In this modern world that we live in, consumers are protected and have certain rights when it comes to debt collection. The practices of debt collection agencies have to abide by rules through the Fair Debt Collection Practices Act (FDCPA) as enforced by the Federal Trade Commission (FTC). According to the FTC, consumers are to be safeguarded from abusive, harassing or unfair debt collection practices. But, the question is, “Does this act protect consumers from being arrested for the failure to pay back their debts and sent to a debtor’s prison?” The short answer is yes, but there are some instances related to debt in which people have been sent to jail.
Debtor’s Prisons were abolished in the US in 1833, and thankfully so. Before the abolishment, being arrested for outstanding debt was a catch-22 situation. Since there were no work-release programs in place at that time, there was no opportunity for the debtors to make good on their outstanding debt. To make matters worse and put more debt strain on the debtor, they would be responsible for paying prison fees as well. So, without the financial help of friends or family, there would literally be no way to escape their sentence.
Consumers’ debt rights have come a long way, but why are people still being arrested if the debtor’s prison was abolished so long ago? Here are some answers that can shed some light.
What Could Put You at Risk for Arrest
While arrests can be made in a debt situation, it’s not the debt itself that will get you arrested; it’s the violation of the court order that can land you in jail. Depending on the court and jurisdiction, it may be required of the debtor to appear in court. If you are summoned to appear and ignore that summons, a warrant may be issued for your arrest for failure to appear in court. It’s very important to ensure that you don’t ignore any correspondence from the courts and are compliant in regards to being sued for debt and the appearances you are expected to make.
If you don’t know what to do, don’t procrastinate and push it aside. Ignoring a summons to appear in court will not go away. You have the option to represent yourself. However, you may want to consult an attorney that understands the laws on what debt collectors can and cannot do by law as well as your legal rights as a debtor. Depending on your state, there are some other specific restrictions on what creditors and debt collectors can and cannot do when trying to collect a debt.
Many types of debt collection practices are prohibited.
Should you have any debt that is in the process of collection, it’s important to educate yourself on the types of debt collection practices that are prohibited. In addition to being prohibited from harassment, debt collectors may not:
Use any threats of violence or harm
Publish a list of consumers who refuse to pay their debts (except to a credit bureau such as Experian, Equifax, and Transunion)
Use obscene or profane language when trying to collect on the debt; or
Repeatedly use the telephone to annoy and harass a debtor.
Take or threaten to take your property unless this can be done legally(meaning the debt is secured and tied to an item that can be repossessed);
Threaten to sue, garnish your wages and freeze your bank account if they have no intention of doing so.
Knowing what debt collectors are legally allowed to can be overwhelming. Consider consulting an attorney in your county to help you find out what you need to know to keep yourself protected.
In the world of personal finance, there are plenty of heated debates. Should you save for an emergency or pay off debt first? Is any debt “good” debt? Are balance transfers an acceptable way to pay off debt more quickly?
And then there’s the classic argument: debt snowball vs. debt avalanche.
Before we launch into the nitty-gritty of the “which is better” argument, let’s talk about what a debt snowball and a debt avalanche are.
Debt Snowball vs. Debt Avalanche
Both of these methods acknowledge a basic fact: you need a plan when it comes time to pay off debt. If you just start throwing a bit extra at debts at random, you’ll likely fail. Your best bet to becoming debt-free is to pay off your debts in a methodical, planned manner.
Snowballs and avalanches are both methods for paying off debt. The only difference between them is in the approach
The debt snowball was popularized largely by personal finance giant Dave Ramsey. The idea is that you start paying off your debts with the smallest balance first. Make all your monthly minimum payments. Then throw any extra funds at that smallest debt balance.
Once that debt is paid off, continue paying the previous minimum payment amount, but put it toward the next-to-smallest balance debt. Each new debt you pay off then essentially rolls into the next one. In this way, you “snowball” your minimum payments, putting more money toward your debts each month until they’re all paid off.
The debt avalanche is similar in that you roll your minimum payments together as you pay off debts. Where it differs is in the order in which you pay off your debts. Instead of starting with the smallest balance, the debt avalanche has you start with the highest-interest debt. Rank your debts by interest rate, and then pay them off in reverse order, following the same “rolling” method as the debt snowball.
Why the Difference?
Having a plan to pay off your debts is, any way you slice it, a good thing. So why is there so much debate about which plan is best? Ultimately, it comes down to two things: math and psychology. With math, the debt avalanche always wins. But with psychology, the debt snowball usually does.
The Math Behind the Avalanche
If you know much about compounding interest, the mathematically correct way to pay off debts should be obvious to you. Knock out your highest interest rates first and you’ll save money over the long haul.
And this is true. In some instances, the difference could be hundreds or thousands of dollars in interest. You can use an online debt calculator to run the numbers. It’ll show you just how much you’ll save by using a debt avalanche rather than a debt snowball.
The bottom line is that even if it’s just a few bucks, you’ll always save money if you go with the debt avalanche method—that is, as long as you stick to your debt payoff plan. And that’s where the psychology behind the debt snowball comes in.
