Maybe you’ve lost your job. Maybe your partner is suffering through a costly illness. Maybe you’ve run up so much credit card debt that you can barely keep up with your minimum monthly payment.
You’re in the middle of a financial crisis. But what can you do to work your way out of it? And how can you do this without destroying your credit?
Here are some tips for how to survive a financial crisis and what to do to prevent one in the future.
Prioritize Your Payments
Ideally, you’ll pay all your bills on time each month. This might not be possible in a financial crisis, meaning that you might have to prioritize. Certain bills are more important than others.
You need a place to live, so do whatever you can to stay current on your mortgage or rent payments. You don’t want to risk losing your home. Mortgage payments are especially important as paying this bill more than 30 days late will cause your three-digit credit score to fall by 100 points or more.
You also need to spend money on the essentials, such as your home’s power and groceries.
You should pay your credit cards on time, too. Your credit card payments are also reported to the three national credit bureaus of Experian, Equifax and TransUnion. If you pay these more than 30 days late, your credit score will again fall. The same holds true for your auto loan and student loan payments. However, if you can’t pay all of your bills, remember that it’s possible to rebuild a credit score, so prioritize paying for the essentials.
Owe Money? Don’t Hide
If you owe money that you can’t pay, your first inclination might be to hide. You’ll avoid opening mail from your creditors. You won’t pick up the phone when these creditors call.
But Karen Ford, a financial coach, public speaker and author based in Fairmont, West Virginia, said that you should take the opposite approach: Instead of hiding from those you owe money to, you should reach out to explain your financial emergency. Your creditors might be willing to renegotiate your repayment schedule to leave you with monthly payments you can afford.
For instance, your mortgage lender might agree to lower your interest rate, lowering your monthly payment at the same time. Some lenders might even rework the terms of your loan, perhaps turning your 15-year loan into a longer-term 30-year one, again lowering your monthly payments.
“Contact your debtors and explain the situation,” Ford said. “Whether you’ve had an illness, hospitalization or job loss, be honest with them. Then explain to them that you will pay them what you owe, but it may be smaller payments than they would normally receive.”
Slow Your Spending
The next step is to curb any spending you can, Ford said. This could include such simple steps as decreasing the heat in your home by two degrees before you leave for work. As Ford says, this can save you about $20 a month.
That doesn’t seem like much, especially when you’re struggling to pay the bills, but by taking a series of these smaller steps, you can reduce your monthly costs significantly.
Some more obvious areas to cut spending include gym memberships, cable subscriptions, eating out and entertainment. If you’re in a financial crisis, focus, again, on spending only on the essentials.
Try to Negotiate Your Credit Card Debt
If it’s your credit card debt that is causing your financial crisis, don’t be shy about calling the issuers of your cards. Carla Dearing, chief executive officer of online financial wellness site Sum180, suggests asking if they’ll lower the interest rate they’re charging you. If this rate falls, your credit card debt won’t grow as quickly and your minimum required monthly payment will drop.
You might think credit card companies would be unwilling to do this, but you’ll never know if you don’t call.
“Many credit card issuers would rather lower your rate than have you transfer to another company,” Dearing said. “It’s worth asking.”
Dearing also recommends that you use as much as 50% of your monthly savings to pay down your credit card debt. Reducing this debt as quickly as possible will help ease your financial pain. The high interest rates that come with cards means that your credit card debt can grow quickly each month if you don’t pay it off in full.
Tap Your Home’s Equity
If you own a home, you might also consider applying for a home equity loan or home equity line of credit to pay off your credit card debt. There is one catch here: You can only take out one of these loans if you’ve built up equity in your home. Equity is the difference between what your home is worth and what you owe on your mortgage. If your home is worth $200,000 and you owe $150,000 on your mortgage, you have $50,000 in equity.
You can then borrow against that equity. The benefit of home equity loans or lines of credit is that the interest rates that come with them are so much lower than those attached to credit cards. If you can borrow money at a lower rate, you can then use it to pay off the credit card debt that is causing your financial emergency. (Note: Quicken Loans does not offer home equity lines of credit.)
“By paying off the credit card and moving that balance to a home equity line of credit, you’ve reduced the amount of interest that will stack up, and you will be able to pay off the debt more quickly,” Dearing said.
An alternative to a home equity line of credit could be a cash-out refinance. Much like a home equity loan, a cash-out refinance uses the equity you’ve built up in your home, but instead of taking out another loan, this refinances your primary mortgage.
Refinance Your Student Loans
Student loan payments are another burden that often leads people into financial crisis. This is especially true for those paying off private, versus federal, student loans.
One way to reduce the financial burden of these loans is to refinance them, Dearing said. When you refinance a student loan, you’re left with one consolidated loan with a single monthly payment and a lower interest rate, Dearing said.
That lower interest rate is important, Dearing says, because it means that more of each payment goes toward paying down the balance of your loans.
You must do your research before refinancing, though, Dearing said. Search for a reputable bank and compare interest rates. There are plenty of companies operating in this space that will overcharge for refinancing student loans.
“Steer clear of companies charging high upfront fees to help you consolidate your student loans or that claim to be ‘approved’ or ‘exclusive’ servicers to ‘special programs,'” Dearing said.
The Ultimate Step: Declaring Bankruptcy
If your debts are too much to handle, it might be time to declare bankruptcy. This, though, should only be considered as a last resort.
There are two types of bankruptcy you can declare: Chapter 7, in which most of your debts are forgiven but you’ll lose your most valuable assets, and Chapter 13, in which a bankruptcy judge works out a plan allowing you to repay all or some of the debt on a monthly schedule you can afford.
Bankruptcy will give you a chance to start over financially, but it comes with a cost. Declaring bankruptcy will devastate your credit score. Chapter 7 will remain on your credit reports for 10 years, while Chapter 13 will stick on them for seven.
If your financial crisis is so severe that you can’t work through it on your own, bankruptcy might be a choice. But only use this tool as a last resort.
Preventing Another Financial Crisis
Once you work your way out of your current financial crisis, it’s important to develop the financial habits that will help you avoid another one.
You can’t prevent every financial crisis, but you can lower the odds that you’ll fall into money problems again. Olga Kirshenbaum, financial coach and owner of New York City–based Rags to Riches Consulting, said that the key lies in not spending more than you earn each month.
To live this way, you’ll have to create a household budget. This budget should list the money that comes into your home each month and the money you spend. Expenses include fixed costs such as your mortgage, rent or car payment and those that fluctuate each month, including your utility bills and transportation costs. You should also provide a monthly estimate for how much you spend on groceries, eating out and entertainment.
Once you’ve created this budget, you can determine how much you can spend each month, Kirshenbaum said.
“Many people don’t have a working budget and can’t tell you if they are living within their means,” Kirshenbaum said. “Once they see that they are spending more than they are making, mindful spending begins to kick in.”
Once your budget is set, it’s time to build an emergency fund. This fund contains dollars that you can tap should an unexpected financial emergency pop up, anything from a furnace that conks out during the winter to a car with a blown transmission. With an emergency fund, you can pay for these emergencies with cash instead of using your credit card and building up more debt.
How big should this emergency fund be? Financial advisors say it should have from three months to a year of daily living expenses.
“This number depends on each person and their situation,” Kirshenbaum said. “How significant are your monthly costs, and how likely are you to find a job right away to get back on your feet? Whatever it is you decide to put away each month, that number needs to go into your budget.”
Have you experienced a financial crisis? How did you get out of it? Let us know in the comments below.
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