1. The dangers of debt consolidation refinances

A debt consolidation refinance is the same as standard refinance except your combining your existing mortgage with other secured and unsecured debts like auto loans and credit card debt. However, it’s important to understand that consolidating unsecured debts from credit cards with a refinance loan can be dangerous. If you miss a credit card payment normally, you’ll get charged a late fee and your interest rate will typically climb. But if your card is tied to your mortgage, missing a payment or two can put you in a position where you could lose your home.

2. Your credit score is crucial

If you have a great credit score, you might do well with a refinance. However, if you’re looking to refinance your home because you’re in bad financial shape from delinquent credit card debts, student loans, medical bills, or other debts, you’re probably better off waiting for your credit score to recover before pursuing a refinance. As soon as your credit drops beneath perfect, lenders’ best deals start drying up. And the lower your score, the faster they disappear. Your best bet is to seek help from an expert like a mortgage banker who can help you find refinance deals you didn’t even know existed, deals that can save you thousands in the long term.

3. Don’t refinance unless the interest rate is significantly lower

It makes little sense to refinance your home mortgage unless the new terms include a significantly lower fixed interest rate. Otherwise, it probably won’t be worth the hassle. Be prepared to seek help from an expert or do an awful lot of legwork on your own to get a good rate.

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However, there are some debt relief “companies” out there that exist only to take advantage of people who are in bad financial shape and are desperate for a quick turnaround. They prey on unwitting victims and take their money without providing any debt help, often leaving consumers worse off than before. Here are three quick tips for spotting and avoiding a debt relief scam.

1. Read the fine print and ask questions

The first thing you should do before signing up for a debt relief program is read all of the company’s documentation carefully, especially the fine print, and then ask as many questions as you can to clarify any points that aren’t 100 percent clear. Even legitimate companies can sneak something in the fine print that they’d rather not advertise up front, but for scammers it can be far worse. Most people don’t red the fine print, and scammers count on you to be one of those people. Don’t be. Read the fine print and ask questions like your financial life depended on it, because, in some ways, it just might.

2. Avoid companies that charge advance fees

Some debt relief companies try to charge you up-front fees to join their “program,” but advance fees are a big red flag. Most companies that charge advance fees will just take your money without helping you out, leaving you deeper in debt. It’s worth noting that, in most states, charging advance fees before rendering some types of debt relief services is illegal.

3. Beware of outlandish claims

Some debt relief companies make outlandish claims that simply aren’t true. Some debt relief firms claim to have a 90 percent success rate or claim that their program will help you become debt-free in a matter of a few short weeks or months. Other programs claim to have super-secret insider knowledge and connections that will allow them to wipe away most or all of your debt. Such fantastic claims are nothing more than predatory marketing tactics and many of them are being cited in lawsuits by state attorneys general against deceptive debt relief companies. Make sure to get all claims, promises, and proof of success rates in writing before you sign up for a debt relief program. If a company refuses, you’ll know it’s a scam.

Following these three simple tips may help you identify and avoid a debt relief scam, but the most important thing to keep in mind is that the best defense against fraud is an educated consumer. Read everything, ask questions, get everything in writing, and make sure you understand what you’re getting yourself into before signing up with a debt relief company. There are lots of good debt relief companies out there to choose from, but there are also some bad apples that can ruin the bunch.

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If you’re in need of debt consolidation, debt management, debt settlement, or other debt relief services, you should familiarize yourself with two basic but important rules put in place by the Federal Trade Commission to help separate the good guys from the bad guys and protect you against scams.

The Telemarketing Sales Rule was amended by the FTC to help protect consumers from fraudulent debt relief programs that are out there to take your money without providing any kind of real debt help. The Telemarketing Sales Rule bans companies that sell debt relief services over the phone from collecting upfront fees before they have actually negotiated, settled, or reduced your unsecured debt (usually credit card debt). If a company wants to charge you an enrollment fee or some other fee before they perform any work, tell them not thanks and hang up the phone because it’s illegal and almost certainly a scam.

