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When people are broke, unemployed and in debt, the kneejerk reaction is often to ignore the situation and hide from your creditors. But the truth is that hiding from your financial challenges will only make them worse. Instead, you need to take action and follow these steps. This will help minimize the financial fallout so that when you do secure new employment, you’ll be able to recover as quickly as possible.

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How to manage debt while you’re unemployed

Step 1: Apply for federal student loan deferment and CNC tax status

Government-issued debts often have built-in solutions for people who temporarily can’t afford to pay. They essentially offer ways to stop or avoid collection actions on things like federal student loans and IRS back taxes. This will help minimize the issues you’ll face with these types of debt.

Federal student loan deferment

Deferment allows you to temporarily stop the monthly payments on federal student loans without facing penalties.  This will keep your loans out of default as you work to secure another job. If you have unsubsidized student loans, interest charges will continue to accrue during deferment, so your balances will be higher when you get back to making payments. However, if you have subsidized student loans, the government will pay those interest charges for you.

Currently not collectible (CNC) status for tax debt

If you owe back taxes to the IRS, there’s a status that you can file for during a period of unemployment called Currently Not Collectible (CNC). This status lets the IRS know that you don’t have the means to make any payments towards your tax debt. It stops all IRS collection actions until you have the means to start paying off your debt. CNC status will not stop penalties and interest that the IRS applies to your balance, but it will stop things like bank levies and liens.

Step 2: Call your mortgage lender immediately

If you are a homeowner, then the biggest concern you need to have during a period of unemployment is keeping your mortgage current. If you default on a credit card, the worst thing that will happen is that they can take you to civil court. However, if you default on your mortgage, the lender can start foreclosure actions and you could lose your home.

The good news is that mortgage lenders generally want to avoid the expense and potential losses they face when a homeowner forecloses. So, they’re usually very willing to work with you, so you can avoid default. This is especially true if you contact them early before you start to miss payments.

It’s fairly common for mortgage lenders to grant forbearance to homeowners. This means they will temporarily reduce or stop your monthly payments altogether while you work to get back on your feet. This will take the stress of losing your home off your shoulders and give you one less bill to worry about.

Step 3: Call your loan servicers to make arrangements

Mortgages aren’t the only loan payments you may be able to temporarily pause. In fact, you should call each of your loan servicers (lenders) to explain your situation and ask if they have any options that can help you. Don’t treat lenders like collectors and attempt to hide! If you’re not making payments and they haven’t heard from you, they’re more likely to write you off as a loss. Then you’ll face collection threats and repossession.

Instead, be proactive and call your creditors to let them know what’ going on. They won’t immediately send you to collections because you admit you’re having income challenges. The worst that will happen is that they will tell you they can’t do anything for you, and you need to make your payments. But in many cases, you may be able to reduce or stop your payments, which would take bills off your plate.

Apply for forbearance through your auto lender

Auto lenders may also provide forbearance, so you won’t need to worry about the repo man coming to take your car. It will work the same way as mortgage forbearance, where the lender agrees to reduce or temporarily stop your payments until you have the means to start making them again.

Report your loss of income to federal student loan servicers

If for some reason, you can’t qualify for federal student loan deferment, there are other options that can provide relief. For example, there’s a federal repayment plan called Pay as You Earn that matches your payments to your income and family size. The payments usually come out to about 10% of your adjusted gross income. However, if you fall below the federal poverty line in your state, your payments can be reduced even further. In fact, in cases where you have no money coming in, your payments drop to zero. You aren’t required to make any payments until your income improves.

If you enrolled in the PayE or RePayE program already, contact your federal student loan servicer to report the change in your income. If you’re not enrolled in it, take the steps to get enrolled and make sure to report your current lack of income.

See if private student loan servicers offer deferment or forbearance

Not all private student loan companies offer the same deferment and forbearance options that you enjoy with federal loans. However, some do, so it’s worth the phone call to check and see. Explain your situation and ask if you can apply for deferment first since this would stop your payments entirely.

Step 4: Review your budget to cut expenses as much as possible

Now that you’ve figured out what loan payments you can reduce or stop, you need to revisit your budget honestly. When you don’t have much (or any) money coming in, then you need to minimize the money going out. This means cutting any expenses that you don’t absolutely need. Cancel streaming services, extra cable packages, subscriptions, costs for dining out, and services you pay for that you can do yourself, like landscaping, pool care, personal care, and cleaning services.

You should also see what you can cut back. Review bills like your phone, mobile and internet bills to see if you’re paying for features you don’t need. You may be able to downgrade to a more affordable package. Also check spending on necessary expenses, like groceries, to see what you can do to reduce those costs.

It may feel like a wasted effort since you don’t have money coming in. But the more you can cut back now, the less you’ll need to pay off once you get back to full employment.

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Step 5: Find ways to make extra cash while you look for full-time employment

From freelance work to side gigs, there are plenty of potential options that you can use to supplement your income while you look for full-time employment. You may feel like these are just temporary stop-gap measures, and they are. You just need at least some form of income to cover your bills and necessities until you can get another full-time position.

