Total U.S. consumer debt was $11.65 trillion at the end of Q1 2014, up 3.7 percent from the previous year, according to the New York Federal Reserve. Let’s put this number in perspective: Just 40 years ago, the total amount of all U.S. debt—including government, business and consumer obligations—was only $2.2 trillion. It has become normal for Americans to start building debt portfolios as soon as they turn 18, when they can start applying for credit cards. What happens when these people lose their jobs or suffer some other financial hardship? Sometimes, it forces them to choose which bills get left unpaid. When default is imminent, prioritizing your debt can mitigate the damage to your credit history.
Lower Priority – Medical Bills
An analysis by NerdWallet Health found 20 percent of all American adults ages 19-64 experienced economic hardship due to medical bills last year. The study also found that 60 percent of bankruptcies in 2013 were due to medical expenses.
Medical bills are one-time invoices that you either pay or you don’t. They only appear on your credit report when collections status is reached. Once this happens, the damage to your FICO score is done. Paying off the debt will not improve your credit, as it does nothing to move the meter on any of the five factors that influence credit scores.
The good news is that collections accounts drop off your credit report seven years after the day the account initially went delinquent. If this doesn’t happen automatically, simply write the three major credit bureaus via certified mail with documentation showing the account should be deleted.
Higher Priority – Revolving Accounts
The payment history and amounts owed on installment loans, credit cards and mortgages account for 65 percent of your FICO score. One late payment on a credit card can not only drop your score from 40 to 100 points, but it could also be the difference between getting approved or denied for a mortgage years later.
If preserving a decent credit score is your goal, make maintaining your revolving and installment accounts your top priority. Make the minimum payments possible to keep the accounts current. If you currently receive periodic payments from a structured settlement or annuity, consider selling your future payments for a lump sum of cash now. You could then use the money to help pay down or off these accounts. These funds can also be used to stave off foreclosure.
Like medical collections accounts, foreclosures stay on credit reports for seven years. They also make a dent in FICO scores far more significant than medical defaults. Borrowers who are underwater have a personal and financial decision to make when thinking about walking away. Keep in mind, “strategic defaulters” will be ineligible for all Fannie Mae loans for seven years and can forget about another mortgage for at least three years.
Middle Ground – Student Loans
Missing student loan payments will hurt your credit score and potentially cause the lender to garnish your wages for payment. But there are far too many ways to kick the can down the road when it comes to delaying student loan payments to make them a top priority.
Temporary deferments can be granted if you enroll in some sort of college or technical school at least half time (six semester hours) if you’re unemployed or underemployed, or if you can simply demonstrate economic hardship. You can even apply for a forbearance, which can stop payments for up to a year. However, interest still accrues during both deferments and forbearances.
All debt is not created equal. The more impact it has on your overall credit history, the more important it is to pay.
