How Much Does it Really Cost to Get Out of Debt?
Many people will confuse the difference between the Price and the Cost of a particular debt resolution option. You can only make a fair comparison of the various options after you fully understand what makes up the Price and what makes up the Cost of something. You may be thinking, ―But aren’t they the same thing? They are actually very different and once you understand the difference, you are on your way to saving thousands of dollars when resolving and paying off your debt.
The Price of something is only a figure, or a number, to establish relative worth. This is like the sticker Price of a car. The Cost is the actual amount of money you have to take out of your pocket to actually own the product or pay for the service. This is like the total of monthly payments on a car loan versus the purchase Price of the vehicle.
For example, let‘s say that the sticker Price of a particular new car is $30,000. After discounts and rebates, the final Price the customer pays is, say $25,000. Add sales tax, license, dealer fees, etc. and the final Price is now $27,000. The customer puts $1,000 down, finances the remaining $26,000 at 9% for 60 months, and drives away thinking he just bought a car for a Price of $27,000 (at least that is what he tells his friends!)
We now know the actual final Price – $27,000 – but what was the Cost? The $1,000 down plus 60 payments at $540 ($26,000 principal balance at 9% for 60 payments), equals a total Real Cost of $33,400. The difference between the $27,000 Price and the amount paid of $33,400 is the difference between the Price and the Cost. In other words, the Cost was actually 20% higher than the Price!
From that illustration you can see that if you have to pay for something over time, with any sort of interest or charges added, the total amount you have to take out of your pocket to pay for it will always exceed the initial purchase Price. The higher the interest, or the longer the time you have to make payments, the more the Cost will exceed the Price.
Now that you better understand the difference between the Price and the Cost of something, we can evaluate the true cost of various debt resolution options. Remember, people want the lowest Cost option, but usually buy what they think is the lowest Price option. As demonstrated earlier, Price should not be the determining factor in making a buying decision – it should instead be the total Real Cost.
The Bankruptcy Option
Bankruptcy may seem like the only way out of some situations, but you should consider what it will cost you. Sometimes, these costs will lead you to look for another solution.
You will need to consider more than just the costs for filing the bankruptcy. You will pay the filing fees and most likely need a lawyer. These filing fees have gone up as part of the Deficit Reduction Act. The filing fees were $200 for a Chapter 7 and $185 for a Chapter 13 filing, and have now gone up to $299 and $273 respectively.
If you make changes to your case or proposals for added actions, you will pay more. And you will have to avoid missing records and writing bad checks to keep from adding to the bill.
In general, just filing for bankruptcy can cost you in nine ways:
- Attorney fees
- Credit counseling
- Petition fees
- Amendment fees
- Reopening fees
- Conversion from a Chapter 7 to a Chapter 13
- Splitting fees
- Abandonment of property costs
- Withdrawing the reference fees
But you will pay much more than just for those items. For the next decade you will pay higher interest rates on any loans you are able to secure. If you want to buy a home, you will probably have to shop the subprime market, which automatically means higher interest rates.
You will also pay higher insurance premiums as insurance companies look to your credit history for the potential of claims by you. The worse your credit, the more likely you are to have a claim and the higher your premiums.
You may have to sell your existing home, cars and belongings to settle your debts. You may find that even after your debt obligations are fulfilled and your credit history is on the way to repair, you will still be unable to secure credit from your previous lenders. They keep the information on file for ten years from the time the bankruptcy is discharged, not from when it is filed.
Bankruptcy isn’t something to be taken lightly. It will cost you a lot of money and lost sleep. If you are able to find a way to avoid it, you should. Under the new law, you will have to attend credit counseling to be able to file for bankruptcy. You will have to pay for this, usually $50 a session.
You are not required to have an attorney represent you, but the paperwork can be overwhelming if you are not familiar with all the legal terms and requirements. There can be a broad range of fees for attorney services, but you can expect to spend at least $500 for competent legal counsel.
Generally, the total fees for the filing itself, credit counseling, and attorney fees can run anywhere from $700 to $2,000. If you shop around, you should be able to cover all the costs for about $1,000.
But of course just paying the costs does not get you out of debt – not by a long shot. If you are forced into a Chapter 13 filing, you will also have to pay your creditors back for somewhere between 40 and 60 cents on the dollar typically, plus Trustee fees.