The Psychology Behind the Snowball
The question of snowball versus avalanche looms so large that social scientists have weighed in with actual studies. Their findings show that the snowball method is more likely to work. One study from Harvard showed that focusing on one debt at a time and knocking out the smallest debt is the best approach. Another study from the Kellogg School of Business concurred. Essentially, consumers who start debt payoff with the smallest debt are more likely to be successful in their debt payoff efforts.
Why is this? Well, psychologists theorize that it has to do with the quick wins you can get with the debt snowball method. If your smallest debt is a few hundred bucks, you can probably pay it off quickly. Then you begin to gain momentum as you move through your debts. By the time you’re tackling that monstrous $30,000 student loan, you have plenty of experience and drive to pay off your debts.
So Which Is Better?
To be honest, neither approach is considered better than the other.
Here’s the deal with this and other personal finance arguments: it’s personal. If you’re motivated by math—as many people are—you may find the debt avalanche is a better fit. If you’re like most consumers, though, the debt snowball is more likely to keep you on track.
One thing to keep in mind, though, is that the savings you get from the avalanche method will depend on a variety of factors. The longer it takes to pay off your debts, in general, and the wider the spread between your highest and lowest interest debts, the more you’ll save with the avalanche.
Of course, you can always take a hybrid approach. Say one of your middle-of-the-road debt balances has a super-high interest rate compared with your other accounts. You might consider paying it off first and then paying off your debts in order of balance and get the benefits of both methods. Or you might get some momentum by knocking out a few smaller debts first, and then start knocking out your higher interest rate accounts.
The goal here is to choose a method and stick with it. If you find yourself losing steam, find a smaller debt to get rid of. Just keep going until you’re finally debt-free.
Nobody likes being in debt, but it’s even worse when it seems like there’s no way out. That’s how the 12 million Americans who take out payday loans each year usually feel. That’s understandable, considering they pay out around nine billion dollars in loan fees. But there is hope—you don’t have to be stuck in the payday loan debt cycle forever.
Why It’s So Easy to Get Buried in Payday Loans
Payday loans are unsecured personal loans targeted at people who need money fast but don’t possess the type of credit or collateral required for a more traditional loan. Usually the only requirements to qualify for a payday loan are an active bank account and a job. Companies like MaxLend, RISE Credit, and CashMax have made an art out of providing high-interest loans to people who feel desperate and out of options.
The very structure of payday loans is set up to keep people on the hook. Here’s a breakdown of what payday loan debt looks like, according to the Pew Charitable Trusts:
It’s not short-term. Although payday loans are advertised as quick, short-term loans, the average payday loan borrower is in debt for a full five months each year.
Loan fees are huge. Average loan fees are $55 every other week, and the average borrower pays $520 per year for multiple loans of $375.
People borrow for the wrong reasons. Most payday loan borrowers—70%—spend the money on everyday expenses, like groceries, gas, and rent, rather than on emergencies.
It’s a vicious cycle. To totally pay off a loan, the average borrower would need to fork over $430 the next payday following the loan. Because that’s a big chunk of change, most people end up renewing and extending the loan. In fact, 80% of all payday loans are taken out two weeks after another one was paid in full.
What Happens If I Don’t Pay My Payday Loan?
As with any other loan, if you default on a payday loan, it can result in growing fees, penalties, and possible legal action. Because many payday loans use automatic debit payments to take funds directly out of a bank or prepaid account, you can also end up with overdraft fees on top of everything else. This can leave you without the funds you need to pay for necessities like food, childcare, and utilities. To top it all off, you may also experience a barrage of calls and threats from debt collectors.
This all sounds extremely unpleasant, but there are ways you can get help with payday loans.
How to Get Out of Payday Loan Debt
As we’ve established, it’s crucial to stop the vicious cycle of payday loan debt. There is payday loan help, but it can be hard to know where to start.
The best way out can depend on where you took out the loan. Laws governing payday loans vary from state to state. Some states, like Colorado, are currently working to change the way payday loans are administered in order to make it easier for customers to pay loans back and avoid the snowball effect of constant loan renewal. Other states require payday lenders to offer borrowers an Extended Payment Plan (EPP), which stops the accrual of fees and interest.
Here’s a closer look at some of the options available to get rid of payday loan debt.
Extended Payment Plans (EPPs): If you borrowed from a lender who is a member of the Community Financial Services Association of America (CFSA), then you may be in luck. CFSA’s Best Practices allow a payday loan customer the option of entering into an EPP. This means you’ll have more time to repay the loan (usually four extra pay periods) without any additional fees or interest added for that service. Best of all, you won’t be turned over to collections as long as you don’t default on the EPP. Here are the steps to follow if you want to apply for an EPP:
Apply on time. You must apply for the EPP no later than the last business day before the loan is due.
Sign a new agreement. If you took out your loan through a storefront location, you’ll have to go back to that location to turn in your application. If you took out a loan online, you’ll need to contact your lender for instructions about how to sign your new agreement.
