Credit Risk Problems

Credit risk is a problem for both consumers and lenders. If a consumer is deemed a credit risk, he will encounter widespread financial problems that hurt his personal finances. If a financial institution grants too much credit to unworthy borrowers, its business suffers. As of 2010, total individual debt in the United States is up to $2.46 trillion, according to the Federal Reserve.

Definition

A high credit risk is a term used by banks to connote when a borrower is unlikely to pay back a debt. In consumer's terms, if you are considered a credit risk, you usually have insufficient or poor credit history. A potential lender determines riskiness by reviewing your credit report and credit score, which list information about your account history, credit to debt ratio, payment history and more.

History

Before communication and computers came onto the scene, a person's credit worthiness was determined by word of mouth. In the 20th century, credit bureaus began to form -- including today's three most well known, Experian, Equifax and TransUnion -- and these bureaus collected credit information to provide to potential lenders. In 1971, the Fair Credit Reporting Act was passed, requiring reports to include positive information rather than just negative behaviors. This act also allowed consumers to view their own reports, which you can now do online.

Significance

Potential lenders must analyze your credit risk because they are essentially giving you money for nothing in return, and they need to know how likely it will be that you will be able to pay it back. If a bank doesn't constantly monitor credit risk, it runs the risk of losing capital and even going out of business.

Effects on Consumers

If you are considered a high risk to lenders, you may encounter a number of difficulties. First, your credit cards or loans may have high APRs, meaning you will be required to pay more interest on balances. Also, your credit limit may be set lower than it would be if you had good credit. If you have mismanaged your credit or lack a credit history, obtaining a mortgage or car loan can be incredibly difficult. It may even be difficult to be approved for an apartment, phone contract or occasionally a job if you are a high credit risk.

Prevention/Solution

Though it won't happen overnight, it is possible as a consumer to transition from being a credit risk to being credit worthy. The Federal Trade Commission recommends paying your bills on time, paying down outstanding debts and avoiding new debt. Enrolling in a debt repayment plan may help you meet your goals, but if you prefer not to pay for assistance, focus on paying down your debts in descending order starting with the debt with the highest interest rate.

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The Statute of Limitations on Debt in Small Claims

A creditor who wants to sue a debtor to recover an unpaid debt has a limited time in which to do so. This time, known as the statute of limitations, is established by the laws of each state. A creditor can file a debt lawsuit in state small claims court, but these courts have additional restrictions that affect the case.

Statute of Limitations

A statute of limitations is a specific law, a statute, that limits when a person or entity can initiate an action. An action is a lawsuit, and initiating an action means filing a lawsuit in court. The statute of limitations, therefore, limits when a creditor can file a lawsuit against the debtor. The statute time limit begins once the cause of action has occurred. A cause of action is the set of circumstances or upon which the creditor's claim is based. In a debt situation, the cause of action typically occurs when the debtor defaults on the loan.

Kinds of Debt

States differentiate debts into four categories for the statutes of limitations: open accounts, oral agreements, written contracts and promissory notes. A promissory note is a document in which the borrower expresses an unconditional promise to repay a debt. A written contract, on the other hand, is a document in which both the debtor and creditor enter into a binding agreement. An oral agreement is a verbal contract on a debt, and an open account is any revolving form of credit, such as a credit card, regardless of whether a written document is involved.

Limitations

Each state has its own statutes of limitations. These differ widely between states and even between the kinds of debts involved. For example, according to Nolo, California's statute of limitations on oral contracts is two years, while the limit on written contracts is four years. Louisiana, on the other hand, allows 10 years for both written contracts and oral agreements.

Small Claims

While the time frame in which a plaintiff can file a small claims court case varies depending on the nature of the debt and the state, small claims courts themselves have limits that affect the claim. Small claims courts limit the damages on any claim filed with the court. This means that if the plaintiff wins the case, he can only recover as much as he claimed up to a limited amount. For example, if the state small claims court is limited to awarding a $5,000 judgment and the plaintiff files a small claims case to recover on a $7,500 debt, he can only recover $5,000 if he wins.

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Can a Judgment Holder Garnish a Federal Refund?

Paying your debts on time is important for maintaining a good credit standing. Past-due debts affect your credit rating when creditors report late payments and file judgments against you. A judgment creditor may garnish your wages, your bank account and, in certain cases, take your federal and state tax refunds to offset your debt balance.

