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  • The Pros and Cons of Settling Your Debts

    This is a guest post from John Ulzheimer, credit blogger for, and a contributor for the National Foundation for Credit Counseling. If you would like to guest post at Chief Family Officer, please review the CFO Guest Post Policy.

    Over the past four years we’ve unfortunately had to become familiar with the term “short sale,” which is actually a settlement accepted by your mortgage lender. And while mortgage settlements have become a common practice over the past few years, the process of settling other debts, such as credit card debt and debts being worked by collection agencies is a much more established process.

    Debt settlement works like this: You owe someone a large or not so large sum of money. For whatever reason you are unwilling or are otherwise unable to pay the creditor the entire amount. You approach the creditor or the creditor approaches you with an offer in compromise, which is a fancy way of saying that they are willing to take less than the full amount due and call it even. If you take advantage of their offer then you have “settled” the debt.

    Settled in Full Versus Paid in Full

    There is considerable confusion of the final status of a debt that has been settled. Some people suggest that it has been paid in full. Others suggest that it has been settled in full. Neither is actually true.

    Paid in full is reserved for consumers who did, in fact, pay the entire amount due to the creditor resulting in a fully exhausted debt, or a $0 balance. Settled in full is a contradiction of terms. Settlement, by definition, means to pay less than the full amount so a debt cannot be settled in full, ever. But, a debt can certainly be settled and left with no monies due. The appropriate and unnecessarily formal way to refer to a settled debt is that it has been settled and now has a $0 balance.

    Self Help or Third Party Settlements

    A settlement can be negotiated a variety of ways. Consumers can hire 3rd party debt settlement companies, that will charge a fee, to facilitate the settlement process or, they can attempt to negotiate a settlement on their own. And, there’s even a chance that the lender will reach out to the consumer and begin the settlement discussions proactively.

    Using a 3rd party debt settlement company can cause some problems with your creditor. First, the settlement company will likely instruct you to stop paying your lender and to start paying them directly. This accomplishes a couple of things. First, your payments to the debt settlement company will begin to build a war chest of money that the settlement company will eventually use to make settlement offers to your lenders. Second, some people would suggest that by not paying your lender for several months that they are getting desperate for payment and will be more flexible when considering your settlement offer.

    Of course consumers can negotiate with their lenders on their own. This not only saves the cost of the debt settlement company’s fee but it also might yield a settlement as good as one negotiated via a 3rd party.

    Impact To Credit Reports and Credit Scores

    Settlements are considered to be “major derogatory” items by all credit risk scoring systems, including FICO and VantageScores’ credit scoring models. And, when you choose to settle a debt the lender will almost certainly report that disposition to all of the credit bureaus. On a credit report, the debt will include language such as “Settlement accepted on this account”, “Partial payment plan”, or “Settled for less than full amount.” Regardless of how it’s reported to the credit bureaus, the impact is still the same.

    Just because a settlement appears on your credit reports doesn’t mean that it’s going to automatically have a severe negative impact to your credit scores. For example, if the debt already shows as being in default on your credit reports, it likely already has a negative impact. The fact that it is eventually updated to show as being a settled debt doesn’t add to the already negative impact.

    However, if you have clean credit reports and solid credit scores and you settle a debt that is not already in default and has no late payments associated with it, then the reporting of the settlement will likely result in a significant reduction in your credit scores. The length of time the settlement will be reported is seven years from the default date. Depending on what your scores were before you settled the debt, you could expect to see your scores drop over 100 points.

    Settling a Collection Agency Debt

    When you settle a debt with your original creditor, like a credit card issuer, you really are causing them to lose a considerable amount of money. However, when you settle a debt with a collection agency or a debt buyer you are not at all causing them to lose money. To the contrary, when you settle a debt with a collection agency, they are likely making a large profit on the debt.

    When collection agencies or debt buyers purchase a defaulted debt from a creditor or service provider they do so for pennies on the dollar. They are able to purchase your defaulted debt for so little because they are likely purchasing hundreds of millions of dollars of defaulted debt at one time and can command a very low “per dollar” price. When they purchase the debt, they become your creditor. You no longer have a relationship with the original creditor and any payments must be made to the collection agency.

    Still, this is not always bad news. If they purchased a $10,000 defaulted debt from your credit card issuer, they likely did so for a few hundred dollars or less. That means even if they can collect a few thousand dollars from you, they’ll make a huge profit by purchasing your debt. Clearly this means they’ll be more open to settling for considerably less than the original loan amount.