Credit Counseling: If an EPP isn’t an option, you may want to talk with a credit counseling agency. While credit counseling agencies spend their time helping consumers get out of debt, these kinds of loans can present unique challenges. “It’s not a traditional loan with set guidelines in terms of how they work with us,” explains Fox. In spite of those challenges, there are things a credit counseling agency can do to help you get out of payday loan debt:
Restructure the payback. Fox says that payday lenders who are members of the CFSA “seem to be more lenient” and are “more apt to try to work with people.” Those lenders will often “restructure to pay back (the balance) over six to twelve months when coming through our program.” But he also adds that this applies in only about 40–50% of the payday debt situations clients are dealing with.
Negotiate a settlement. If restructuring the payback terms isn’t an option, the credit counseling agency will try to work with the lender to determine a settlement amount that will resolve the debt altogether. If you can pay off the loan with a lump-sum payment (this is the time to ask Mom or Dad for help), the agency may be able to settle the debt for a percentage of the outstanding amount.
Adjust your budget. If no other options are viable, the agency can work with you to come up with a budget that will help you find the money to get the loan paid off. Sometimes that means reducing payments on other debts, consolidating debts, or reprioritizing other expenses.
Bankruptcy: Nobody wants to resort to this option, but sometimes it’s the only way to get out from under this kind of debt. There is a myth out there that you can’t include payday loans in a bankruptcy. However, that is not the case: “For the most part, payday loans aren’t treated any differently in bankruptcy than any other unsecured loan,” writes attorney Dana Wilkinson on the Bankruptcy Law Network blog.
Another unsubstantiated claim is that you may be charged with fraud or arrested if you can’t pay a payday loan back or if you try to discharge the loan. One of the reasons this fear is so widespread is that payday loan debt collection scammers often make these kinds of threats, despite the fact that these threats are illegal.
What to Do After You Get Rid of Payday Loans
After you get out of payday loan debt, you want to make sure you never go to a payday lender again. Some of the smartest things you can do to start cleaning up your credit include signing up for a free credit report. Regularly checking your credit is the best way to make sure you clear up any mistakes. Plus it’s rewarding to see your credit score improve.
Getting out of payday loan debt can seem daunting, but it’s worth the effort and hard work. Taking control of your finances—and actually being able to plan for the future—is a reward worth striving for.
Are you trapped in payday loan debt? Or have you found your way out? Share your story in the comments below.
Finding the words charged off on your credit report isn’t good news. It can be scary and confusing when you don’t understand what it means or how it happened. The name itself isn’t helpful either. People often misinterpret the meaning, which can lead to more costly mistakes with your credit.
Learning what charged off means and the impact charged-off debt has on your credit report can help you make informed decisions to get your credit back on track. Here is what you need to know about the meaning of charged off.
What Is a Charge-Off?
Having a charged-off debt means you have not been paying the full minimum payment on money you borrowed for a significant amount of time. Because of the delinquent payments, your debt is re-categorized as “charged off” on the company’s profit-and-loss statements. That means your creditor has given up hope that you will pay them back. The company considers the debt a loss, marks it charged off as bad debt as a profit-and-loss write off, and will either sell or transfer your delinquent debt to a collection agency or a debt buyer.
At that point, one debt may now appear twice on your credit report, compounding the confusion. One debt listing will be from the original company you borrowed money from. The second listing is from the debt collector the account was transferred or sold to. Both accounts will show up as active, which can make it frustrating to decipher.
Does Charged Off Mean Paid Off? Do I Still Owe the Debt?
Having your debt charged off does not mean your debt is paid off. Charged off is often used interchangeably with written off, sometimes leading people to believe the creditor has written off their balance and they no longer need to pay their debts. That is not the case. The company is writing off your debt as a loss for its own accounting purposes, but it still has the right to pursue collection of the past-due amount.
You are still legally obligated to pay back the money you borrowed unless you settle (or file for certain types of bankruptcy) or the statute of limitations has been reached.
When Will a Charge-Off Happen?
Creditors will first try to send letters to remind you of a past-due bill. If that fails, they move to a collections process. Re-categorization to “charged off” typically happens after your payment is 180 days past due, though installment loans (something along the lines of a mortgage, for example) can be charged off after 120 days of delinquency. The six-month mark comes from a generally accepted accounting principle that determines 180 days to be the point after which receiving payment is highly unlikely.
It is important to note that debts can be charged off even if payments have been made, providing that all of the payments were below the account’s monthly minimum. Once the debt is charged off, the delinquency is reported to credit agencies.
How Does a Charge-Off Affect My Credit Report?
A charge-off will be bad news for your credit report. Because a charge-off comes from missing payments, you will have late payments and a charge-off listed on your credit report. Negative information such as those lead to a lower credit score. In fact, late and delinquent payments have the largest impact on your credit score: up to 35% of your score is determined by your payment history. And a lower credit score can cause everything from higher insurance rates to larger utility deposits to being denied credit.
