
If you have a handle on your consumer debt but are worried about defaulting on student loans, get one-on-one support by booking a consultation with Student Loan Planner®.