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Which debts to pay when you can't pay them all

Erica Sandberg

January 3, 2014

QDear Erica,

Which do you suggest I pay now? My car loan or my Visa? I'm behind on both. I also have a student loan in forbearance, and when I have to start paying, it will be $380 a month. I'm working part time, and don't see how I can pay everyone and live, too. — Abel

AHi Abel,

When dollars are few but obligations are many, you've got to make a decision about which of your creditors take priority. The consequences for falling behind on each of your debts are quite different. To know which debt is most important to satisfy, it's best to know what can happen to you if you don't pay.Ask Erica

Credit cards
Damage is gradual when you don't meet the contractual obligation of a credit card account. In the beginning, the issuer may penalize you with a late fee of around $25 to $35. If they still have not received remittance after an entire cycle as lapsed, they will also notify the three credit reporting bureaus. Each month that you fail to pay will be recorded, and the credit report and scoring damage will worsen, as payment history is the most important factor in your FICO score, the most commonly used score today.

After 180 days of nonpayment, the issuer will either sue you for the balance or charge the debt off and sell it to a collection agency. The collector will contact you so they can get repaid, and if they can't encourage you to send a check, they may also revert to legal action. Oh, and all the while, interest and fees will pile up. In the event you're sued and lose the case (likely), you'll have a judgment on your credit report. Court costs will be added on, so the debt will be far higher than it was before the lawsuit began.

Vehicle loan
As for your car, well, that's a different story. The lender may be a bank, credit union or finance company, but in all cases the loan is secured by the vehicle. Depending on the state you live in, the creditor can take the car pretty quickly after at least a few payments are skipped. That is called a repossession.

If you're in the very beginning of the loan, the creditor may be more apt to repossess, and do so quickly. The longer you have the property, the less value it has.

When a car is repossessed, you, the owner, will experience a major financial burden. Towing and storage fees, collector and auction costs, legal fines and ultimately a deficiency balance (if the car is sold for less than the amount due to the lender) can create a large unsecured debt. And if you don't pay that liability, lawsuits and collection agencies can be part of your life. Oh, and of course your credit report will be marred by the original late payments, the repossession itself and the ending debt, too.

Student loan
The nice thing about student loans is that if you can't pay when expected, you may be eligible for deferments and forbearances, allowing you to delay paying without penalization. Still, you'll eventually have to start, and if you don't send the payments, you'll be in default. Credit damage will be pretty severe at that point.

Worse, defaulted student loans can result in wage garnishments and income tax interceptions — without you being sued.

So which debt do you satisfy first and in full? Here's my suggested strategy:

  1. Make your car payments on time and in full. This is especially important if you need your car to get to and from work.
  2. Ask the student loan provider for another period of forbearance. This way you'll have at least six more months to secure a full-time job. When you do, contact the lender and request a payment plan that suits your income and expenses. Another advantage of these types of loans is that as long as they're in good standing, flexible payment arrangements exist.
  3. If you can't meet at least the minimum payments to your credit card issuer and you've eliminated all extra expenses, call them immediately. They may be able to help you with a hardship program where you make smaller payments for a few months. Trust me: You bank doesn't want you to go underwater any more than you want to drown. After all, they will have to take a loss if you don't pay. Hardship programs can be tricky to qualify for, however, and they're not advertised. Your charging ability will also be frozen while you're in the program. Yet if you can't afford basic living expenses and debt repayments, consider asking your issuer if a hardship program is an option.

The best way to deal with all of this is to earn enough money for your current living expenses as well as your past debt. Concentrate hard on getting a full-time job or another part-time one. Then live low so you can send the maximum to your creditors. After they (at least the car and credit card) are at zero, you can save for the future and send more toward your student loans.

Got a question for Erica? Send her an email.