How Long Does Charged-Off Debt Stay on My Credit Report?
Just like late payments, a charged-off account will remain on your credit report seven years from the date of the last scheduled payment before the account went delinquent. The time period does not start over again if the debt is sold to a collection agency or debt buyer. After the seven years, the charged-off account will automatically be removed from your credit report.
What Should I Do if I Have a Charge-Off?
The best thing to do is to pay the balance of your charged-off debt in full. Once paid, the report will show “paid charged-off.” It won’t remove the charge-off from your credit report, but it will show you are making an effort to resolve the negative account.
If you are unable to pay the debt in full, create a budget to find extra money to pay down the debt quicker. Paying your other debt on time each month is another great way to improve your credit report.
If you want to avoid having any of your accounts charged off, the best thing to do is take preventative measures. Learn and maintain positive financial habits and avoid living outside your means. Look into automating your finances as well to make sure you don’t miss any payments on your cards and put yourself at risk for getting charged off.
And don’t forget to check your credit report at least once a year to make sure everything is accurate and being paid. If you want to check your progress more often, you can get a free credit report summary, updated monthly, from Credit.com.
Source: Leonard & Reiter (2013). Solve Your Money Troubles, Debt, Credit & Bankruptcy. Berkeley, CA: NOLO
In June, it increased to $1.02 trillion, according to a report from the Federal Reserve. In other words, Americans now have more credit card debt than just before the 2008 financial crisis.
When facing such massive amounts of debt, it may be tempting to consider consolidation, one of the most popular ways for consumers to cope with mountains of bills. But before making such a move, it’s important to think about the potential downsides and drawbacks—and there are quite a few.
“Debt consolidation is rarely a good option,” says Holly Morphew, a certified financial health counselor. “Those looking to consolidate debt usually don’t understand what it is and are simply stressed about unmanageable debt and looking for a way out of it.”
Among the nuances to understand is how consolidation impacts your credit score, what your new interest rate will be, and what the repayment terms are—particularly when consolidating student loan debt, which can be dangerous, says Morphew.
Here are six of the biggest drawbacks to keep in mind when considering debt consolidation.
1. Transfer Fees
Consolidating credit card debt via a balance transfer to a new card can seem enticing, especially when there are so many 0% APR offers being presented to you at every turn. But Han Chang, cofounder of InvestmentZen.com, warns that nothing is ever free.
“Offers like this usually come with a one-time balance transfer fee ranging from 3% to 10% of the total balance transfer,” says Chang. “That can really add up and, if you’re not careful, completely negate any savings that 0% APR offers.”
2. Government-Backed Program Losses
Another often-overlooked drawback of debt consolidation is the potential loss of government-backed programs, primarily pertaining to student loans. While there can definitely be some advantages to combining all of your student loans, be sure to read the fine print of your new agreement carefully.
In particular, determine whether you’ll still be eligible for common federal government perks.
Morphew says student debt consolidation is actually one of the most risky things to do.
“If you don’t choose the right company, or decide to consolidate federal subsidized loans into a private loan, you can lose those repayment benefits such as deferment, forbearance, and loan forgiveness,” she says.
3. Credit Score Dings
If you are working with a debt consolidation company or a financial institution to combine your bills, the company will likely conduct a hard credit inquiry. While the effects of this inquiry are temporary, says Chang, be prepared to see your credit score drop in the short term.
Often the goal of debt consolidation is to secure a lower overall interest rate. But that’s not always what happens, says Morphew. You can actually end up paying more because the company giving you the new consolidated loan will average the rates on your debt and round up based on its terms, she says.
In addition, if you have poor credit to begin with, you may not qualify for a lower interest rate, says Amber Westover of BestCompany.com.
“You may end up paying more for your debt over the course of your consolidation loan,” Westover says.
5. Expensive Debt Consolidation Costs
Debt consolidation companies don’t work for free. Many national companies offering this type of service charge a fee of 15% of the total debt, says Richard Symmes, a consumer bankruptcy attorney.
“This leads the consumer to pay much more than if they had negotiated with the creditor on their own. Many of these fees may even be fraudulent under individual state laws, which cap how much a company can charge for debt consolidation services,” he says. He instead suggests conducting such negotiations with the help of an attorney, who simply charges a flat fee.
6. Increased Overall Loan Costs
One last drawback worth noting: just because your monthly payments may go down under a debt consolidation program doesn’t necessarily mean your overall debt is going down.
“If you consolidate high-interest short-term debt for very long-term debt, then you may actually be paying more,” says financial analyst Jeff White. “For instance, paying $500 per month for one year (which translates into $6,000) is less than paying $75 per month for 10 years (which is $9,000).”
Consolidating could be a smart financial move, or it may just sound like it. To find out if consolidation or another debt management strategy is right for you, visit our Managing Debt Learning Center.
The next time you speak to a debt collector, you might find yourself negotiating with a computer. And you might actually prefer that.