Past-Due Credit

Generally, credit companies, such as banks and financial institutions, cannot take your federal and state income tax refunds to pay off your debts. Creditors may intercept refunds if they are a part of a court-approved debt settlement. A creditor can, however, obtain a court judgment to garnish your bank account. If you tax refund is deposited directly into your account, the judgment creditor can take the funds. If you file your taxes jointly with your spouse and she is not a party in the lawsuit, she may file an injured spouse claim and receive part of the refund back.

Back Taxes

You must pay income taxes, if you work, and property taxes, if you own a home. If you failed to file a tax return within the past 10 years and owe back taxes, the government has a right to take your money to offset the debt. The IRS and the state government can levy your bank account, garnish your wages and take your federal and state tax refunds to apply the money to the balance your owe. Unlike creditors, the government does not need a court order to do so. You will receive a notice of an intent to garnish or levy before it happens.

Student Loans

If your federal student loan is past due for 270 or 360 days, the U.S. Department of Education Debt Collection Service can intercept your federal and state refund checks and apply them to the outstanding debt balance. In addition to taking your refund money, the Department of Education can garnish your wages and levy your bank account. You may prevent these measures by negotiating a repayment schedule and making payments on time.

Child Support

The Federal Tax Refund Offset program can intercept your federal and state tax refunds if you owe child support payments. The local child support enforcement agencies submit names of delinquent non-custodial parents, Social Security numbers and past-due amounts to the IRS. When the government processes tax refunds, it identifies those individuals who owe child support payments and takes all or part of the refund to offset the debt balance. The debtor receives a notice of offset that states the intercepted refund amount.

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How to Choose A Credit Card Debt Settlement Company

Finding a legitimate debt settlement company among the fraudulent ones can be difficult. Debt settlement companies have terrible reputations and many are fly-by-night operations set up to defraud desperate people eager to discharge their debt. Fortunately, the Federal Trade Commission has created a list of things to look for and things to avoid when shopping for a debt settlement company. Consider these items before you sign anything.

Instructions

1

Start looking for a legitimate business through the Better Business Bureau's website. Seek a company that's a bureau member in good standing: Don't take the company's word for it. In addition, make sure the company has written policies and procedures; services the debt itself rather than through a third party; and has an open-door policy for regulators.

2

Check the agency's willingness to disclose information. For example, does it have written disclosure of its fee structure? Check whether the agency discloses that credit agencies may continue to call even though you're involved in debt settlement; that debt settlement is likely to damage your credit; and that the agency cannot guarantee results. Some credit card companies will sue rather than accept a settlement. If the agency does not disclose this information it's likely hiding something.

3

Avoid companies with unreasonable promises or unreasonable fees. Avoid companies that promise you will be free of debt in an amount of time that seems too good to believe. Avoid companies that charge unreasonable fees. Many fees are between 14 and 18 percent of the debt to be discharged. Never pay more than 30 percent. Also avoid companies that "escrow" your money, saving up a given amount before they begin paying your creditors. You and your creditors might never see that money again.

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Ways to Clear My Debt

Clearing your consumer debt can lift a huge burden off your shoulders. Creditors require monthly payments and, if you have a large amount of debt, you may spend a huge percentage of your monthly income paying down bills. Eliminate your debt to reduce your monthly expenses and start saving.

Changing Your Spending Habits

You can't eliminate your debt without first altering the way you manage your money. Buying items that you don't need can play a role in huge debts--especially if you do not have the money. Credit cards are practical but if you're not careful, you can easily accumulate thousands of dollars in bills. Use credit cards as a last resort, and only during emergencies. If you must pull out your cards to make a purchase, make sure you're able to pay off the balance within a month.

Set Personal Goals

Setting your expectations too high or giving yourself unrealistic goals can hinder your efforts to get rid of debt. You didn't accumulate bills overnight, so don't expect to pay off your balances overnight. Debt elimination is a process. Unless you're able to write a check to get rid of balances, prepare to spend the next months or years paying down balances. Based on your disposable income after paying your monthly expenses, establish a payoff goal or date. For example, if you have $5,000 in credit card debt with a disposable income of $250 each month, you could eliminate this debt in 20 months.

De-clutter and Make Money

Going through your closet or garage can reveal material possessions or belongings that you no longer use or need. Rather than throw these items away or donate them, plan a yard sale or take these items to a consignment shop to earn extra cash. Old furniture, clothing, jewelry and electronics can provide you with extra money to pay down some of your debts.