The Mortgage Assistance Relief Services Rule also helps protect consumers against scams. The Mortgage Assistance Relief Services Rule bans companies offering mortgage debt relief, foreclosure relief, or mortgage modification services from charging upfront fees unless specific conditions are met. According to the rule, a debt relief company must provide you with a written offer from your mortgage lender or servicer that explains the key changes in the mortgage terms that would occur if you accepted the offer. Only if you agree to this written offer can a debt relief company then charge you a fee.

The FTC spends a lot of time going after crooked debt relief companies, but that doesn’t mean good ones aren’t out there. Good companies are out there and these two rules are there to help make sure you can identify the bad actors and that the FTC can prosecute them.

For more information on consumer protection rules and resources, or to file a complaint or report a scam, visit the FTC’s Bureau of Consumer Protection at www.ftc.gov/bcp.

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While that reality isn’t any fun, it’s a lot better than being audited. And although we’re not tax experts, we’ve provided a helpful summary of what you might be looking at in terms of tax responsibilities resulting for debt relief services. Of course, we recommend that you consult a tax professional who can help you prepare your return accurately. After all, you don’t want to make mistakes with the IRS.

Generally speaking, you’ll probably owe federal income taxes on cancelled debts if the cancelled amount exceeds $600. Possible sources of cancellation of debt income include credit card debt settlements, loan discounts or modifications, and home loan modifications.

Nonbusiness Credit Card Debt Relief

You might be able to exclude cancelled nonbusiness credit card debt from federal income if the cancellation occurred in a title 11 bankruptcy case or you were insolvent immediately before the cancellation. Otherwise, you’ll probably have to pay taxes on the forgiven debt.

Loan Discounts and Loan Modifications

For loan discounts and loan modifications, you’ll likely owe income taxes on the amount of the discount or the amount of the principal reduction if are personally liable for the debt (called recourse) and keep any associated collateral. However, if you’re not liable for the debt (called nonrecourse) and you didn’t keep the associated collateral, you don’t have cancellation of debt income and you won’t have to pay taxes.

Home Mortgage Modifications

Whether you pay taxes and how much you pay on home mortgage modifications is complicated. You might be able to exclude some or all of a principal balance reduction from federal income taxes, especially if the reduction was secured through the U.S. Home Affordable Modification Program (HAMP). For more information, see the sections of IRS Publication 4681 on Qualified Principal Residence Indebtedness, including the subsections under Exclusions and Reduction of Tax Attributes.

Exceptions

Exceptions from cancellation of debt income may include income from cancelled debts as the result of a gift, certain student loan forgiveness programs, certain types of deductible debt, and often when reductions in collateral prices occurred after a sale.

Exclusions

Exclusions from cancellation of debt income are provided in some cases of bankruptcy and in insolvency and in some cases of qualified farm indebtedness.

Remember, this is just a brief rundown of some of the things you’ll need to know about your tax liability resulting from cancelled debts and debt relief services in 2010. You should use this information simply to help get your paperwork in order before consulting a tax professional.

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1. Stop using credit cards

The first thing you need to do to get out of debt is to stop using credit cards. As Bill Hardekopf, chief executive of LowCards.com says, “Don’t be throwing dirt on yourself when you’re in the hole already.” Put those credit cards away and start paying off as much credit card debt as you possibly can. Stick to cash or debit cards for your expenses and you’ll be doing yourself a tremendous favor, one that can help get you you out of debt and keep you there for the rest of your life.

2. Build an emergency fund

Between car notes, home loans, and credit card balances, you’re probably looking at interest rates anywhere from 2 percent to 29.99 percent — in fact, the average credit card interest rate is 14.56 percent, according to Bankrate.com. It might sound silly at first to sock cash away in a savings account that pays less than 1 percent interest, but building up an emergency fund will help prevent something like a blown tire or a doctor’s visit from causing you to break out your credit card to cover the unexpected expense. Having an emergency fund is just as important as paying down your debt. Ideally, you should aim for enough savings to cover three to six months of living expenses.

