Rising Bankruptcies Show Value of Managing Debts

Credit cards are both a boon and a bane for American consumers. Fitting neatly into our wallets and pocketbooks, they allow us to get items we need and not pay for a month - or perhaps much longer.

But, if we're not careful, plastic also allows us to spend more than we can really afford.

Consider the recent news that, in the year ending June 30, the number of bankruptcy filings totaled more than 1 million for the first time ever in a 12-month period. That's almost one person for every 100 US households.

"Today's bankruptcy boom is the natural result of three years of sustained consumer spending increases that far outpaced income growth, in an era of greater social acceptance of bankruptcy," says Sam Gerdano, executive director of the American Bankruptcy Institute, a research organization in Washington.

If bankruptcy has lost some of its stigma, however, it hasn't lost its sting, both emotionally and in a tarnished credit record.

Whether or not you're at risk of financial fiasco, managing debt may be important step. How do you do it wisely?

Experts offer several tips:

Watch your total debt level. The sounds obvious, but it's actually quite easy to focus instead on minimum payments on your credit-card balance, for example.

Credit card debt, of course, isn't the only factor here: Loans for children's college education or for hard assets such as a home also count. Total debt generally shouldn't be more than three times your annual income, suggests Eric Tyson, a financial counselor and author of "Personal Finance for Dummies" (IDG Books).

But Mr. Tyson says plastic and auto loans represent "bad" debt, because interest rates tend to be high and the credit is not used for sound long-term investments. He suggests that if the total of this consumer debt is more than 25 to 33 percent of your annual income, it's too high. "The right amount to have is zero."

Some advisers get really drastic, recommending that people simply cut up all their cards.

Get control of your spending. You're not reaching for your scissors yet? Well, you can still control spending. Try to plan so that each month, you pay off your whole card balance. Sometimes you might miss because of a temporary situation, but with effort you can stay on track. "With freedom comes responsibility," Mr. Gerdano says.

Pick the right credit cards. Many Americans have a dozen or so credit cards. But quality is much more important than quantity, experts say.

If you never carry a balance, interest rates may not matter. Go for cards with no annual fees or with perks such as airline miles.

If you do carry a balance, look for low-rate cards. One source of advice is CardTrak, a publication of RAM Research Group in Frederick, Md. Call (301) 695-4660 for information.

Turn high-interest debt into lower-interest debt. Always pay off high-interest debt first, lower-interest debt later. Better yet, you may be able to change the interest rate you pay.

Sometimes, if you call your card issuer and say you plan to transfer the balance to another card, the company will reduce your rate to keep your business, Tyson says.

Another approach, he says, is to actually transfer balances to lower-cost cards or to a home- equity loan. After being approved for a new, low-interest credit card, you can often use so-called transfer checks from the card issuer to pay off high-cost cards and put the debt on the new card.

A similar approach can work with a home-equity loan, Tyson says, since these loans typically have lower interest rates than do credit cards. The interest is generally tax-deductible. You are putting your home at risk, however. These loans are mortgages.

Sometimes rob savings to pay down debt. If interest on your debt is higher than what you're earning on savings, it may make sense to use the savings to pay off debt. Still, withdrawing or borrowing money from a tax-sheltered retirement account is seen by many experts as a last-ditch move.

Be sure to keep some savings on hand for emergencies, enough to live on for three to six months. Many people "just don't have a cushion" to help them in a crisis such as job loss, Gerdano says.

If you get in trouble, beware the advisers. Sometimes the people who are available to help you out of debt trouble have vested interests, Tyson says. Consumer-credit counseling services, for example, are sometimes funded by credit-card companies and will be hesitant to hold out bankruptcy as an option. Conversely, bankruptcy attorneys sometimes steer people toward bankruptcy when it's not needed.

Other services may offer to consolidate all your debts into a single loan. But often these services end up charging you a higher interest rate than you might otherwise pay.