This article is written by Peters and Associates.
Question: I’m about to get a large tax return and am planning to use the money to pay down my old debts. Is there anything I should know?
Answer: Around this time every year, we get questions like yours coming into the firm. Using your tax return to pay off debt is an excellent strategy, and it may be your ticket to becoming debt-free.
If you are current on your debts, paying them is easy; just pay as you would any other month but increase the amount.
When dealing with creditors such as big banks, credit-card companies and large loan firms, I usually recommend paying online at the creditor’s website. This tends to lower the potential for error. You’ll pay down your debts at a $1-to-$1 ratio, and you’ll keep your credit report looking good.
However, if you’re behind on your payments or struggling to make them on a monthly basis, paying the bill directly may not be your best option.
Depending on the type and amount of debt, arranging a debt-settlement agreement with your creditor may be an option. Debt settlements can allow you to pay 20 to 40 percent of what you would have owed.
When settlements are executed properly, you may be able to pay off your entire debt for much less money than you actually owe and finally be debt-free. For this reason, debt settlement can be an especially handy option when paying off debt with a lump sum, such as a tax return.
Tips for debt settlement
• Get everything in writing. Debt settlement can be a complicated process. If a debt is settled incorrectly, you could end up owing more than your original balance.
• Don’t pay a dime until you have all the proper documentation and understand the exact terms of the agreement.
• Law firms that handle debt settlement and bankruptcy typically are able to negotiate better settlements than people who try to settle debt on their own or use debt-settlement companies that aren’t law firms.
• You can settle debt on your own in some cases, but fees paid to debt-settlement lawyers often are offset by the lower settlement the lawyer is able to negotiate.
When to consider filing for bankruptcy
If you’re not able to pay off your current debt in full or if you can’t get out of debt 100 percent within 12 to 18 months using a debt-settlement plan, you may want to consider using your tax return to retain a lawyer and begin the bankruptcy filing process.
Bankruptcy can be a scary word, and while it’s true that it should be treated as a last-resort option, sometimes it’s better to rip the bandage off quickly than to peel it away slowly.
Struggling for years to pay back debt is painful, and that pain can be made much worse if, at the end of the line, you wind up having to file bankruptcy anyway. If bankruptcy is inevitable or even strongly probable, avoiding it only postpones your eventual recovery. Recovering from bankruptcy can be an easy process, but it does take time and patience.
The sooner you file, the sooner you’re able to reroute your path toward financial freedom.
Beware of scammers
They’re out there, especially during tax season. Whenever you’re dealing with debt, be sure all agreements are legal and in writing.
Pay attention to your credit
You should check your credit report every year. If you make it a habit to check your credit report on Tax Day, you’ll be on track to check it annually.
A time to reset each year
Tax season is a great chance to sit down and take an accurate and honest look at your personal financial situation. Assessing your finances in the big picture — what you bring in, what you spend, how much you save, what debt you’re accruing, etc.— can be difficult but is hugely important.
When you filed your taxes last year, did you promise yourself to get out of debt in 2015? Did you make it? If so, great. If not, when you’re making the same promise to yourself this year, it might be time to evaluate your options, set up an action plan and make some potentially tough decisions.
Please note: The information in this column is intended for general purposes only and is not to be considered legal or professional advice of any kind. You should seek advice that is specific to your problem before taking or refraining from any action and should not rely on the information in this column.