Digging yourself out of the financial hole of credit-card debt

Our mistakes take many forms.

Relationships.

The dreaded foot in the mouth.

Oh, and money.

Like the time I found myself in line at my college's student union, waiting for a Western Union money transfer from my father. A few hours before, the lights in my apartment had gone out. A few days before that, I got a certified letter from my landlord, who was not just saying hello.

The problem: I had spent too much of my paycheck on beer and sandwiches at Jimmy John's and failed to account for essentials. I was flat broke.

I called my father and begged for help. After some grumbling, he wired $500 to the campus branch of Western Union, where the woman at the counter said the cash came with a message. Stripped of some colorful adjectives, my dad's message was clear: "Learn how to manage your money!"

That slip-up years ago certainly wasn't my last one involving money, and heeding my father's advice has occasionally been a struggle. But I draw comfort in knowing that I'm hardly alone when it comes to making financial blunders.

Now that we have become a nation of debtors, fixing our financial mistakes has become much harder. Collectively, we carry $11.8 trillion in household debt, including mortgages, car loans and other borrowing. About 75 percent of U.S. families have some sort of debt, but what makes financial planners nervous is the size of the debt and how quickly it is growing. Credit-card debt alone leaped to $1.8 trillion in 2005 from $69 billion in 1980, according to industry data.

As our borrowing creates more opportunities for error, large financial institutions are prepared to pounce on our smallest mistakes. Late-payment fees on credit cards now average $39, up from $13 a decade ago, according to a government survey recently released. And that's just for one missed monthly payment. A small string of errors can easily spiral out of control, as fees pile up and interest rates jump. For debtors in deeper trouble, a new law that took effect a year ago made filing for personal bankruptcy much harder and more expensive.

Financial planners and credit counselors say money mistakes come in all shapes: borrowing too much against the equity in our homes, buying a pricey house with risky financing, failing to buy enough health or property insurance, and (my favorite) spending beyond our means.

For people in deep financial holes, digging out requires drastic measures.

Financial epiphany

Brian Robinson's financial mistakes began when he was traveling the country as an independent contractor, lecturing on time management and customer service. He used his credit card to pay for each trip's expenses, typically $1,500, and was then reimbursed by his clients with a check.

The problem: He spent the money from the check not on credit-card bills but on dating, dinners out and shopping. He maxed out his credit cards, and his mom's, before his debt totaled $50,000. About $20,000 of that came from work-related expenses that he could have paid off had he not spent the reimbursement checks elsewhere. His mother, brother and sister eventually stopped speaking to him.

"A friend of mine finally told me I was like an alcoholic with credit cards," said Robinson, 40, who now works in advertising in New York. "I agreed ... I had to get my sobriety back around numbers."

Robinson's financial epiphany may sound like a cliché, but debt-management experts and financial planners say that realizing your major financial mistake is the initial step toward solving it.

"The first thing you've got to do is face up to the problem. You have to ask, 'Why did I do that?' " said June Walbert, a certified financial planner with USAA, a Fortune 500 financial-services company that caters to military personnel. "But there are people who are not ready to face the music. They think if they ignore it that it will go away. That's not the case. It only gets worse."

Robinson began attending Debtors Anonymous, a 12-step program started in 1968 by Alcoholics Anonymous members who wanted to discuss their financial problems as well. Founded under the name Penny Pinchers, the organization now has more than 500 regular meetings in the United States and in 13 countries. As in AA, there is a religious bent. The group charges no fees and says its only membership requirement is a "desire to stop incurring unsecured debt."

The meetings quickly taught Robinson that he could not borrow again, ever. He cut up his credit cards, then went to work on holding himself accountable, recording every purchase he made every day, even a pack of gum.

"What you really have to do is take a deep breath" and start tracking where your money goes, said Clare Stenstrom, a certified financial planner who is advising Robinson. "It doesn't matter what you spend, you need to write it down. People are shocked to see how much money they drop away in Starbucks or lunch."

The next step is figuring out how to stop the financial bleeding. Stenstrom suggests making a budget — she prefers calling it a spending plan, which sounds less intimidating — and dividing it into three categories: necessities, livable and comfortable. You spend money here and there on livable and cut back heavily on comfortable. You move the comfortable money, for the time being, into necessities, and use that money to pay down debt.

Many financial planners say you should take on the highest-interest debt first, then work your way down. But some financial planners, including Walbert, say that paying down debts with the smallest balances can motivate people to pay the remaining debts faster.

"For a lot of people, debt is a very emotional situation," Walbert said. "Many people find it psychologically pleasing if they take care of the smallest balances first because they are getting to a zero balance faster and they are like, 'Yes, I knocked one out and I can do another!' "

While many mistakes result from purely selfish choices, such as recklessly spending on nonessentials, others are because people rely on credit to take care of their family's most basic needs.

Eddie Coon, a church administrator in Georgia, used credit cards to pay for basic necessities after high out-of-pocket health-care expenses drained his cash reserves. Coon and his family piled up nearly $16,000 in bills and couldn't make the minimum payments.

"We were falling behind so badly that we just had to do something different," said Coon, who contacted Consolidated Credit Counseling Services, a Florida organization that helps financially strapped people manage and pay off their debts.

Consumer-credit-counseling groups typically operate as nonprofit organizations, helping debtors work out payment plans and lower interest rates with creditors, usually for a small monthly fee of about $10. Once a plan is arranged, consumers make one monthly payment to the counseling organization, which distributes the money to creditors.

Coon set up a monthly payment of $550, and his debt is down to about $8,000. "I got a lower payment and lower interest rates," he said. "They began fielding the phone calls and managing the payments for me."

The new bankruptcy law requires people to seek credit counseling before they can file for court protection from their creditors. The Justice Department, which supervises the nation's bankruptcy courts, maintains a list of approved organizations on its Web site.

Some lofty fees for help

But credit-counseling groups have generated hundreds of consumer complaints over lofty fees and high-pressure tactics. Consumer advocates charge that some firms have abused their nonprofit status and seek to profit from the fees charged to their debt-ridden clients.

Some financial planners question the wisdom of paying someone else to make arrangements with creditors. Walbert, the USAA financial planner, said Coon could have done everything that Consolidated Credit did for him.

"You can call all of the credit-card companies and tell them you have every intention of paying off this debt and paying in a timely manner," but that a lower interest rate would be of great help, Walbert said.

Coon, after spending a decade struggling with his finances, says his credit rating is improving. "It's still not where I want to be, but I'm better off than I was a couple of years ago," he said. "I don't live in fear of opening the mail or answering the phone."

One of the most important steps he has taken, Coon said, is to involve his children, now teenagers and 20-somethings, in what the family is going through so they can avoid similar mistakes.

"They understand this is a family matter," Coon said. "Hopefully it will pay off in the long run and give them a better perspective on their own financial lives. They seem to get tired of hearing me saying that they need to control their expenses and watch their money."

He tells them: "I already went through that. I'm trying to teach you better."