5 First Steps to Deal With Debt

If your credit card's monthly minimum payment is starting to look more like your old balance or you're not answering the phone for fear of another call from a creditor, it's time to take drastic action. As thousands of Americans are finding out during this recession, personal debt can become a nightmare. The costs—both financial and emotional—make it tough to face the reality of just how bad the situation might be. But the sooner you face the problem, the sooner you can get back to even. U.S. News asked Mitchell Allen, author of A Survival Guide t o Debt: How to Overcome Tough Times & Restore Your Financial Health, to discuss how to take those first steps in dealing with out-of-control debt.

1. Understand your debt; cut your spending. It's the first, most obvious, and ultimately the most important step in getting back into the black. Most people can pull out a pay stub confidently and list exactly what they're bringing in each month. What gets murky is the spending. So make a personal balance sheet. That's your income compared with your spending, including housing, utilities, transportation, food, clothing, entertainment, insurance costs, and any other sort of regular outlay you can pin down. Remember to include the costs of servicing debt you already have. Allen says it's often small expenditures—eating out, your morning coffee—that make the difference for people on the edge. Spending $10 a day on lunch can add up to more than $400 a month for a household if two people are eating out. If you're living paycheck to paycheck, it's enough to push you over a financial cliff. See what you can cut. "As we get through the lists, people often find a pretty big surplus," he says.

[Also see: "Could Your Credit Report Cost You a Job?"]

2. Manage your debt the right way. If you can't deal with debt just by tightening your belt, there are several options to consider immediately when putting together a debt management plan.

• Credit counseling: Get started

Nonprofit debt management companies are popular options for creating a plan to repay debts and halt harassment from creditors. Debt is consolidated into a single monthly payment, often with a lower interest rate, and ongoing damage to your credit score will begin to reverse as long as you make payments on time. Allen recommends Money Management International, a Houston-based firm that's the nation's largest nonprofit counseling service. He says other reputable counselors can be found through the National Foundation for Credit Counseling (NFCC) and the Association of Independent Consumer Credit Counseling Agencies (AICCCA). A couple of caveats when entering into a debt management plan with a counselor: Keep an eye on monthly fees, and make sure your credit counselor has relationships with all of your credit card lenders so that your entire debt is represented in the plan.

• Debt settlement companies: They're an option, but not a great one.

Debt settlement companies are a controversial tool for deeply troubled borrowers, especially those with hefty credit card debt. These for-profit firms agree, for often hefty fees, to try to negotiate a lower debt balance with your creditors. Creditors are willing to work with debt settlement firms because getting partial payments from customers is a better option than customers filing bankruptcy, in which case the creditors would likely get nothing. The problem is, debt settlement firms have a less-than-sterling reputation, and if creditors decide to sue you, the settlement firm isn't legally obliged to represent you in court. Allen recommends that you request documentation from other settlements to make sure the company you choose has a solid track record.

• Home equity loans: Don't do it.

Taking a loan out against the value of your home was a popular option during the housing boom. But using home equity to pay off credit cards, for example, isn't the safest way back to fiscal health. Allen warns that home equity loans simply replace unsecured debt (credit cards) with secured debt (your house). If you can't repay a home equity loan, it gives another creditor (in addition to your mortgage lender) the legal right to take your home. "The negative consequences of not making those payments are such that it's a poor decision for people to take a home equity loan to pay off credit card debt," he says.