How to handle creditors and avoid wage garnishment

A College Student's Debt Collection Crisis

by Gary Foreman

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Dear Dollar Stretcher,
One of my creditors is threatening to garnish my wages (up to 25% of my $895 per month wage) if I don't pay them more than I am currently paying. If they garnish, I won't be able to pay my numerous other creditors. The debt is $5000 at approximately 25% interest. They have made an offer of $77 a month and they will drop my interest rate to 10%. I earn the above stipend plus my university tuition.

If recent statistics are correct, Helen isn't the only college student who's having trouble with credit card debts. We'll use Helen's question to examine her situation as well as how all of us can use credit wisely.

Let's begin by analyzing the offer that's facing Helen, starting with her current payment plan. A $5,000 debt at 25% interest will cost a little over $100 each month in interest payments. So if Helen is currently paying less than $77 per month, her balance is actually increasing each month even if she never pulls the card out of her purse. For illustration, let's assume that she pays $50 every month for the next ten years without using the card. At the end of ten years she will have written checks totaling $6,000. But, incredible as it seems, her debt will now be over $11,300.

What happens if she accepts the company's offer? The interest rate reduction will lower the interest charges to $42 in the first month. As she continues to pay $77 each month the balance (along with the interest she owes) will go down. The entire debt will be paid off in a little less than eight years.

It doesn't seem as if this is an offer that Helen can refuse. Unless accepting it makes it impossible to keep current with the 'numerous other creditors'. Which brings up a second question. How much debt is affordable? Because of limited income, the question is especially important for students.

One standard suggests that interest payments shouldn't exceed 5% of after tax income. For simplicity's sake, we'll assume that Helen's $895 per month is after tax. That means that Helen shouldn't be paying more than $45 per month in interest charges. Clearly, she's way over the guideline.

So, if Helen shouldn't have accumulated so much debt, how did it happen? Why did the credit card companies extend her so much credit?

For a moment, let's pretend that we're the owners of the credit card company. We want to know how to make more money. That's easy. By encouraging consumers to use our cards and carry a balance. So it's good business to try to find young customers to carry our card. They'll spend a lot of money as they start families and buy homes and furnishings. They're also likely to carry a balance.

Another way that we can increase our earnings is to get customers to borrow more money. The more they borrow, the more we make. We want them to get comfortable with a 'low minimum monthly payment'. We also want them to focus on the size of payment rather than the total amount owed.

A customer that thinks only in terms of the monthly minimum will add to their debt when they get pay raises. Remember, our goal isn't to have them pay off their debt. It's to make more money. The best way to do that is to have the minimum payment about equal to the interest charges. That way we keep the payment 'affordable' and the debt plan goes on forever.

Related: Understanding How Your Minimum Payment is Determined

There is one problem that we'll need to watch to protect our profits. Some customers spend too much and get in over their heads. As their total payments begin to exceed 20% of income, a customer account becomes dangerous, especially if it continues to increase in size. Then we need to change our strategy. Initially, we'll increase the interest rate we charge the customer. After all, there's a greater chance that they won't be able to repay the debt. We need to cover that additional risk.

Finally, if a customer shows signs of being unable to continue timely payment, we'll need to try to collect the total amount due as quickly as possible. In most cases, we're not the only company who has loaned money to this customer. Eventually, some companies will not be repaid. We don't want to be one of them. The trick is to get our money before that happens.

That's where Helen comes in. She's already been paying outrageously high interest rates because the card company is afraid that she won't be able to keep up with the payments. Now they're concerned that the game is nearly over and they want to be the first off a sinking ship.

What should Helen do? This is probably her last chance to get her debts in order without declaring bankruptcy. Realistically, she has about four options.

Am I a good candidate for bankruptcy?

She can turn down the offer and continue down the same path. Other companies will likely follow the first and want a portion of her wages. Ultimately, this trip's most likely end is the bankruptcy court.

A second choice is to accept the offer and try to keep the other accounts current. If she's able to keep current with her payments until graduation, a higher salary could bail her out.

Seeking professional help for her debt problem is another option. Many areas have non-profit organizations like Consumer Credit Counseling Service available. They will contact her unsecured creditors and attempt to negotiate lower interest payments. They will also expect her to stop using her credit cards and the fact that she sought help will be reflected on her credit reports for a number of years.

Am I a good candidate for credit counseling?

Helen does have one option that's not available to most debtors. She could work full-time until her debts are repaid. She wouldn't be the first student who had to go to school part-time because of financial constraints. And it certainly beats having a bankruptcy on her file when she goes to buy her first home.

Hopefully, Helen will be able to resolve her problem and learn from it. We're fortunate when we can learn from youthful problems. It gives us extra time to benefit from the wisdom we've gained. Thanks to Helen for asking a helpful question.

Reviewed July 2017

Gary Foreman

Gary Foreman is a former financial planner and purchasing manager who founded The Dollar website and newsletters in 1996. He's the author of How to Conquer Debt No Matter How Much You Have and he's been featured in MSN Money, Yahoo Finance, Fox Business, The Nightly Business Report, US News Money, and Gary shares his philosophy of money here. Gary is available for audio, video or print interviews. For more info see his media page.

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