3. Consider taking advantage of balance transfer offers

Balance transfer offers from credit card companies can help you pay off your debts, but you’ve got to play it smart. Some offers may sound great, like 0 percent interest for up to 21 months, but you have to avoid the pitfalls contained in the fine print, such as interest rate hikes up to 19.99 percent or higher after one late or missed payment, and need to be able to pay off the balance in the promotional timeframe. After the promotional period expires, so do those low interest rates. And whatever you do, don’t buy anything with your transfer card. You’d just be throwing gas on the fire and going deeper into debt.

4. Look into a debt consolidation loan

If you decide not to seek help from a professional debt relief agency, you might be able to get a debt consolidation loan to help pay off your debts. If you have high interest rates from things like credit cards, an unsecured personal loan with interest rates of 10 percent or less might be a good deal. But a word of warning: a debt consolidation loan is like dynamite. According to Scott Halliwell, a financial planner for USAA, a debt consolidation loan in the right hands can do a lot of good, but “it’s pretty dangerous” if used incorrectly. You could end up deeper in debt if you fail to budget payments and you can end up owing more down the road if your repayment term is too long.

The key to keeping your debt relief resolutions this year starts with not using your credit cards. It’s that simple. Cut them up if you have to, but stop using them to buy stuff. Once you budget your monthly expenses and switch to a cash-and-carry lifestyle, you can start making some decisions about building an emergency fund, transferring your credit card balances, or looking into a debt consolidation loan. If you find you’re still struggling with your debt, you can always contact a debt relief professional.

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In part one of our six personal debt relief tips we offered the first three pieces of advice for completing a much-needed debt diet, including calculating your debt, cutting up your credit cards, and trimming the fat. For part two we discuss the final three tips, including seeking professional help, finding additional income, and rewarding yourself to keep your momentum going.

4. Consider professional help

Credit counseling organizations and debt relief companies can likely help you organize and pay off your debts if you’re in financial trouble. Nonprofit credit counselors recommended by the National Foundation for Credit Counseling can help you develop a debt management plan. Debt relief companies offer services such as debt consolidation, debt management, and debt settlement that can help you get a handle on your debt and eventually become debt-free.

5. Bring in additional income

Of course, a good way to get out of debt is to find a way to bring in additional income while you cut your expenses. Being creative is key. You’ll stay focused on your debt diet goal if you remember that the extra work and the extra cash are going to pay off your debts. Try to find a way to take on extra or overtime shifts, get a part-time job, or sell stuff you don’t use on eBay. You can even consider selling other assets, but make sure to not go overboard. Dipping into retirement accounts to pay your credit card debt isn’t advisable.

6. Be kind to yourself

A debt diet is like a food diet, the best changes are the ones that you can incorporate in your everyday life. And, just like a food diet, you should allow yourself some occasional breathing room. Go out to eat once a month or save for an affordable vacation. If you cut off too much and make too many inflexible changes, you’re likely to go off your diet and start making poor decisions. And don’t be afraid to try and save money for emergencies and retirement while you’re paying off your debt. Even $10 or $20 a week will make a difference in the long term.

Getting professional help, finding additional income, and rewarding yourself will help you successfully follow thorough on your debt diet and eventually help you shed all those unwanted debt pounds for a leaner, stronger, healthier financial future.

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For part one, we offer three tips about calculating your debt, cutting up your credit cards, and trimming the fat. Make sure to check back for part two, where we offer three more tips on seeking professional help, finding additional income, and rewarding yourself to keep your momentum going.

1. Calculate how much you owe

The first step to beginning your debt diet is to sit down and determine how much you actually owe. Whether you use a money management program, a spreadsheet, a free service like Mint.com, or a pad of paper and a pencil, gather all the information from your various debts and record your current balances. Include credit card debt, student loan debt, auto loan debt, and any personal loans. Record minimum monthly payments, interest rates, and terms. Now you know how much you owe and which debts are costing you the most to carry.

2. Cut up your credit cards

Whether you use your credit cards to pay for living expenses because you’re out of work or use them to pay for things you want but don’t need, one of the only ways you’re going to get out of debt is to avoid going into debt any further. You’re best bet is to cut up your credit cards and cancel your accounts (and pay off your balances under current terms) to prevent further use. Some financial experts caution against closing accounts because doing so could lower your credit score and advise that you keep at least one credit card for emergencies. The important thing is to prevent access to credit cards if you have a problem with spending. Instead, opt for a cash-and-carry lifestyle and use debit cards if you have to.

