Climbing out of debt: How to recover from overspending

After years of scrimping while living on school loans, some physicians emerge from medical school and go hog-wild on a spending binge with their first paychecks.

"They've been in deprivation mode for so long because they've been in school for so long. Then they get out of school and it's easy to get into an overspending mode," said Barbara O'Neill, a professor of family and consumer sciences at Rutgers University.

This spending bender can produce a debt hangover.

Symptoms include worn-out credit cards, final notices from creditors and a seemingly insurmountable pile of IOUs. Extreme cases can develop into full-blown bankruptcy.

But experts say there are ways to recover from having too much debt. For some, using a debt counseling agency is the best way to appease creditors and develop a repayment plan. Others may choose to get a loan and consolidate their debts into one regular payment. Still others may simply turn to family members for help or rely on creating their own budget and repayment schedule.

Fueled by a weakened economy, consumer debt in America has reached an all-time high. The Federal Reserve estimates that consumer debt totaled $2 trillion in November 2003, up from $1.4 trillion five years earlier. Faced with lower reimbursements and often loaded down with school debts, physicians have been part of this trend.

While some debt can be good -- like when it is used efficiently to pay down other debts -- having just a little too much can cause financial ruin.

"It's like fire and water. Fire and water are two of mankind's best friends. You can't live without either. But out of control they can be devastating," said Fred Siegel, president of The Siegel Group Inc., a financial services firm in New Orleans.

Determining how much debt is too much depends on each individual's financial circumstances at that point in his or her life, Siegel said. For example, some physicians can expect to have more debt early in their careers, after finishing school or opening a new practice. Since everyone's situation is different it may be best to have a financial professional decide what is too much.

O'Neill said a good yardstick is considering what percentage of a person's income is going toward debt repayment. She said if the figure is 20% or more, that could be a red flag that the individual is headed into financial trouble.

Once it has been determined that a person has too much debt, O'Neill says the first step toward managing it is creating a tally or itemized list of everything that is owed, including school loans, business loans, credit card debt, loans to family members and more.

"Just get a handle on it. A lot of times people know they owe a bunch of creditors and may know the balance of each debt but have never added it all together," she said. The total figure can be sobering but it will help with developing a repayment plan.

Next, O'Neill recommends that people in debt check their credit reports, which can be obtained through credit bureaus. She said this step will help them get a better handle on their finances.

After the preparation work is complete, a debt repayment strategy can be developed. If a physician isn't confident in setting up his or her own strategy, there are many options for outside help. Experts say the best strategy depends on the individual's situation.

Debt counseling

Debt counseling agencies might best serve those who need help dealing with creditors and want to have a repayment plan developed for them. Typically, these agencies will develop a plan to take over a person's debt payments to creditors. In return, the person pays the agency a fixed amount each month.

O'Neill said this strategy can be advantageous, because some agencies might be able to get concessions from creditors, including reduced interest rates and waivers for fees.

It is also possible for agencies to persuade creditors to re-age an account balance, making it current so it is no longer delinquent, said Robert Closs, president of the nonprofit Orlando, Fla.-based agency Profina Debt Solutions. That way, he said, the person's credit report no longer would show a delinquency so he or she could start rebuilding credit while making payments.

But O'Neill said the drawback to debt counseling agencies is that when they are used, they will likely show up on the person's credit report. Some creditors view that as a bad sign, but others believe it is good, showing that the consumer is making an effort to take care of the problem.

For these services, consumers may have to pay the counseling agency an administrative fee. Some agencies can save the consumer enough money to cover the fee or more.

Experts, however, add a big caveat when recommending this strategy. They say consumers need to be very careful when choosing a debt counseling agency, because some are simply out to make money and have been known for unscrupulous practices.

"There are some credit counseling agencies that people should stay away from. Some have judgments against them and have been found guilty in courts of law of defrauding people," O'Neill said. "Check them out before you sign a contract and start handing money over to them. You may have to play detective a little, but it could be well worth your time."

Local Better Business Bureaus might be able to steer consumers to a well-respected debt counseling agency, and some state banking divisions offer licensing to quality agencies. Siegel said the National Foundation For Credit Counseling also can help.

Loan consolidation

But some consumers may want to stay away from debt counseling agencies all together. For many of them, loan consolidation may be the best strategy.

Typically, debt consolidation involves obtaining one umbrella loan from a bank to pay off several debts. They can come in many forms, but there are two main types: unsecured and secured. Unsecured means the money is being lent without the borrower having to put up collateral. A secured loan means the borrower has to put up collateral -- for example, in a home equity loan, you borrow against the value of your home.

O'Neill said the advantage to loan consolidation is that the debts can be consolidated at a lower interest rate than what the debts had previously. But she warned that this strategy is not suited for people who can't stop overspending.

"The downside is if you're using the home equity loan and you don't pay it off, you could lose your house," she said.

Siegel said the loans could be difficult to get, because banks are wary that the consumer will continue to overspend and ultimately might default on the loan.

"If you're a physician with a very good practice, fairly well-known, a bank will certainly look at your credentials and you may get a consolidation loan. But banks are very skeptical about consolidation loans because they're concerned you'll get back in the same situation," he said.

Siegel says loan applicants should do some homework before seeking the loan and be prepared to answer questions about finances and debts. He said that preparation could impress the bankers and convince them to offer a loan.

"It may be they want some sort of collateral. First try it without collateral," he said. If the banks wants something, the loan applicant could put up office equipment, a second mortgage on a home or building or other assets.

After being granted the loan, the consumer can ask the bank to write out the checks to creditors so all that's needed from the debtor is a signature. Siegel said this tactic helps bankers feel more comfortable about the loan.

Consolidation loans carry interest rates that are typically higher than those on a mortgage and lower than those with credit cards, Siegel said. That means consolidation loans might be especially beneficial to people who are carrying a lot of debt from credit cards.

He said the disadvantage to consolidation loans is how some people perceive them.

"Some physicians may feel a little reluctant to let the banker know they have the problem," Siegel said. "They may need [the banker] for something else. That's really unfounded, but it's a psychological thing that really holds people up."

Filing for bankruptcy

If none of these plans work, some people may look at filing for bankruptcy protection as an alternative.

"Sometimes it's better to just start over; maybe reaffirm your automobile and your home and start all over," said Tirrell Paxton, a lawyer and accountant in Chicago.

Different types of situations warrant different bankruptcy filings, he said. The most common individual filing is known as Chapter 7, which involves liquidating a debtor's assets to pay creditors. Another personal bankruptcy filing, Chapter 13, allows the debtor to propose a plan to repay creditors over several years. Individuals who owe large amounts and have a high net worth may be required to seek aid under Chapter 11, a reorganization plan usually used by businesses.

Paxton said bankruptcy can get rid of debt. However, he said it can be disadvantageous in that it stays on a person's credit report for seven years and may make it difficult to get good loans during that time. Also, he said, student loans cannot be discharged in bankruptcy.

Regardless of what strategy is employed for digging out of debt, experts agree it is important for debtors to develop a budget or spending plan that will keep them from falling back into the red.

"It's really imperative to put together a realistic budget and start investing," Paxton said. "You've got to stop and realistically ask yourself what you need and what you don't need.

"Get a handle on income and how much you're spending on what is mandatory, then see what is left over."