Consumers buy toothpaste and bread without talking to a person. They get boarding passes for flights with a few swipes of a credit card or mobile phone. Why not pay off debt with a click or a text? After all, many consumers expect self-service now, and would rather perform these kinds of transactions without ever interacting with another human being.
Debt Collection Is Going Digital
In April, Experian announced a self-service platform named eResolve, which it says will let consumers negotiate and resolve past-due obligations without ever talking to a debt collector.
“The eResolve platform negotiates with the consumer on the client’s behalf and direction to resolve their obligation in a frictionless environment,” Paul DeSaulniers, senior director for risk scoring and trended data solutions at Experian, said in an email. ”eResolve is providing a way for the consumer to interact on their terms, at any time of the day or night using a digital channel that is more preferred over the traditional phone call and avoids aggressive collection tactics.”
A firm named TrueAccord attracted a lot of attention in 2014 promising to create a similar digital debt collection platform. CEO Ohed Samat says that since then, TrueAccord has generated plenty of success stories. He claims more than 60 clients with 1.4 million consumers are “on the platform.” There have been “hundreds of thousands” of resolutions — including consumers who could easily click and tell the firm they’d been victims of ID theft, or had filed bankruptcy, so collections efforts should stop.
Adios, Debt Collector Misbehavior?
It’s easy to see the potential advantages of digital collections. For starters, the obvious: Misbehaving debt collectors top most lists of consumer gripes, so getting rid of the “human element” can get rid of the illegal threats. After all, computers don’t get frustrated.
“Debt collection is a powder keg. There are explosive situations,” Samat said. “A computer doesn’t get tilted (frustrated). You can’t yell at computers and scare them.”
The old-fashioned method of debt collection resembles telemarketing, and when done badly, adds a layer of badgering that can violate the Fair Debt Collections Practices Act. While more phone calls don’t mean higher collection rates, they do mean greater risk for harassment allegations. Both Experian and TrueAccord claim their technologies work to optimize the timing and method of communication with customers to get the best results.
“Consumers desire a more seamless and convenient way to resolve their debts, without what is often felt as an uncomfortable exchange,” DeSaulniers said. “The process is about making the experience less threatening for consumers and gives them the flexibility to access their account at any time. Doing so increases the consistency and efficiency of the debt collection process.”
ACA International, a trade association that represents collection agencies, did not immediately respond to request for comment for this article.
“First, the lender or collection agency contacts the consumer to remind him of his debt owed. At the same time, a website link is provided to the consumer, who can negotiate the payment of his debt without human interaction,” DeSaulniers said, describing the process. “Next, the consumer logs on to the website to submit a reference number associated with their account and then explores repayment options. Here, the consumer may negotiate payment amounts, terms and dates within parameters set by the lender.”
For example: Debtors get an email with an offer such as making three payments with 0% interest, or 90 cents on the dollar if paid in full. Depending on what lenders say they’ll accept, a consumer who turns down that offer might get a subsequent pitch for an 80-cents-on-the-dollar settlement. (Do you know your state’s statute of limitations on debt collections? Check them out using our handy map on debt collection statutes of limitations by state.)
Samat says machine-based debt collection solves several problems. Chief among them: thorny regulatory issues. Computers don’t call or text at the wrong times. They don’t use forbidden language, such as threat of law enforcement.
“Because of our machine-based approach, almost every line of text we send (to consumers) is pre-written and preapproved. It’s much easier for us to be compliant,” he said. He claims TrueAccord gets 66 times fewer complaints than traditional collection agencies (the sample size is still small).
Digital debt collection also fits into modern consumer behavior, Samat said. More than 60% of the interactions his firm has with debtors happen after hours, when it would be illegal to call.
“It’s people at 2 a.m., on their mobile phone, looking at their options,” he said.
Collection Efforts Tailored to Your Behaviors
But there’s more going on than just staying on the right side of the law. TrueAccord’s computers watch consumer behavior and learn when best to ping them for a resolution. If someone has spent several nights clicking through settlement options, perhaps that’s a good time to send a text, or even make a better settlement offer.
“People are different. Some need encouragement. Some need inspiration. Some need to be pointed to the facts,” he said. “We reach out in the right channel at the right time in the right language.”
Some of that language is funny – one note tells a debtor that a bill feels neglected and is “listening to breakup songs and eating ice cream” because it is unpaid. Per one consumer’s report, however, some were more sanctimonious, or even menacing.
When asked about the complaint, Samat said that if the cited email was really from TrueAccord, it was probably “very old and long decommissioned.”
“It did take us a while to find the right type of honest and clear communication that consumers respond well to,” he said. “And, of course, we have unfortunately seen cases where consumers confused us with other agencies.”
But digital debt collection might have a secret weapon: embarrassment – or rather, the lack of it.
“Consumers feel less judged,” when talking to a computer, Samat said. “Consumers in debt are afraid and overwhelmed. We speak to them in a tone they appreciate … we give them more flexible choices, so they feel like they aren’t being harassed.”