3. Make a budget and trim the fat

Make a budget based on your income and track your spending for 30 days. It can really open your eyes to how you’re spending — and wasting — money. That $4 cup of coffee you buy every day at work could end up costing you nearly $28,000 over a 35-year career. Investing the same amount of money could earn you $247,000 at 3 percent interest over the same period. And that’s just coffee. Your debt diet should include cutting out expenses such as eating out and pricey cell phone plans. You should cut back on groceries, utilities, gas, clothing, and gifts, and drop services that you don’t use, like gym memberships. You should also change your behavior and stop smoking, playing the lottery, and spending money on other costly habits.

Calculating your total debt, cutting up your credit cards, and trimming the fat will get you enough personal debt relief to get you started on your healthy debt diet. Check back for part two for three more tips that will help you follow through on your debt diet and get you where you want to be financially.

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1. What the IRS considers when it comes to debt cancellation

Generally speaking, the IRS considers any type of forgiven debt from a commercial lender or creditor, including but not limited to home mortgage loans and credit cards, to be subject to federal income tax in the year the debt was cancelled, as long as the amount cancelled is $600 or more. For example, say you borrow $10,000 and default on the loan after paying back $2,000. If the lender forgives the remaining $8,000, then that $8,000 is considered income for purposes of federal income tax and should be reported on Line 21 of the 1040 tax form.

2. Debt cancellation amounts are not always taxable

Although the amount of debt cancelled through things like mortgage principal reduction and credit card debt negotiation is generally considered taxable, not all debt cancellation amounts are taxable. There are several categories of nontaxable forgiven debt:

• Bankruptcy — Debts discharged as the result of bankruptcy proceedings are not counted as taxable income.
• Insolvency — If you are insolvent (your total debts are more than the fair market value of your total assets) some or all of your forgiven debt may not be taxable.
• Certain farm debts — If you had any debt forgiven that was incurred directly in the operation of a farm, more than half your income from the previous three years was from farming, and the loan was from a regular commercial lender or and individual who regularly lends, your cancelled debt is generally not considered taxable income.
• Non-recourse loans — If your debt was incurred through a loan for which the lender’s only recourse in case of default is to repossess the property being financed or used as collateral — and the lender can’t pursue you personally — doesn’t result in taxable income from the cancelled debt but may result in other tax consequences.

3. Homes lost through foreclosure

If you lost your home through foreclosure, there are two possible tax consequences. In the first possibility, for recourse loans, the amount of cancelled debt (called cancellation of debt income) is considered taxable if the total amount of debt owed prior to the foreclosure is greater than the fair market value of the property. You may also be taxed if you received gain from the foreclosure, which means the fair market value of the foreclosed property is greater than your adjusted basis in the property (usually your purchase price plus the cost of improvements).

In the second possibility, for non-recourse loans, the cancellation of debt income is considered taxable if you received gain from the foreclosure (in this case, the amount of debt immediately prior to foreclosure is greater than your adjusted basis in the property).

For both recourse and non-recourse loans, gain from foreclosure is subject to certain exclusions. For more information, visit www.irs.gov or contact a tax professional.

4. Losses on foreclosed homes

While you may be taxed on gains from foreclosures, you unfortunately can’t deduct losses from the sale or foreclosure of personal property.

As with any tax issue, it is advisable to contact a tax professional if you have any questions. We strongly recommend contacting a tax professional if you have been the customer of a debt relief service of have had any debt cancelled or forgiven this year.

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Military OneSource

The first debt help resource you should consider using is Military OneSource, a free service provided by the U.S. Department of Defense (DOD). Military OneSource helps service members and their families with a broad range of issues, including money and debt management. Services are available 24 hours a day by telephone or over the internet. Many of the professional consultants have military experiences and all receive training on military matters and military lifestyle to better help you.

