May 2010 Archives

It comes as a surprise to many people that taking on debt can make wise financial sense. Of course, certain types of debt are undesirable, but under the right circumstances, taking on debt can be the first step toward building good credit and putting yourself on the road to financial security.

As a general rule, debt incurred for the purpose of investing in something that will increase in value over time is a positive debt. On the other hand, borrowing money to purchase something that will decrease in value is considered a bad debt. These are somewhat simplistic explanations, but some illustrations may be useful in showing the difference between a good debt and a bad debt.

Some debts that are generally thought of as good debts include: student loans, home loans or mortgages, and business loans. Why? Because these loans are thought to be investments in something that will one day pay off and be more valuable than when originally purchased.

Given the recent events in the housing market, it may seem odd to think of a mortgage as "good debt," but there is another reason these debts are preferable. Interest that accrues on mortgages, home equity loans, and student loans is generally tax-deductible for the borrower.

For many people it is hard enough to build a solid credit rating, but when errors creep into credit reports, it can make it nearly impossible to obtain credit when needed. How common are credit reporting errors? In one 2004 study, nearly 80% of credit reports reviewed had some sort of mistake that could have resulted in a refused loan or other denial of credit.

Obviously, your credit is something that you have to be proactive in monitoring. Fortunately, there are some tools available to help. The Fair Credit Reporting Act allows you the ability to dispute information on your credit report and ensure that it is removed in a timely manner if it turns out to be incorrect.

These challenges to your credit report involve an investigation by the credit reporting agency and the creditor involved. Within 30 to 45 days you should find out if the disputed item will be removed, changed or remain on your report.

The Treasury Department announced its April figures for the Home Affordable Modification Program (HAMP) on Monday, revealing a surprising statistic. Nearly twice as many homeowners with loan modifications through the program dropped out in April than had done so in March.

Overall, over 299,000 applicants had received permanent home loan modifications through the program as of April. That number accounts for about 25 percent of those who started the process since March of last year. The average reduction in the mortgage payment for those who completed the program and obtained a permanent modification was $516, or 36 percent.

The rate of homeowners dropping out before obtaining a modification - starting the process but either not being able to negotiate a modification at all or failing to make the first three payments on time - rose abruptly from approximately 155,000 in March to about 277,000 in April.

Among those who succeeded in negotiating a modification and made the first three payments, 1.3 percent dropped out, most often because they defaulted on the modified loan.

The total number of permanent mortgage modifications does continue to grow overall. Nearly 300,000 homeowners have completed the program, an increase of 68,000 or almost 13 percent over March.

According to a report by the credit-rating agency Experian, residents of San Diego County have seen their average credit score drop to an average of 762 to 757 in the last two years, even as their average debt load has increased. For thousands of people seeking credit repair and control over their debt, those two statistics raise eyebrows.

Experian's senior director of analytics, Michele Raneri explains that the average score is down because lenders have cut back on lending, which means that the same amount of debt uses up more of your available credit. How much of your available credit you use is referred to as "utilization."

"Utilization is important because it still reflects how needy a consumer is and potentially shows cash flow problems," she said in an interview with the San Diego Union-Tribune.

The Average San Diegan Owes $24,012 in Non-Mortgage Debt

San Diegans owe, on average, $24,012 in on credit cards, car loans and personal loans, slightly lower than the national average of $24,775. Nevertheless, the average San Diego resident has a credit score of 751 - or a C grade under Experian's model.

According to a report by the Administrative Office of the U.S. Courts, the number of people and businesses who filed for Chapter 7 bankruptcy protection rose 34 percent over the past year. Chapter 13 filings were up 12 percent, and Chapter 11 business bankruptcy filings grew by 30 percent.

By far, consumers accounted for the majority of debtors filing for bankruptcy. The total number of personal bankruptcy filings was up 28 percent for the year, although Chapter 7 and Chapter 11 business bankruptcies, as a group, rose by 28 percent over 2009.

The data further document a trend - bankruptcy filings overall have risen nearly to their levels in 2005 before the new federal bankruptcy law was passed. Although the 2005 law was intended to force more debtors to choose Chapter 13 bankruptcy instead of Chapter 7, about 73 percent of bankruptcy filings in the last fiscal quarter came under Chapter 7.

In this economic downturn, a lot of responsible people are among the long-term unemployed and drowning in debt. If your credit score is already plummeting, is it worth it to try debt negotiation or consolidation? Or should you file for bankruptcy?

The truth is there's no one-size-fits-all answer. Whether to file for bankruptcy or seek alternatives to bankruptcy is a decision you need to make based on concrete information, understanding the options available, and a clear look at your goals.

The very first thing you should do is contact a reputable credit counselor who can help you determine how much you can afford to pay. Don't believe slick advertisements claiming they can settle your debts for 40 cents on the dollar.

Look for companies that belong to the National Foundation for Credit Counseling (NFCC) or the Association of Independent Consumer Credit Counseling Agencies (AICCCA). Bankruptcy lawyers are also a good resource, and the Bankruptcy Legal Group offers some of these services.

These days, your credit score can affect everything, and bad credit starts a vicious cycle: You're overwhelmed with debt, so your credit score drops. Your credit score drops, so the interest rates you pay go up. High interest pushes you farther into debt. To escape this cycle, it's tempting to turn to a debt negotiation or "credit repair" or "credit correction" company.

Usually for an up-front fee, credit repair companies typically agree to contact all of your creditors and convince them to give you a break. Some companies promise to reduce your interest rates or monthly payments - even your total debt. Others promise to "clean up" your credit report so you can deal more favorably with lenders.

It's always good to be skeptical of things that seem too good to be true, of course. Bankruptcy attorneys, consumer advocates and non-profit credit counselors have been sounding the warning about for-profit debt negotiation companies for some time now.

These companies -- especially those that charge up-front fees -- are often mere scams. At best, they are probably powerless to do anything you could not easily do for yourself.

Simply stated, homeowners who are "underwater" - owing more than their homes are worth - are much more likely to default than similar borrowers who do not. As currently structured, the Home Affordable Modification Program (HAMP) offers access to debt negotiation programs that can result in the reduction monthly payments. However, it does nothing to promote principal reduction. Critics, including regulators, members of Congress and mortgage bond investors are calling for that to change.

The April report on HAMP by the Congressional Oversight Panel (COP) appears to indicate that those homeowners who seek relief through HAMP may actually end up more deeply underwater than they were before they entered the program.

Of those who received a five-year mortgage modification through the program, the report found, the average borrower entered the program underwater by about 35 percent. Upon leaving the program, the average was more than 43 percent.

The reason for the increase is simple: Reductions in interest and extensions in mortgage terms are virtually the only relief offered through HAMP. They can reduce the borrower's monthly payment but do nothing to address the problem of negative equity.