Credit Smart: Your Step-by-Step Guide to Establishing or Re-Establishing Good Credit

Excerpted from Credit Smart by Gudrun Maria Nickel ©2003

Simply put, debt is owing money to someone else. However, there are many types of debt-each with its own legal and financial obligations. Understanding the various categories and types of loans available will strengthen your ability to better manage your own personal debt.

SECURED DEBT All debts are either secured or unsecured. When an interest in property is given to your lender to make the loan safe, you have a secured debt. Examples of secured debt are your home mortgage and your car loan. The lender puts everyone on notice about its interest in your property by filing a mortgage on your real estate or a security interest in your personal property in the appropriate county or state records. The lender will secure its interest in a car or mobile home by placing its lien directly on the title.

Where the lender has taken the proper steps to record its interest, you cannot sell the property without either paying off the lender or having the buyer take the property subject to the lender's interest. The property given as security is also referred to as collateral.

The lender may also take an interest in personal property by taking possession of it.

Unsecured Debt becoming Secured Debt An unsecured debt may become a secured debt if a judgment becomes a lien (or claim) on your property. Even without judgments, some states allow liens to be filed. In Florida, for example, condominium associations generally have the right, without first getting a judgment, to place a lien on your property if you do not pay your condominium association assessments. Likewise, people that you employ to work on your property or provide material may be able to file a lien before getting a judgment if you do not pay them. A judgment may also become a lien on your property. Ultimately, the lienholder may take the property and foreclose its lien, just like a creditor to whom you actually gave a security interest in your property.

Lender Selling the Collateral After the lender sells the collateral, depending upon your loan agreement, he or she will then apply the money from the sale, less expenses, to your loan. This does not necessarily mean that you are no longer liable to your lender. The loan document you signed may also give the lender the right to get a deficiency judgment against you if the amount realized from the sale is not enough to pay the balance due on the loan. (Deficiency judgments are discussed in other chapters in this book.)

Right of Set-Off If you have several accounts at one bank as well as a loan, and you fail to make your payments on the loan, the lender may have the right to take the money from your deposit accounts and apply it to your debt. This is called the bank's right of set-off.

However, the bank may do this only if this was disclosed to you in the loan documents. The bank cannot use your other accounts as collateral without meeting the disclosure requirement. Otherwise, you can sue the bank for damages, including any cost to you for overdrawn checks.

UNSECURED DEBT An unsecured loan is one for which the lender has taken no collateral. Most credit cards and any loan given to you requiring only your signature are unsecured loans. (The signature of someone guaranteeing payment, or a co-signer, is given as security for the debt.) Unsecured debt also includes any amount you owe for services, such as doctor's bills. The service provider (i.e. hospital, doctor, dentist, accountant) and the creditor of an unsecured debt will often first try to contact you personally in an attempt to work out payment of the outstanding bill.

DEBT AFTER A DIVORCE Anyone who is contemplating separation or divorce should keep in mind that an agreement between you and your spouse is effective only between the two of you. Unless a creditor agrees in writing to release one or the other, both parties remain fully responsible for payment.

CONTINGENT LIABILITIES If you have a contingent liability, you will be liable for payment to a creditor only in the event the primary borrower does not pay.

BUSINESS DEBT If you own your business and the business is having financial difficulties, these difficulties may affect your personal financial situation as well.

Proprietorship or Partnership As a new business, you may have entered into leases for space and other legal contracts. If operating as a sole proprietorship, you will be held personally responsible for any contract or agreement you enter into. Likewise, signing as a partner does not protect you from personal liability; all partners are usually responsible for partnership debt.

Corporation You may have set up your business as a corporation, which is considered a separate, legal entity. Although a corporation usually shields its stockholders/owners from liability, you may still have personal liability as an officer or director.

In other words, if the corporation goes out of business before it has met its obligation under a particular contract, (for example, if the corporation vacates leased space before the end of the lease term) then you may be held personally liable for the remaining obligation.

As a defense against any action against you personally for your corporation's obligation, you will need to show that only the corporation signed the contract and that you signed as president (or other officer) of the corporation and not individually.

If you have signed a personal guarantee for any corporate obligation, determine whether it was for a secured debt. In other words, is the creditor able to take the collateral as payment for the balance owed? (Your guarantee may be conditional, requiring the creditor to first take the collateral, or unconditional, allowing the creditor to come directly to you for payment regardless of the collateral.)

While your guarantee of payment might not require the creditor to first take the collateral in satisfaction of the debt, the creditor may be willing to do so to minimize any potential losses, particularly if the creditor believes that you personally may not be able to pay the amount due.