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    5 Basic Steps for Managing Household Debt

    This post is sponsored by Quick Cash Funding. Read CFO’s full disclosure here.

    Whether you’re just starting out on your own, or you’ve decided that it’s time to take control of your financial situation, one of the major things you need to do is manage your household debt. Here are the basic steps you’ll want to take:

    1. Make a list of your debts.

    I’ll admit, this is no fun. But to get to where you want to go, you first need to determine where you are. So, list your mortgage, car loans, student loans, credit card debt, and any other money you owe to someone else.

    2. Decide how you want to handle your debt.

    My hope is that you’ll want to pay off your debts quickly, because I know from personal experience how great it feels. But you may decide that you’re content to pay the minimum and carry the debt, at least for now. You have to decide what’s right for you, and no one else can tell you what that is.

    3. Prioritize your debts.

    Assuming you want to pay off your debts, the next thing you should do is decide the order in which you’ll attack each debt. You could attack them all equally at the same time, but it’s easier, more rewarding, and often cheaper, to pay off one debt at a time.

    The fastest and cheapest way to pay off your debts is by attacking the one with the highest interest rate first. You’ll pay the minimum on all of your other loans, and put all of your other debt payoff funds toward the debt with highest interest. Once that’s paid off, you focus on paying off the loan with the second-highest interest rate while continuing to pay the minimum on the rest of your debts. And you repeat this pattern until your loans are all paid off. This is what’s frequently referred to as the Debt Snowball, because you’re “snowballing” your money from one debt to the next.

    If your highest interest rate loan is large, and you have a lower interest rate loan that’s comparatively small, you may find it more psychologically rewarding to pay off the smaller loan first. You might pay a little more in interest in the long run, but the psychological benefit of eliminating smaller debts and the mental clutter they create should not be overlooked.

    And speaking of psychological benefits, if you have a personal loan from a friend or family member, it may be best to pay that one off first, even if it’s your lowest interest loan, because of the impact the debt may have on your relationship.

    4. Choose a method.

    I’ve already mentioned the debt snowball, and I’m proof that the debt snowball method works. But it’s most effective when you’re willing to commit to living well beneath your means so you can apply as much money as possible to the snowball. You should take a good look at your expenses and spending habits, and decide on how much of each paycheck can and will be used to pay off debt. I also recommend setting up a system for making that payment as automatic as possible, so you’re not tempted to spend the money in other ways.

    After you’ve got your snowball set up, consider the the Debt Snowflake, through which you direct any small amount of money you can toward paying off your debt. The idea is that every quarter you pick up from the ground, every monetary birthday gift, and all other small amounts can add up to chip away a big chunk of debt. In fact, once you’re on a roll, you’ll probably be motivated to find as many snowflakes as possible, by selling items (I used Amazon), earning extra money (I love Swagbucks), and more.

    5. Get accustomed to a new lifestyle.

    As you pay off your debts, think about making the mental adjustment to living without owing anyone money. For example, I was so accustomed to thinking that you get a loan when you buy a new car that I still remember my shock when I realized we didn’t have to get a loan. And so we’ve been saving so that we can pay cash for our next car. I’m still working on paying off the mortgage, but I am confident that we will get there, and in less than 30 years.

    Your new way of thinking will ensure that you don’t take on any additional debt. Be sure to allocate some of your income for an emergency fund, even if it means your debt snowball is a little smaller than it could be.

    Once you’ve discovered how amazing it feels to have your finances under control, you’ll have your debts paid off in no time!

    Why Saving is Less Rewarding than Paying Off Debt & How to Motivate Yourself to Save

    It took us nearly ten years to pay off our non-mortgage debt and become otherwise debt-free, but towards the end, our debt snowball had become so big that we were able to pay off a lot very quickly.

    Since then, our financial goals have changed as our lives have changed. At first, I wanted to pay off the mortgage. But then I wanted to build up a cash cushion so I could quit my full-time job as a lawyer. I did that two years ago, and the first year was really about learning to live on one income plus the substantially smaller amount I bring in blogging.

    The wonderful thing is that even now, we are able to build up our savings. In fact, I have a savings goal that is so outlandish, I’ve given us until mid-2016 to reach it. Each month, I add up our account totals and calculate how much more we have to save to reach our goal. We’ve made progress toward our goal every month except one (when we used savings to pay cash for our bathroom remodel). But I’ve noticed the last few months especially that I’m feeling dissatisfied with the relatively slow progress we’re making – just a few percentage points at best. At this rate, we may reach our goal by 2016, but we’re unlikely to get there early.

