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The Simple Dollar

Credit repair: What's the smart plan for clearing out debts?

Credit repair (Question #1) and recovering from bankruptcy (Question #10) let you erase old debt and improve your credit score – in the long run. But be careful about short-term implications.

By Guest blogger / December 31, 2010

Feeling squished by your debt load? You can clear out old debts (Question #1) and rebound from bankruptcy (Question #10), if you're one of the increasing number of Americans worried about credit repair. If you're financially solid, check out employer matching in Question #6 or Roth vs IRA advice in Question #9, from today's Reader Mailbag.

Illustration / VIPL / FS / smartmagna.com / Newscom / File

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Q1: Clearing off old debts
All my creditors write to me each year and offer greatly reduced settlement figures to clear the debt but, as yet, I haven’t had to money to settle any of them so would it be a good idea to implement a version of the snowball effect by saving fixed amount that I can afford each month and put it into an account to earn some interest, no matter how small, and then when I have a couple of thousand saved up contact the smallest debt creditor and offer an amount, say 30% of the balance owed to clear the debt? I am sure they would agree in order to clear the debt. Then carry on saving as before and add the amount I used to pay the creditor … and so on.

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I don’t want to increase the amount I pay each creditor on the current agreement because they might think I can afford more and therefore increase the likely amount they would accept in the future as a settlement.

I do want to pay off my debts and so far I have done a fairly good job of working towards this goal. I want the best possible deal but I am unsure of the best strategy.
- Tom

Since these debts are in collections and thus not accruing more interest, I’d say your strategy is a relatively good one assuming that your goal is to actually be honest with your debts and pay them off now that you have your life in order.

It’s important to note that when you pay off the debts, the act of paying them will have an immediate negative impact on your credit rating which will be somewhat mitigated by an improved debt-to-credit ratio. It’s crazy, I know, but when you pay a debt that’s been in collections, you take an old debt and make it current, and your credit score pays much more attention to recent debts than to old ones.

Why am I mentioning this to you? If you’re about to take out debt for some other reason, wait until after you take out the new loan before paying off an old loan. You need your credit score as high as possible in the moment in which you’re getting a car loan or a home loan.

Q2: Life insurance and suicide
Is it true that life insurance does not pay out if you commit suicide?
- Fred

I excised a good deal of Fred’s note for obvious reasons. I sent him a personal note directly encouraging him to rethink some of the things going on in his life.

Nevertheless, Fred’s question is a good one. The truth is that most life insurance policies have some sort of suicide clause in them stating that there are either no benefits or reduced benefits in the event of suicide. This is obviously to protect a life insurance company from someone signing up for a big policy just to off themselves and give their family a big payout.

In short, if you’re considering some sort of misbegotten “I’ll get life insurance and then kill myself” plan, not only is it a dangerous and painful idea, it won’t work, either. Instead, you should spend your energy seeking out someone to talk through your problems with, whether it’s a trusted friend or a psychology professional.

Q3: Handling three child seats
My husband and I are expecting our third child. Our kids are currently 3 and 18 mos., and of course both are in car seats. By the time the next one arrives, the oldest will be in a booster, I think…but of course we’re contemplating the car question.