Consider these options:

  • Pick up freelance work through services like LinkedIn Pro Finder, particularly if you are a creative professional, such as a graphic designer.
  • Find side gigs, such as becoming an Uber driver or being a delivery driver for Uber Eats.
  • See if you have items that you can sell for cash, such as old clothing or electronic devices.
  • Get a part-time job at a local retailer or in hospitality, so you can earn income in your off time when you’re not looking for employment.

Looking for full-time employment in your chosen career field should certainly be your primary focus. However, you can’t ignore opportunities to keep your finances afloat while you find that next opportunity.

Step 6: Consider lending options that could provide cash, but be careful

As you look for ways to keep yourself afloat during this period of unemployment, you may consider financing solutions that can provide cash. Getting funds that you keep you out of the red for a few months may sound like a no-brainer. However, there are some key points that you’ll want to consider before you get a loan that you potentially don’t have the means to pay back.

  • How much time will you have before the new loan payments start? Will that be enough time for you to find new full-time employment?
  • How much does the new loan increase your financial risk? What will you be risking by taking those funds out?
  • How much will this new loan cost you and when will you need to pick up that tab?

Here are some of the most common financing solutions that people consider when they’re facing unemployment. Understand the risks of each of these options and make sure to talk to an expert before you use any financing solution during a period of unemployment.

Home equity loans / HELOCs

With these types of financing solutions, you borrow against the equity built up in your home. Equity is the fair market value of your home minus the remaining balance on your mortgage. You can generally borrow up to 80 percent of the equity you have available.

With a home equity loan, you borrow a set amount of cash in a single lump-sum that you pay back over time. The payments on a home equity loan will generally start immediately. With a HELOC, the lender extends you a line of credit that you can borrow from as needed. There’s generally a 10-year draw period, where you’ll only be required to pay interest charges on what you borrowed. After 10 years, you must begin to pay back the principal debt.

The risk of these two options is that both are secured forms of credit. They use your home as collateral. So, if you don’t make the payments, you could be at risk of foreclosure. You should only consider this option if you have a high degree of certainty that you can secure a new job quickly to get your income back. And even then, it’s an increased risk that shouldn’t be taken lightly.

You may also have issues getting approved for these types of loans when you’re unemployed. Verifying income to make payments is a requirement during the loan underwriting process. So, if you have no income to make the payments, you may not get approved at all.

Cash-out refinancing

This is another lending option that homeowners can potentially use if you have equity in your home. With this option, you take out a new mortgage for an amount equal to the fair market value of your home. You use part of the funds to pay off your existing mortgage. Then you receive the difference in cash.

While this option can provide you with a significant cash influx without taking out a second mortgage, it still increases your risk of foreclosure. It will also increase the total amount of mortgage debt you have to repay and may increase your monthly payments and total costs. All of this can make it tough to keep up with your new mortgage payments. You could end up using the cash you receive just to make those payments. And again, if you don’t keep up the payments on the new mortgage, you could risk the lender starting a foreclosure action.

This may also give you issues with approval if you’re unemployed. If the lender can’t verify that you have the income you need to make the payments, they may not extend you the loan. So, even though the equity is there, you may not be able to access it.

Cashing out your 401k

If you’ve left the employer where you started your 401k plan, you may need to decide what to do with the money you have saved. Since you don’t have a new job with a new 401k plan, you can’t roll it into a new plan until you get a new job. You can roll it into an IRA or if you have over $5,000 saved in the plan, then you’re permitted to leave it where it is and continue to let the money grow.

The last option is to cash it out entirely. You close the account and they send you a check for the money you had in it, minus the 10% early withdrawal penalty if you’re under age 59. This may sound like a good idea when you’re unemployed, but it can really set you back on achieving your retirement goals. Also, keep in mind that the money you receive will be treated as taxable income by the IRS. In other words, you’ll pay income taxes on those funds next April.

401k loans

When you’re employed, many employers allow employees to take out 401k loans. This is where you borrow against the money you have available in your 401k. However, those loans are extended at the employer’s discretion and it’s rare that an employer allows 401k loans by former employees. In fact, many employers will require an employee to immediately pay back the loan if they are no longer employed with that company.

So, the chances of getting a 401k loan are slim if you’re no longer employed with the company.

Early distributions from an IRA

Another retirement option is to take early distributions from an IRA. You may consider this if you roll your former employer’s 401k into an IRA or you might already have an IRA open to support your retirement goals.

In either case, you will face tax penalties on the money you take out of your IRA. Again, the IRS will treat the money you receive as taxable income. That could lead to a tax bill next April, even if you get a new job before that.

Payday loans, cash advance loans, and short-term installment loans

Another solution you may be considering during a period of hardship is any no-credit-check loans. These are loans that tout the advantages of getting cash in your account within 24 hours, no credit check required. This can sound great. You don’t have the income to qualify for any traditional loans, so you turn to the alternative financing solutions (AFS) to get the cash you need.