Unemployment is low, inflation is historically low and even wages are perking up, leading many observers to believe the U.S. economy is humming along nicely. So why do many Americans say they are struggling?
A new book born of meticulous, years-long research offers a fresh insight into this burning question. Month-to-month swings in income, even for those with full-time jobs, are often the cause of Americans” financial anxiety, claim the authors of “The Financial Diaries: How Americans Cope in a World of Uncertainty.”
For a stunning number of American households, both income and expenses swing 25% or more in either direction on a regular basis, leaving many families scrambling on a month-to-month basis, even if things don’t look so bad annually, the authors argue in their book and a Harvard Business Reviews essay.
Economic data tends to examine broad movements; even at its most micro, it tends to identify years-long trends. Researchers Jonathan Morduch and Rachel Schneider had a sense government statistics were missing things, so they went nano. They spent 12 months getting 235 families to track every single dollar going in and out — 300,000 cash flow events in all. The product of their painstaking research offers perhaps the clearest view yet of why even middle-class Americans find themselves living with deep economic anxiety. The book even offers up a new term — “precarity,” or precarious economic volatility — to describe the plight of everyday Americans.
One of the more bold claims made in the book: Despite all the talk about income inequality, the authors say income instability has risen even faster and is the more immediate problem.
What’s Income Instability?
Many readers are familiar with the idea that unexpected expenses — like a health scare or major auto repair bill — can derail many households. But the book establishes another reality that might be new to many: income volatility, even among those with full-time jobs.
The book’s opening anecdote cites a research subject who works as a truck mechanic in Ohio. While he works full time, his pay relies largely on commissions and can vary from $1,800 to $3,400 each month. In bad weather, trucks break down more often. That means in the spring and fall months, mortgage payments aren’t made, and the electricity bill goes unpaid. Later, for a fee, the family catches up. (You can see how any missed loan payments may be affecting your credit scores by viewing your free credit report summary on Credit.com.)
This same problem is repeated again and again among the families studied. Morduch and Schneider found that the term “average income” is a bit of a farce, as typical families lived through five months each year with income that swings either 25% above or below “average.”
“This is creating a lot of anxiety and uncertainty that is impossible to see in the usual data,” Morduch said in an interview. About five months out of each year, incomes “weren’t even close” to average.
“Often we see the (financial) problems as a discipline problem, a failure of personal responsibility. What we’re trying to say is there’s something else going on,” he said. “The underlying conditions are really hard. It probably isn’t just about self-discipline.”
Income swings are to be expected among families suffering job loss, the self-employed or those who rely on tips, like waiters. But the researchers found a stunning rate of income volatility even among those with traditional-sounding full-time jobs.
“This was the single biggest surprise (in the research),” Morduch said. “There’s insecurity that’s because you are going to lose your job, but that’s not what’s driving anxiety for these folks … What we see is that when paychecks bounce from month to month, people can be making good financial choices but are still struggling.”
As a result, even earners who are safely in the middle class spent a month or two living as poor or “near poor,” the book says. The problem for many is better described as a lack of liquidity — getting enough cash to pay the mortgage this month — than as insolvency, or a hopeless difference between income and expenses.
“Not balancing on a high wire, driving on a rocky road,” the book says. “(There’s a) distinction between not having money at the right time vs. never having the money.”
While economists might just be becoming aware of this month-to-month struggle, the financial industry has known about it for some time. That’s one reason there are more payday lending storefronts in America than McDonald’s restaurants. (You can find tips for escaping payday loan debt here.)
Trouble Saving for a Rainy Day
The volatility problem is closely related to Americans’ lack of emergency savings. Study after study shows a large percentage of Americans don’t have the recommended three months of living expenses stored in short-term savings. Some studies show even more dire data. A stunning 46% of Americans told the Federal Reserve in 2015 they could not cover an emergency $400 expense without selling something or borrowing the money. Income and expense volatility, combined with no savings, is a perilous combination.
“Households don’t have a big cushion. Into this mix is the reality that levels of income have not risen – the bottom 50% has seen no income growth since 1980 — then you are really squeezed,” said Morduch. As a result, even in good months, earners don’t have any extra left over to build a rainy-day fund – economists say their budgets have no “slack.”
“There is a knock-on effect of diminished slack so when the budget gets hit by a car repair or the house needs a new roof, it’s just that much harder,” Murdoch said.
How did this income volatility come to pass? The authors blame what they call “the Great Job Shift.” Employers are increasingly sharing risk with their workers. That means cutting back hours, often on the spot, when times are slow. Or basing a large portion of pay on commission, as in the case of the truck mechanic. In other cases, workers rely on tipping to top-up wages that otherwise aren’t livable. In one of the book’s more frustrating scenes, as casino blackjack dealer in Mississippi describes how her income relies on events as whimsical as the nearby college football team schedule.
The subjects in the book are anonymized. Their names changes and a few other personally identifiable data points have been obscured, but otherwise, their financial diaries are disturbingly real.
How Do We Fix it?