Bankruptcy is something that is hard to recover from, both emotionally and financially. So look at bankruptcy not as a way to start over, but a long pause in your life. Everything will change. You should try to avoid it. The total Cost of bankruptcy is just too much to be a temporary fix for your problems.
The debt settlement industry is one of the hottest and fastest growing industries in the country right now. So many people are over extended on credit card and other unsecured debt that any solution can seem attractive. But what does it really cost to get out of debt using this option? Virtually all of the ads for this type of service tout savings of 40-60% off your current balance, with most quotes being for 50% plus the fees to the debt settlement company.
Although there is some variation on the costs associated with this option, we will use the most common pricing model being sold nationwide. The most typical program calculates repaying the debt for 50% of the original amount, plus a fee of 15% of the total debt. Using this as a starting point, we can do some calculations to determine the true Cost of this option.
For example, if you had total credit card debt of $40,000, you would be expected to pay $20,000 to your creditors and $6,000 to the debt settlement company, for a total of $26,000 paid over four years with a monthly payment of about $540. However, there are more fees associated with this option. The first is the monthly account maintenance fee that debt settlement companies charge. The typical fee is $40 per month, which would total another $1,920 in cost over the 48 months of the program.
There is one more cost that the debt settlement companies rarely mention, and that is the imputed income tax we discussed earlier. Debt settlement companies negotiate with the primary creditor and they are required to file a 1099-C for any forgiven debt. If you are in the 15% tax bracket, you would owe income taxes on the $20,000 in forgiven debt, or $3,000.
Now we can add up the total cost of getting out of debt using this option. The amount to the creditors plus the fees is $26,000, plus the monthly fees of another $1,920, and the taxes of $3,000 totals $30,920, or 77% of the original debt and would require payments for the next four years.
The Debt Consolidation Option
Due to dropping real estate values, this option has lost popularity in recent years but is still available as an option to some people. Although the low monthly payments available under this option can appear attractive, don‘t be fooled by this one – it is by far the most expensive option to get out of debt.
Since this is a one hundred cents on the dollar option, you would have to borrow $40,000 plus pay closing costs of about $1,200, for a total loan of $41,200 to be paid back at 9.5% interest over the next 15 years. This option would have a monthly payment of about $431, but it would last for a full 15 years, or 180 payments. The total amount paid back would be the $41,200 principal plus interest of $36,240 for a total amount of $77,440, or 194% of the original debt!
But wait. What about the interest deduction on the home equity loan? Based on a total interest payment of $36,240 and again assuming a 15% federal tax bracket, you would save a total of about $5,436 in taxes over the 15 years. Even if we subtract this amount from the total paid you would still end up paying $72,004 back on $40,000 in credit card debt – not a very good deal at all.
The Credit Counseling Option
This is another popular, and expensive, option to get out of debt. Basically there is no attempt made to reduce the principal balance, only to negotiate more favorable interest rates and perhaps lower minimum payments. The typical program takes 60 months to get out of debt and you will end up paying back more than the total current debt.
Using our earlier figure of $40,000 in credit card debt paying 18% interest and making payments of $1,200 a month we can see how the costs come out under a credit counseling program. You could possibly get the interest rate reduced to an average of 10% and set up a payment plan for 60 months. Using a credit card debt calculator we can determine that you would now be paying $850 a month and a total interest of $10,993. The total of payments and interest then would be $50,993 to be debt free in five years.
Asset Protection and Debt Resolution
The final option we will review when considering the true Cost to get out of debt is asset protection and debt resolution. There are variables that determine the actual cost of this option but we will use the following assumptions: You are current on your credit card debt; have some available credit left on your cards; can afford to make small monthly payments; and live in a state where wages can be garnished.
Using the same $40,000 in current debt from our earlier examples, we can determine that this is by far the lowest cost option, and the quickest, to get out of debt. It will also have the least long-term impact on your credit scores. At this debt level, the total cost to get out of debt, including the fee for the program, for a couple is less than 40 cents on the dollar. And the best part is, the entire program can be completed in about 18 months – faster than any other option available. Because of the leverage this type of program provides, you can expect to negotiate and pay off your debts for around 20 cents on the dollar and the balance will be in program fees.
Asset Protection and Debt Resolution would allow you to hold your creditors at bay while you accumulate enough funds to pay your creditors off at a substantial discount. You should expect to spend a total of around $15,000 to become debt free using this process – a fraction of the cost of any other option we have discussed.
Contact Plan B Debt and Credit Consultants Today!