Personal Guarantee As for business leases that you have personally guaranteed, the landlord may be obligated to minimize its losses by finding another tenant as quickly as possible. (State laws vary on this issue.) However, any landlord attempting to obtain a judgment against you, personally, for the balance due on a lease may find the court much more receptive if he or she can show that he or she made a diligent effort to re-lease the space. You should do your best to help the landlord in finding a new tenant to minimize your liability under the guarantee. Even if the law does not require the landlord to attempt to minimize damages, your efforts may discourage the landlord from proceeding against you for the full amount due on the lease.

If there is any question as to whether the guarantee is legally valid and enforceable by the landlord, you should discuss this with an attorney.

Joint Liability If you have signed a document for payment of an obligation containing the words joint and several liability, along with other owners of your business, do not assume that you will be responsible for repayment only to the extent of your share in the business. Joint and several liability means that each of those individuals who signed the document are individually, as well as jointly, liable for the total amount due. You may be liable for the entire amount due if the other guarantors do not pay.

Creditors usually pursue the signor with the greatest ability to repay the debt. If the creditor pursues you, make him aware of your personal financial situation. You may be able to reach an agreement with the creditor for payment, then pursue the other guarantors for indemnification or reimbursement.

Payroll Taxes Aside from the corporate obligations you may have personally guaranteed, you must keep in mind that as an officer of the corporation, owner of the business, or partner in a partnership, you have other responsibilities and liabilities. The most important of these are payroll taxes.

As the business owner or authorized signer on the account from which payroll taxes are paid, you are personally obligated for the amount that the business deducted from the employees' wages and failed to send to the Internal Revenue Service (IRS). In other words, if your bookkeeper fails to make the deposits when due or if the business ceases operation and taxes are still owed, you may be held personally liable for payment. If this is in fact the case, you should consider the same suggestions for dealing with the IRS.

Student Loans The costs of college education are continually rising. More often than not, students must seek the help of student loans to finance their education. Various types of loans are available.

FEDERAL LOAN If you had financial help with your college expenses through a student loan, chances are that repayment was guaranteed by the federal government. In other words, if the loan was made to you by a bank and you failed to pay, the bank looked to the federal government for the money.

Sallie Mae. Following either your graduation or withdrawal from school, you had a grace period (typically six months) before beginning to repay the loan. The bank, school or other lender could collect the loan itself or could sell the loan to the Student Loan Marketing Association (SLMA, or "Sallie Mae") for collection. The SLMA is a corporation set up by the federal government for the purpose of collecting outstanding student loan obligations. The U.S. Department of Education may attempt to collect the balance due if SLMA is unsuccessful.

Both SLMA and the U.S. Department of Education will report your delinquent student loans to the credit reporting agencies (credit bureaus) and may take other action such as to sue for collection or intercept your income tax refunds.

Default. If you are in default on a federally guaranteed loan, but are now able to start making payments, you may be able to bring the loan out of default by making a certain number of regular, consecutive monthly payments. Contact the guarantee agency that has your loan to find out how to bring the loan out of default.

PRIVATE LOAN If you borrowed money from your college or university and the loan was not federally guaranteed, the same options are open to the institution as to any other creditor, such as reporting your delinquent account to a credit reporting agency, hiring a collection agency, and filing a lawsuit. The school may also refuse to give your transcript and your diploma to you, as well as refuse to allow you to re-enroll. On the other hand, you have the same options as with any other creditor, including negotiating a smaller payment amount.

Your Options Your options will depend upon the type of student loan. The types of federally- guaranteed student loans include the following:

• Perkins Loan-based upon need, the loan is made by the school and with federal funds;
• Stafford Loan-unsubsidized (interest is charged from the date the loan is disbursed); and,
• Stafford Loan-subsidized (given on the basis of financial need; the interest is paid by the federal government until repayment begins).

In addition, Parent PLUS loans assist parents in paying the expenses of an undergraduate student. U.S. Public Health Service loans are also available to students in health-related studies.

Each of these programs has its own unique rules regarding repayment and collection. Depending upon the type of loan you have, you may have one or more of the following options if you are unable to pay:

• cancellation of the loan;
• deferment of payments;
• negotiating for temporary suspension or reduction of payments;
• consolidating your loans; or,
• filing for bankruptcy (only in case of extreme hardship.)

We will now consider each of these separately.

Cancellation. Again depending upon the type of loan, full or partial cancellation is generally available if you:

• die or become disabled;
• serve in the U.S. military;
• are employed full-time as a nurse, medical technician, or law enforcement or corrections officer;
• are a Peace Corps or VISTA volunteer;
• are a Head Start program staff member;
• are a teacher in certain low-income areas; are a teacher of handicapped children; or, a teacher of math, science, foreign languages, or in other designated teacher-shortage areas; or,
• return to school to study at least half time.