When asked for policy recommendations, Morduch leaps to the defense of the Consumer Financial Protection Bureau, which he says is working hard to regulate many of the short-term lending products that have emerged to services workers with volatile incomes. He says there’s also been constructive conversations with large firms about making hourly wage worker schedules more predictable, and moving away from so-called on-call workers. The “Schedules That Work Act” that would have promised some workers two-weeks scheduling notices was considered but tabled by Congress under President Barack Obama.
Other changes would help, too. Many social benefits programs are cumbersome to apply for and don’t offer much help for families who are only occasionally “near poor,” and might need help one or two months per year.
Changes that could encourage saving for short-term events would help, too. Tax-advantaged products like 401K accounts help families plan for decades in the future, but families living on the margins are afraid to use them for emergency savings because of the severe early withdrawal penalties. (You can learn more about withdrawing from your 401K here.) More flexible rules would encourage greater use of retirement accounts, Morduch believes.
“A lot of Americans wisely don’t want to lock up their money,” he said. “There isn’t enough attention paid to shorter-term policies.”
In a larger sense, Americans should probably change the way they think about income and spending, Morduch said, and many could learn from research subjects described in the book.
“The families we got to know, they think a lot about liquidity. They have a lot to tell other Americans. Mainly, prepare for a life of ups and downs,” he said.
You’re probably going to die with some debt to your name. Most people do. In fact, 73% of consumers had outstanding debt when they were reported as dead, according to December 2016 data provided to Credit.com by credit bureau Experian. Those consumers carried an average total balance of $61,554, including mortgage debt. Without home loans, the average balance was $12,875.
The data is based on Experian’s FileOne database, which includes 220 million consumers. (There are about 242 million adults in the U.S., according to 2015 estimates from the Census Bureau.) Among the 73% of consumers who had debt when they died, about 68% had credit card balances. The next most common kind of debt was mortgage debt (37%), followed by auto loans (25%), personal loans (12%) and student loans (6%).
These were the average unpaid balances: credit cards, $4,531; auto loans, $17,111; personal loans, $14,793; and student loans, $25,391.
That’s a lot of debt, and it doesn’t just disappear when someone dies.
What Does Happen to Debt After You Die?
For the most part, your debt dies with you, but that doesn’t mean it won’t affect the people you leave behind.
“Debt belongs to the deceased person or that person’s estate,” said Darra L. Rayndon, an estate planning attorney with Clark Hill in Scottsdale, Arizona. If someone has enough assets to cover their debts, the creditors get paid, and beneficiaries receive whatever remains. But if there aren’t enough assets to satisfy debts, creditors lose out (they may get some, but not all, of what they’re owed). Family members do not then become responsible for the debt, as some people worry they might.
That’s the general idea, but things are not always that straightforward. The type of debt you have, where you live and the value of your estate significantly affects the complexity of the situation. (For example, federal student loan debt is eligible for cancellation upon a borrower’s death, but private student loan companies tend not to offer the same benefit. They can go after the borrower’s estate for payment.)
There are lots of ways things can get messy. Say your only asset is a home other people live in. That asset must be used to satisfy debts, whether it’s the mortgage on that home or a lot of credit card debt, meaning the people who live there may have to take over the mortgage, or your family may need to sell the home in order to pay creditors. Accounts with co-signers or co-applicants can also result in the debt falling on someone else’s shoulders. Community property states, where spouses share ownership of property, also handle debts acquired during a marriage a little differently.
“It’s one thing if the beneficiaries are relatives that don’t need your money, but if your beneficiaries are a surviving spouse, minor children — people like that who depend on you for their welfare, then life insurance is a great way to provide additional money in the estate to pay debts,” Rayndon said.
Poor planning can leave your loved ones with some significant stress. For example, if you don’t have a will or designate beneficiaries for your assets, the law in your state of residence decides who gets what.
“If you don’t write a will, your state of residence will write one for you should you pass away,” said James M. Matthews, a certified financial planner and managing director of Blueprint, a financial planning firm in Charlotte, North Carolina. “Odds are the state laws and your wishes are different.”
It can also get expensive to have these matters determined by the courts, and administrative costs get paid before creditors and beneficiaries. If you’d like to provide for your loved ones after you die, you won’t want court costs and outstanding debts to eat away at your estate.
Here’s something your may not know: Tax season is like Christmas for debt collectors.
In fact, as president of a national debt collection company, I can tell you some agencies will collect as much money from February through May as in the remaining eight months of the year. Why?
Well, the first reason is a bit obvious: Many consumers in debt will receive a tax refund and go on to use that money to pay off their delinquent debt. Second, many debt collectors are good at what they do and want to help consumers resolve their outstanding liabilities. They’re willing to work out or negotiate a payment plan the consumer now has the ability to repay. (And, yes, that means the debt collector who’s been contacting you may be willing to settle up for less than what you owe.)
So who has the upper hand when it comes to getting debt repaid during tax season? If the cards are played right, both the consumer and the debt collector come out ahead.