Use Your Spare Time

Everyone's situation varies, and some people don't have items to sell or extra income to pay down debts. There are two ways to deal with this situation. You can either accept debt and continue to make small minimum payments for the next 20 or so years, or you can be proactive and create additional income. Many employers seek part-time help on nights and weekends. Working an additional 10 o 15 hours a week could possibly increase your income by $100 or more each week. Apply extra money from your part-time job to debts.

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Secured Debt Solutions

Secured debts have collateral ties. For instance, your mortgage is secured by your house and your car secures your auto loan. Consequently, if you don't pay, the lender can collect the security by repossession or foreclosure. If you're having trouble keeping up with monthly payments, you can take steps to prevent the loss of your property.

Negotiation

If you fall behind on secured debts, your lender has the legal right to take the property back. Some lenders, particularly mortgage lenders, may be willing to work with you to avoid this: Foreclosure costs time and money, and your lender may agree to strike a deal -- a lower interest rate or a few months with no payments, for instance -- if you can show that the delinquency wasn't your fault. The federal Making Home Affordable program offers incentives for lenders to work with you.

Outside Assistance

Any number of firms will offer to work with you when your debts are more than you can handle. Services range from advice on money management to companies that offer to negotiate with lenders on your behalf. Credit counselors and debt-management companies can be a help, but some are scam artists. Before you sign up for any service, find out the costs and conditions; if the company offers to negotiate, find out how long it will take them to make your creditors an offer and how much they expect to save you.

Chapter 13

Chapter 13 bankruptcy can't wipe out a secured debt. If you're behind in payments, however, Chapter 13 allows you to work out a plan for making up the delinquent debt, provided you can cover current payments as well. You'll have more money to spend on your secured debts because bankruptcy law makes them a priority: Unsecured creditors will have to settle whatever you can pay after your living expenses and secured debts are taken care of.

Walk Away

Sometimes giving up makes better financial sense than trying to hang on to the collateral. If you can't afford your car payments, for example, selling it may be a smarter move than waiting for the repo men to take it. If your lender will agree to let you turn over the deed to your house in payment of the mortgage, or allow you to try and find a buyer, that might also be a better solution than trying to hang on.

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How to Discharge Debt Legally

In the United States today, more people than ever before are suffering from overwhelming consumer debt. It can be difficult to decide how to deal with mounting debt. The upside of our current financial crisis is that the U.S. Government is making it easier than ever for consumers to deal with their debt. The modern debtor has several options available to him or her in order to safely and legally discharge debts that cannot be repaid.

Instructions

1

Contact your creditors. This is most effective if you contact them shortly after your account becomes delinquent. If you have recently become unable to pay off your debts, place a phone call or write a formal letter to your creditors explaining the situation, giving them an estimate of how long it will persist, and asking if you can revise your repayment terms so that you can continue to pay off the debt. Many creditors are willing to renegotiate payment schedules or repayment terms if it means their clients are less likely to default on an account.

2

Just ask. This technique is most effective for debts which have been reported for collection. If you're being hounded by a collection agency, it means your original creditor has given up and sold your debt. Collection agencies know that many of the debts they purchase are essentially worthless and will never be paid off. It can't hurt to be straightforward with debt collectors and ask them to discharge all or part of your debt. Most collectors won't agree to discharge all of it, but may settle for dimes on the dollar. If you do make an agreement with a collection agency, be sure to get it in writing or some other hard copy such as a phone recording. Note that it's illegal for you to record a phone call without the other party's knowledge. If they do give you an agreement in writing, however, they are legally required to honor it. If not, you can take legal action if they continue collection attempts.

3

Enroll in a debt management program. This option presumes that you plan on repaying your debts eventually, but do not have the means at the moment to keep up with your monthly payments. A debt management program will contact all your current creditors for you and work out a gradual repayment plan with them. You pay the DMP with a single check each month and they distribute the money according to the schedule they arranged for you with your creditors. This approach grants the debtor a reprieve from collection attempts by creditors included in the DMP, but requires the debts be repaid eventually.

4

Declare bankruptcy. This is the most extreme option for a debtor, but may be necessary. Bankruptcy presumes that you do not have the means to repay your debts anytime in the near future. If you do not have enough income to both meet your basic needs and pay off your debt, this may be the right option for you. Keep in mind that bankruptcy can create a huge black mark on your credit report and make it difficult for you to obtain credit for up to 10 years after your bankruptcy proceedings conclude. You should pursue other options and seek out credit counseling before filing for bankruptcy.

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