Cancellation of the debt may also be possible in certain cases of fraud or misrepresentation by a trade school. In the past, there were numerous trade schools (for such occupations as truck driving, cosmetology, computer operation and repair, etc.) that got students to take out a government loan and turn the money over to the school, then closed the school before the course was completed. Other schools failed to provide sufficient education to allow the student to obtain employment once the course was completed.

If your trade school closed before you could complete the course of study, you were falsely certified to be eligible for the program, or you were entitled to a refund you never got, you may be able to have your loan cancelled. For more information contact the Department of Education and ask for a list of closed schools, or contact your state's Attorney General's office.

Deferment. Typical situations in which deferment may be allowed are where you are:

• enrolled in school;
• unemployed;
• on active duty with the military or NOAA;
• a full-time teacher in a teacher-shortage area;
• disabled;
• completing an internship program;
• on parental leave;
• the mother of preschool children; or,
• suffering economic hardship.

Depending upon the type of loan, the deferment may be of both principle and interest, or of just principle (meaning you will have to make interest-only payment for the deferment period). For more information, contact your loan holder. Ask for a deferment application.

Negotiation. As with any other loan, you can always contact the holder of the loan, explain your situation, and try to arrange for payments to be temporarily suspended or reduced. If you do not have any luck negotiating an arrangement you can live with, contact your local Consumer Credit Counseling Service. They may be able to negotiate a better deal.

Consolidation. If you have more than one student loan, you may be able to consolidate them at a lower interest rate with a lower single payment, and possibly qualify for a deferment. Much will depend upon the types of loans you have and whether you are in default. For more information contact the holder of your loan or Sallie Mae at 800-524-9100. The website for Sallie Mae is www.salliemae.com. You may also contact the U.S. Department of Education, Federal Direct Loan Program at 800-494-0979 or: www.ed.gov/offices/OSFAP

Bankruptcy. You will generally hear it said that student loans cannot be discharged in bankruptcy. A student loan may be discharged in bankruptcy only if repayment would cause extreme hardship. However, there are a couple of exceptions to this rule, and even if you can not get a discharge, you may be able to get some indirect help.

It may be possible to have a student loan discharged in bankruptcy if the payments first became due more than seven years before filing for bankruptcy, or if you can convince the judge that repayment of the loan would cause you undue hardship. If you file for a repayment plan under Chapter 13 of the Bankruptcy Code, and include your student loan in your repayment plan, it will at least stop lawsuits and other harassment over the delinquent loan. If your school is withholding your transcript because of your non-payment, it will have to release the transcript once you notify it of the bankruptcy proceeding, regardless of whether the debt is discharged.

Child Support A child support obligation is not to be taken lightly. Congress has taken a special interest in payment of child support, and addressed the problem of non-payment by passing the Federal Family Support Act of 1988 and the Revised Uniform Reciprocal Enforcement of Support Act (URESA). In 1997, as part of the Welfare Reform Act, Congress passed the Uniform Interstate Family Support Act (UIFSA), which is more streamlined and gives the states less latitude in enforcement as did the URESA. Under UIFSA, the District Attorney in your state will be contacted by the District Attorney in your spouse's state regarding the child support due. The District Attorney in your state will then pursue you for the amount.

The law requires your employer to honor a court order to withhold the support payment from your wages. (You can also agree with the other parent or guardian of the child to pay directly.) You can also be ordered to go to jail for contempt of court if you fail to pay child support.

NOTE: In some states, you may be charged with a misdemeanor.

Modification If you simply cannot pay the amount ordered by the court, then you should file a request for modification, explaining the circumstances and why you believe the amount should be reduced. In all states you will generally need to show that your income has decreased so that you are no longer able to pay the amount originally ordered.

Depending upon your state, the guidelines will be in either the statutes, court rules, or a document from some state agency. If you cannot find them in the statutes or court rules, request a copy from the court clerk or child support enforcement agency. You may find that you are paying more than the guidelines require. If so, you can request a modification.

Judgment If your spouse gets a judgment against you for past-due child support, that judgment may also be collected like any other judgment and the same time periods for collection may apply.

Income Tax Refund In addition, your income tax refunds may be intercepted and applied to your past due child support. If this occurs, you will receive a notice of the impending tax intercept. The notice will advise you of your right to request some kind of hearing to challenge the taking of your tax refund, and how to go about getting a hearing.

Generally, you will only be able to stop the intercept if you have already paid what is owed, or are making regular payments pursuant to an agreement you made for payment of the past due amount (of course, other unusual circumstances may also avoid an intercept, but these are so varied and unusual that they cannot be covered here).