During this time of year, consumers are generally going to come across two types of debt collectors. The first is a debt collector who understands a consumer has access to a limited tax refund — and is potentially trying to pay off a multitude of debts. This collector will be looking to help the consumer resolve as many debts as possible with the funds they receive back from Uncle Sam. The other type of debt collector will hold their ground, knowing the consumer has funds to pay off a singular debt, and will ultimately refuse to negotiate payment for a lesser amount. Odds are consumers will run across both types of debt collectors during this time of year.
What Drives a Debt Collector’s Settlement Stance?
If you have an outstanding debt, it is important to understand the delicate balance collectors face during tax season. Several factors determine what debt collectors ultimately are able to do for consumers looking to settle a debt for less than what is owed.
The main factor is the client whose behalf they are collecting on. Settlements live and die with the requirements of a client; either they authorize the debt collector to offer a settlement or they do not. If the client allows for settlements, it is dependent upon the agency as to when, where and/or how they offer one. Some agencies may only offer settlements for accounts on file for 60 days or more, whereas other companies will offer settlements on the first day the account gets to their office.
The Odds Are in Your Favor
It is more probable than not that during tax season a debt collector has the ability to offer a settlement. Contrary to popular belief, debt collectors do not like to turn away money, especially this time of year. While one may hold firm for a while, when approached with a reasonable settlement offer, they will generally do what is in their power to get it approved. They may be willing to waive excess interest, late fees and other non-principal-related charges before tax season is up as well.
On the flip side, consumers should not expect a debt collector to take “pennies on the dollar” to settle accounts. Even if their agency did directly purchase the debt — which happens less frequently these days — the debt collector you’re dealing with isn’t the person who directly bought the debt, and they are going to be required to follow the guidelines set forth by their employer. You can find more tips for negotiating with a collector here.
The Bottom Line
Tax season can be a mutually beneficial time for the consumer and the debt collector, so if you’re hoping to shore up an outstanding account and/or are looking to strike a deal, now may be the right time to do so.
Just keep in mind, if one side tries too hard to “game” the other, an opportunity to resolve a bad debt will likely fall through and that bill will remain delinquent. At the end of the day, if consumers and debt collectors engage in a professional and respectful dialogue, it’s likely they’ll reach a resolution that benefits all parties.
[Editor’s Note: A collection account can wind up hurting your credit score. To see where yours stands, you can view your free credit report snapshot, updated every 14 days, on Credit.com.]
This story is an Op/Ed contribution to Credit.com and does not necessarily represent the views of the company or its partners.
If you’re expecting a hefty refund this year from Uncle Sam, you may be tempted to spend it all on something extravagant for yourself. But it’s important to resist temptation and use that money wisely — at least most of it.
Your tax refund may feel like a windfall, but you should treat this surplus cash just like your other earnings, says David Weliver, personal finance expert and founding editor of Money Under 30.
It’s all about your attitude and making sure you set realistic expectations.
“The biggest mistake I see people make … is treating [bonuses and tax refunds] as ‘found’ money instead of earned money. Research shows we’re more likely to spend a windfall frivolously than money we’ve earned. This is especially true of money we weren’t expecting,” he says.
While tax refunds are still earned money, “the fact that it comes all at once means we associate it less with our daily efforts,” says Weliver. If your refund is what you’ve expected, or even bigger than you expected, you could be triggered to spend more of it. It’s probably not a good idea to count on having a sizable refund every year, “because that can lead to spending it before you’ve received it,” he says.
What’s the Best Use of My Tax Refund?
Before you spend anything, first you need to take stock of your debt situation. If you have credit card or consumer debt, attack that first. That’ll help your bank account — and your credit score, since high credit card balances can affect your credit-to-debt ratio. (You can see how yours is doing by viewing your free credit report summary, along with two free credit scores updated every 14 days, on Credit.com.)
When it comes to paying down larger debts, like student loans or a mortgage, the decision is more personal, and could be a good move as long as your other long-term financial goals are being met.
Should I Invest my Tax Return?
After addressing any applicable debts, make sure you have an emergency fund that will cover at least six months of expenses. That money, along with anything that will be going toward big purchases in the next three years, like a car, the down payment on a home, or a big vacation, should be kept in a savings account.
“It can be tempting to invest that money in a rising stock market, but if there’s a big market correction before you cash out, you could be forced to sell at a substantial loss,” Weliver says. “If, however, you’ve got the emergency fund and won’t need that cash in the next few years, you’ll want to invest in boring old index funds or with a robo-adviser. Invest it, forget it’s there, and go back to working hard.”
You can also make contributions to a Roth IRA or a 529 savings plan.
At the end of the day, your tax refund shouldn’t turn you into a Grinch (unless you’re digging out of credit card debt), and spending some on a splurge could be good for you.
Setting aside between 10% and 25% of your tax refund for something you really want is a great way to reward yourself and stay motivated, Weliver says.
Another option? Get involved with causes you’re passionate about and donate some of your refund to charity. There’s a bit of a bonus to that option, too: The donation could net you a tax deduction next year.