However, just because you can use AFS to get the cash you need, it doesn’t mean that you should. These types of financing solutions come with two huge problems:

  1. Extremely high interest and financing charges
  2. Automatic ACH payments that can drain your bank account
Finance charges

It’s not uncommon for these types of loans to have interest rates over 200% or even 400%. You can also expect to pay about $30 for every $100 you finance. These loans have excessively high costs and if you don’t have a job to pay the loan back within the first two weeks of taking it out, those costs will stack up quickly.

ACH direct debit

The other issue is the ACH direct debit that most of these loan systems use for payment. They connect to your bank account to direct deposit the funds you receive, then they direct debit the payments from the same account. This can create issues with your bank account. ACH payments can be hard to stop and most AFS lenders make it extremely difficult, if not impossible, to stop those payments. They’ll drain your bank account and stack up NSF and overdraft fees.

When you’re unemployed, you don’t have the means to pay back these loans, so it’s best to avoid them. You may be able to pay a specific bill on time, but you’ll hurt your finances in the long run. And don’t be fooled! A short-term installment loan or cash advance loan or fast loan are all basically just alternative names for payday loans. No matter what it’s called, it’s bad for your finances!

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Which debt solutions work when you’re unemployed?

When you can’t afford to make your payments, then you start looking for alternatives – consolidation, credit counseling, debt settlement, and bankruptcy. However, the truth of the matter is that if you have absolutely no income to make payments or cover fees, then most of those options won’t work for you. You’ll need to get a job first, then focus on getting back to stability when it comes to your debt.

Debt consolidation

Debt consolidation rolls multiple debts into a single monthly payment that’s often lower than what you’re paying now. However, to get a debt consolidation loans, you’ll need to provide verification of your employment. Since you can’t do that when you’re unemployed, lenders are unlikely to extend loans to you.

Debt management program

If you need to lower your monthly payments, you can often go through a credit counseling agency to enroll in a debt management program. This is a repayment plan for credit card debt that rolls all of your bills into one monthly payment. That payment is typically lower than what you’re paying now, and most creditors will agree to reduce or eliminate interest charges as well.

However, you still need to have the means of making the payment every month. So, if you can’t make the monthly payment every month, this option won’t work until you secure new employment.

Debt management programs tend to work best after you get a new job and need to stop any damage you may have already caused your credit. Once you get back to a stable income, one of your first calls should be to a credit counseling agency.

Debt settlement program

Debt settlement programs are another option you may be considering. The commercials claim to get you out of debt for “pennies on the dollar.” That sounds great when you only have pennies to spare and no new dollars coming in. However, the truth is that debt settlement pays out about 48% of what a borrower owes, on average. So, while you can get out of debt for less, you won’t get out of it for nothing.

What’s more, most debt settlement programs work by requiring you to pay a monthly set aside. It’s basically a low monthly payment you must make to generate the funds needed to make settlement offers. If you have no money, you can’t make settlement offers. So, even debt settlement usually won’t work while you’re unemployed.

Debt settlement also tends to work best once you get a new job. If you just want to get out of debt quickly and don’t care about the credit damage, settlement tends to offer the fastest, cheapest exit versus other solutions. It’s also ideal for debts that have already been charged off and sold to a third-party collector.

Bankruptcy

Another solution people think you can easily use when you’re broke is bankruptcy. However, bankruptcy costs more money than you might think. A Chapter 7 filing costs $335 and Chapter 13 costs $310. There may be additional fees that the bankruptcy trustee can charge when you file as well. You may also need to pay a fee for pre-bankruptcy credit counseling, which ranges from $50-$100, depending on the state where you live.

Those are the fees you’d pay without paying any fees to a bankruptcy lawyer to file. In some cases of extreme financial hardship, you may be able to waive the fees or ask to pay it back in installments. You will need to apply for the fee waiver at the time when you file.

Steps to take when you get a new job

Once you secure new employment and start to receive steady paychecks again, you need to make a plan to regain financial stability. These tips can help:

  • Don’t restore expenses you cut from your budget until you’re in the clear with the debt you generated during your unemployment period. Stay on a tight budget until you’re really back to maintaining stability, then you can start to reintroduce those expenses that you cut.
  • Assess where each of your debts stands:
    • Current
    • Behind
    • Charged off / default
  • Concentrate on keeping the current debts paid on time and bringing those that are slightly past-due current.
  • If a debt is past-due, call the creditor to make payment arrangements to catch up. You may be able to set up something called a workout arrangement, where the creditor helps you set up catchup payments and may agree to freeze interest charges so you can pay off the debt faster. Your account will generally be frozen during this time.
  • For debts that have already been sold to collectors, debt settlement is really the best option to use. You offer a percentage of the balance you owe and in exchange, the collector agrees to discharge the remaining balance.

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Article last modified on October 3, 2019. Published by Debt.com, LLC