Military OneSouce: (800) 342-9647, including via Voice Over Internet Protocol (VOIP), or online at www.militaryonesource.mil

Credit Counseling

Credit counseling is available in person or over the phone through a DOD partnership with the National Foundation for Credit Counseling (NFCC). You can also contact the Association of Independent Consumer Credit Counseling Agencies (AICCCA) directly for assistance. Make sure to spend time with the person you end up contacting so they can better assist you and your family.

NFCC: (800) 388-2227 or online at www.nfcc.org

AICCCA: (866) 703-8787 or online at www.aiccca.org

Servicemembers Civil Relief Act

The Servicemembers Civil Relief Act (formerly called the Soldiers’ and Sailors’ Civil Relief Act) provided a wide range of protections for servicemembers, including helping you and your family postpone or suspend certain obligations, such as financial obligations, while you’re serving. Financial protections include deferring credit card debt, mortgage payments, and tax payments. For example, interest rates on credit card accounts that you had prior to beginning active duty can be reduced to 6 percent while you’re deployed, but you have to ask your credit card company for the protection.

For more information, contact Military OneSource or visit www.military.com/benefits.

Other Debt Help Resources

Depending on your service branch, you may be able to also receive debt help and money management advice and assistance through the Army Emergency Relief, Air Force Aid Society, Coast Guard Mutual Assistance, and Navy-Marine Corps Relief Society.

Army Emergency Relief: (866) 878-6378 or www.aerhq.org

Air Force Aid Society: (800) 769-8951 or www.afas.org

Coast Guard Mutual Assistance: (800) 881-2462 or www.cgmahq.org

Navy-Marine Corps Relief Society: (703) 696-4904 or www.nmcrs.org

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1. Avoid using debt to buy depreciating assets

It’s hard to buy a car, new or used, without taking out a car loan. However, you should strive to avoid taking out loans or using credit cards to buy depreciating assets like cars. No matter what you hear from car salespeople, cars are not a “good investment” because of a high resale value; they never increase in value like an actual investment can (although maybe some super-collectable car will 50 years from now). Unlike appreciating assets — such as homes, investments, and rental properties — cars and other depreciating assets continually decrease in value from the moment you buy them. Add interest payments to the mix and you start paying a lot more for something that’s worth a lot less.

2. Follow a strict budget

The best way to ensure that you manage the debt you have while avoiding going into further debt is to develop a good monthly budget and follow it. The key component is spending less than you earn. Try using the Build-a-Budget Worksheet if you don’t already have a budget.

3. Build an emergency fund

Part of your monthly budget should be setting some money aside in a savings account that you can use for emergencies instead of breaking out your credit card. Emergencies, like medical treatment, home repairs, or unemployment, are bad enough. But paying 19.99 percent interest on related expenses because you don’t have an emergency fund is only going to make it worse and saddle you with more credit card debt. Ideally, you should strive to save from three to six months worth of wages to cover unexpected expenses.

4. Save for big purchases

Need to make a big purchase on the horizon, like a TV, computer, or dishwasher? Obviously, it’s best to not be blindsided with an emergency situation that you have to cover with a credit card. But if you know you’re going to need something on the horizon, or want something you don’t really need (like a 60-inch LCD TV), the best thing to do is to save up for the purchase. As part of your monthly budget, take part of your earnings — after saving for your emergency fund — and put it away in your savings account. Keep track of these additions and, when you have enough money, pay cash for your purchase. This way, you’ll avoid having to spend a lot more for the things you buy.

Here’s an example of how bad buying things on credit can be: if you have a credit card with an 18 percent interest rate (pretty common these days), making minimum monthly payments on a $1,500 TV will take you roughly 153 months to pay off (that’s almost 13 years) and will cost you a total of about $3,175. That means, in exchange for instant gratification and not having to save your money, you bought a $1,500 TV for $3,175. Not exactly a great way to spend your money or a wise way to stay out of credit card debt.

The best way to manage your debt is to not incur any. But for those who are in debt, including those enrolled in a debt management program to pay off a lot of debt, these four tips for creating a personal debt management plan can not only help you get out of debt, they can help make sure you stay there.

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