    I don’t remember feeling that way very often when we were paying off debt, but I realized it’s because there were smaller, tangible goals when we were paying off loans. We started with multiple loans and gradually paid off one after the other. So it was easy to see the balance of the targeted loan go down toward zero. We knocked off one loan, then another, so that felt like progress too. And even when the last, biggest loan was left, I approached it eagerly because of the momentum from paying off the other loans.

    So the current savings goal feels different because it’s this one big number waaay down the line that we’re not close to yet.

    The obvious solution is to break the big goal down to smaller goals and create mental milestones that will be rewarding. Since we keep our savings in different accounts, one way of doing this would be to establish a savings goal for each account, giving me a very reachable number to aim for. Another way would be to set a target for the end of the year and then have fun getting there. Just thinking about these strategies makes me feel more positive and optimistic about how far we’ve come and where we’re going – it’s going to be fun!

    Experian’s Second Annual State of Credit Report: Where does your state rank?

    Experian released its second annual State of Credit Report yesterday, which found that Midwesterners are most mindful of their money and Southerners continue to struggle. The report lists cities with the highest and lowest credit scores, and topping the list is Wausau, Wis., which unseated Minneapolis, Minn. from the number one spot after a four-year reign. Apparently the most fiscally responsible people in the U.S. live in Wisconsin, which has four of the top 10 ranking cities with credit score ratings in the upper 700 range.

    Many cities have improved their credit scores compared to last year’s State of Credit report, but not by much. And the average debt nationally has decreased by only 1% to approximately $24,500. Michele Raneri, Experian’s vice president of analytics, says, “Experian’s State of Credit data shows that we still have a long way to go toward economic prosperity but that many consumers are taking small steps toward improving their credit and debt management.”

    The complete State of Credit report, along with credit education tips and information for consumers, is available at There’s a nifty interactive map, which you can click on to see the findings of your city. I was stunned to learn that the average credit score in Los Angeles is 738 – that seems really high to me, and I wonder if the stats are skewed by the sheer volume of “rich” people who live in the city. (But I would think they’d be balanced out by the “poor” people so I don’t know . . . maybe overall we’re doing better than it seems.)

    You can also check out Experian’s Twitter feed and Facebook page for more info.

    What’s your State of Credit?

    This post is sponsored by Experian. All opinions are my own. Read the full CFO disclosure policy here.

    Saving Money vs. Being Debt-Free

    Our public school district is in serious dire straits, so I’ve been thinking about life five years from now. While I feel reasonably confident our current elementary school will be okay, in five years, our oldest will be heading into sixth grade and off to a middle school. The problem is that I’m finding it difficult to find a really desirable public middle school. I’ve had my eye on the Sherman Oaks Center for Enriched Studies, which has a great academic reputation and goes from fourth through twelfth grade, but it’s incredibly difficult to get into. Even if I did everything possible to maximize priority magnet points, our odds of getting in will still be slim because of the lottery system.

    So we would really like to have private school on the table as an option in five years. But that will require money, and a lot of it.

    At the beginning of the year, I said that I wouldn’t have any financial resolutions for this year and that I just wanted to get used to living on one income. But we seem to have done that, and I couldn’t help taking a closer look at our mortgage, which is our only remaining debt.

    Ever since we became otherwise debt-free in 2009, I’ve toyed with the idea of paying off the mortgage. We pay a little extra every month, but only enough to accelerate the payoff by a couple of years. But. We could pay off the mortgage in five years if we save aggressively.

    Unfortunately, it’s hard to predict the future. Is it better to pay off the mortgage and free up the mortgage payment in our cash flow in five years? Or would we be better off saving the money and having a huge cash cushion that we can use to pay for tuition?

    I don’t think there’s a right answer, at least not at the moment when there are so many unknowns, like how much tuition would be. My projected calculations show that if tuition at the top schools continues to rise at the same rate it has been, it’s going to be in the neighborhood of $40,000 per year at the most expensive schools. I’m not sure we would opt for a school like that, even assuming we got in, because it’s so expensive. But even a moderately priced school is going to be around $20,000 per year, and we’ll have to pay twice that for two kids for five years (and then there’s college).

    So for now, we’re going to play it safe. It’ll be like last year, when we were aggressively saving so I could quit my job, only we’ll be saving for five years instead of one now. I’ve got a spreadsheet set up to track our progress, just as I did last year. And just like last year, we’ll have to be diligent about doing all of the things I recommend in the Ways to Make & Save Money series. My goal last year was ambitious but we did it – hopefully, we can do it again!