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Understand how different methods to pay down debt impact your credit profile

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By Andrew Housser

If you made a resolution to get a better handle on your finances in 2016, you are not alone. More than one in four people resolved to pay down debt this year, and 30 percent have vowed to save more and spend less starting this year.

There are several ways to get out of debt. Each method has a different impact on your credit profile. Here are several things to keep in mind as you work to get out of debt and protect your credit at the same time.

1. Focus on debt, vs. credit rating. If you are carrying too much debt, your first priority needs to be eliminating that debt. Do that and your credit profile will bounce back. Remember, too, that a key reason to maintain a high credit rating is so that you can prove your creditworthiness when you need to obtain a loan. When you are dealing with excessive debt, it is generally not the time to borrow more. In that regard, your credit profile may not be most important concern if you are really struggling with an unmanageable debt burden.

2. Avoid missed payments. To protect your credit profile, pay at least the minimum, and pay on time. Your payment history makes up 35 percent of your FICO credit score. Every payment you miss has an impact on your score. Even if you cannot pay much, paying on time shows lenders you are making a good-faith effort to pay what you owe.

3. Create a realistic budget plan. Calculate how much you can allot to debt repayment each month. Consider all your sources of income and all of your ongoing expenses – those that are fixed, such as rent or mortgage, and those that vary, which may include items such as food and any discretionary spending. Be realistic. If your grocery bills are $500 a month, and you plan to cut that to $100, you will probably not succeed. But you may be able to cut out $75 with a good savings strategy.

4. Evaluate whether you can repay debt on your own. Take a thorough look at your budget, your debt and your income. Can you clamp down on spending, and use a budget – and discipline – to repay the debt yourself? Or can you increase your income and direct those extra funds to your debt? If you can repay the debt by committing to steady payments, this is the best way to protect your credit.

5. Consider consolidating on your own. Some credit cards have interest rates of 20 to 30 (or more) percent, which can total hundreds or thousands of dollars a year in interest alone. People with good credit history might be able to reduce their interest rate with a credit card balance transfer, a personal loan from a friend or your bank, a home equity loan or a loan from an online lender. Lowering the interest rate may free up money to pay down the balance faster. Be aware, though, that if you default on a loan secured by your home, you risk your home, in addition to your credit profile.

6. Look into credit counseling. If you believe you cannot get out of debt on your own, credit counseling might be an option. Credit counseling agencies help consumers repay their debt on a set schedule, which can take up to five years to complete. Being enrolled in a credit counseling program can negatively affect credit profiles and access to credit.

7. Evaluate debt negotiation. Those who are struggling to make even minimum payments, and have significant debt to repay, may find debt negotiation (settlement) helpful. This will have a negative impact on credit profiles, but can result in saving a significant amount of money, as well as dramatically accelerating the time period to pay off debts.

8. Talk to an attorney about bankruptcy. Bankruptcy can harm your credit profile for many years. Legal fees can be expensive, and bankruptcy can be difficult to qualify for (in particular, Chapter 7). It also can be very stressful. For these reasons, bankruptcy is generally a last resort for most people. If you are seriously considering bankruptcy, talk with a bankruptcy attorney.

The process of getting out of debt is not always fun, but the rewards are great. Whichever method you choose, keep your eyes on the ultimate goal of repaying your debt. In the end, your credit profile will recover, with time and a rebuilt payment history.

Andrew Housser is a co-founder and CEO of Bills.com, a free one-stop online portal where consumers can educate themselves about personal finance issues and compare financial products and services. He also is co-CEO of Freedom Financial Network, LLC providing comprehensive consumer credit advocacy and debt relief services. Housser holds a Master of Business Administration degree from Stanford University and Bachelor of Arts degree from Dartmouth College.
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