5 steps to prioritize debt payments when cash is tight
Owe numerous creditors but don't have enough money to send each a complete payment right away? Prioritize. Here's how to rank debts by order of who should get the most of your limited funds -- and still keep those who get less happy.
Step 1: Know the consequences
"Everyone has their own personal preference on what order to pay their bills in," says Jenny Realo, executive vice president for the debt relief service firm, CareOne Services Inc. "But the truth is some bills have more serious consequences if you fail to pay them than others."
Therefore, your first task is to understand precisely what may happen if you don't pay a particular type of creditor as agreed.
- Jail time. Two types of liabilities, if left unpaid, could land you in the slammer: unpaid child support arrearage and willful evasion of taxes. "In some states, the penalty for lack of child support payments can be as much as five years in prison," warns Realo. As for dodging the IRS, jail is also a possibility, as actor Wesley Snipes, hotelier Leona "Queen of Mean" Helmsley and reality TV star Richard Hatch discovered.
- Being forced from your home. Don't pay your mortgage and your lender can eventually force you out. It happens. RealtyTrac, an online marketplace of foreclosure properties, reported that 1.65 million properties went into foreclosure in the first half of 2010 alone. Avoid rent and you could come home to an eviction notice plastered to your door.
- Repossession. If you fall behind on accounts secured with a vehicle, appliance and other real property, lenders can repossess the items. In fact, some states permit a creditor to reclaim a car after just one or two missed payments. Additionally, says Dave Jones, president of the Association of Independent Consumer Credit Counseling Agencies, you may also be responsible for the deficiency balance. And if the finance company forgives that debt? "You could be liable for taxes on that amount," says Jones.
- Wage garnishment and court orders. If you don't pay your credit and charge cards or other unsecured bills, those companies can sue for the debt. Lose the case and a percentage of your wages may be garnished. Other unpleasant ways a judgment creditor can collect: levy your nonexempt assets (personal affects that may be taken and sold to pay for the debt) and place a lien on your property.
- Severe credit damage. Default on student loans and your credit rating will crash, and the notice of default will remain until cleared. Then again, any account that's listed on a credit report will negatively impact your credit history if you pay late or it's sent to a collection agency. These include credit and charge cards and all bank loans. Other bills, like those for medical treatment and legal matters, can also be reported if collectors take over.
- Relationship wreckage. Want to drive a wedge between you and loved ones? Shirk your co-signed loans and lines of credit. Same goes for "friends and family" obligations -- you know, the ones where you borrow $50 from a buddy. Reneging won't affect your credit, but it can ruin your relationship.
- Increased interest rates and fees. Your credit cards may have low APRs now, but skip a couple of cycles and they may skyrocket. "It's not uncommon to hear about interest rates being increased from 9 percent to 30 percent," says Realo. Expensive fees, too, are often added to the balance, which can cause the debt to become unmanageable.
Step 2: Determine what you have to offer
Next, review your budget and eliminate all unnecessary expenses. According to Jones, the first to nix are the "nice to have but not necessary items, such as cable TV, high-speed Internet, Netflix and other subscriptions, cell phone contracts and exercise club dues." Once those are purged and your lifestyle has adjusted to the reduction concept, pare down even further.
Whatever sum you have left over is the total amount you have for all of your liabilities.
Step 3: Arrange by repercussion
Now you're ready to allocate your funds. List your creditors in order of what can happen if you don't pay as agreed. Place those with the worst repercussions at the top; they should get a complete payment immediately. Those with less painful consequences will get a partial or even no payment for now.
Some decisions will be easy -- you'll want to protect your house rather than your Jet Ski. Others, though, will take deeper consideration. For example, is it more important to keep a high credit score or risk losing a friendship? Only you know the answer to that question.
Step 4: Make arrangements with the rest
Contact everyone who won't be receiving the amount that they are entitled and explain your circumstances and intentions. Never leave a creditor in the dark. They were there when you needed the cash, and they deserve to know what's happening.
Communication can also offset the serious problems. "Most lenders, whether it's a mortgage company or a credit card company, are willing to work with you if you are upfront with them and explain your circumstances," says Realo. "If possible, talk to them before you get behind on payments, but even if you are already behind it's not too late to reach out."
Step 5: Follow through and finish up
Only make promises you will keep. If you say you'll resume payments in three months, do it. And when one creditor is repaid, apply those funds to the next lender on your priority list.
Follow this five-step system and you'll not only appease those you owe, but you'll feel organized and know you're doing your best under the circumstances.
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