Vision Credit Education, Inc.

Your Nonprofit Credit Counseling Organization

What does it really cost to repay $40,000 in credit card debt?

May 16th, 2013 by Kenneth Long

That $40,000 in credit card debt might seem manageable, but if you carry it long term, it could easily cost you over $70,000 in interest over a decade and still owe the entire amount. The decision to eliminate those high balances is admirable, but you still need to understand the costs of each method for ridding yourself of that burden.

There are essentially four methods for eliminating credit card debt. Here are the pros and cons of each method:

  1. Status quo. This is actually the most common method, and least effective option for dealing with debt. By not changing anything, how do you expect to repay your debt on your own? Most debtors struggle with this option for years. Any reductions in debt balances are frequently offset with financial emergencies, holiday spending, repairs and other needs and wants, thereby leaving the balances just as high or even higher than they were a year prior. Similar to an alcoholic, it takes getting over denial, taking responsibility for your situation and admitting that you need to change your current habits. The cost over 10 years is $72,000 or more, and you still owe the entire $40,000, bringing the total to a minimum of $112,000. If you cut up your cards and make minimum payments, it will take 69 years. You will pay average interest charges of $117,863, making the total $157,863.
  2. Credit counseling. There are limits to what credit counseling can do for debtors who have already defaulted on their debts. If you are still making payments, then there may be a possibility of repayment through a debt management program. You would still pay interest, but those interest payments are generally far less than what most debtors are paying on high balances. An average debt management program client could expect to repay $49,752.
  3. Debt settlement. This is a viable option if you have at least $15,000-20,000 in cash. Most settlements are around the 60-70% range, but you may be able to negotiate a lower amount if you are persistent. Assuming that you can settle your $40,000 in debt for $20,000, then your total cost will be approximately $26,000 once figuring in the estimated taxes on your forgiven debt. You must also factor in the additional borrowing costs over the next 7 years. If you anticipate no major credit purchases (home or car), then the long-term costs are negligible. Otherwise, they could offset any savings that you found through settlement. If you do not have upfront cash, then this is not a valid option. Debt settlement companies may offer an attractive monthly payment option, but all this does is leave you exposed to judgments and wage garnishments while the settlement firm earns interest on your deposits. Meanwhile, your debt balances keep increasing, making your total cash outlays closer to $35,000 after accounting for the extra interest and their fees.
  4. Bankruptcy. If you earn less than the median income for your area, then a Chapter 7 bankruptcy filing might be a possibility. For those seeking a strategic default, a Chapter 7 bankruptcy could block legal action against you and wipe out your debts (except for student loans, taxes and child support). If your household income is higher, then you could end up repaying $25,000 or more through a Chapter 13 bankruptcy plan. Expected costs on Chapter 7 are much lower, but there are substantial limits on excludable assets. Chapter 13 bankruptcy could easily cost closer to $30,000 after factoring in the trustee fees. Both types of bankruptcy substantially increase your borrowing costs over the next 7-10 years, so it is important to consider those costs as well. If you still need to buy cars or a home, then bankruptcy may just be kicking the can down the road rather than actually saving you money.

Successful repayment of your credit card debt through options 1 or 2 would generally result in an improved credit rating, thereby reducing any future borrowing costs. Options 3 or 4 would both dramatically increase your borrowing costs over the better part of a decade, so it is important to take these higher costs into account when you are making your decision.

You should also consider what assets you have as well as other liabilities. These can dramatically impact the feasibility and attractiveness of each option. To find out more, you should consider speaking with a credit counselor and/or bankruptcy attorney. Both generally offer a free consultation, so you can get information from both before making a decision or spending any money.

* Estimates provided by Federal Reserve System and American Consumer Credit Counseling.

This entry was posted on Thursday, May 16th, 2013 at 1:16 pm and is filed under Credit Cards, Debt Management. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.

Leave a Reply