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Columns: Dr. Don
Don Taylor, Ph.D., CFA, CFP   Expert: Don Taylor, Ph.D., CFA, CFP
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Lottery winnings help, but debt plan hurts your credit
Ask Dr. Don

Paying off debt with lottery winnings

Dear Dr. Don,
Amazingly, my husband and I have just won $20,000 on a scratch-off lottery card! I'm still in shock. My husband turned in the card today and got a check for about $13,000 after taxes. Unfortunately, we are about $27,000 in debt and after years of working hard to try to honestly pay off these debts, we have not been able to keep up and have recently signed on with a debt solutions company to help negotiate settlements with our creditors. 

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The prize money alone is not enough to pay off our debts, so we think we should deposit this money into some sort of high-yield savings account and wait for it to grow, while at the same time continue with the two-year plan we have with the debt solution company.  

That way, we figure we'll be able to get out of debt sooner. When we have enough in the debt-solution savings account (between our negotiated monthly payment and the extra lottery winnings) to pay the settlement, we'll finally be free of this terrible burden. On the other hand, we are so afraid of mismanaging this incredible windfall that we are over-thinking everything about it. Do you have any advice for us? Thank you!
-- Anka Advice

Dear Anka,
Congratulations on your lottery windfall, but how to invest this money isn't your first priority. Getting out of the debt negotiation plan is your first priority.

Debt negotiation sounds like a reasonable way to get out from under a debt burden that you can no longer afford. Unfortunately, the tactics generally used by debt negotiators to get your creditors to accept partial payment trashes your credit history to the point where you'll have trouble getting credit for years. Filing for bankruptcy is usually a better solution than debt negotiation.

The following is from the Federal Trade Commission's Facts for Consumers publication, "Knee Deep in Debt," about debt negotiation plans:

There also is no guarantee that a creditor will accept partial payment of a legitimate debt. In fact, if you stop making payments on a credit card, late fees and interest usually are added to the debt each month. If you exceed your credit limit, additional fees and charges also can be added. This can cause your original debt to double or triple. What's more, most debt negotiation companies charge consumers substantial fees for their services, including a fee to establish the account with the debt negotiator, a monthly service fee, and a final fee of a percentage of the money you've supposedly saved.

While creditors have no obligation to agree to negotiate the amount a consumer owes, they have a legal obligation to provide accurate information to the credit reporting agencies, including your failure to make monthly payments. That can result in a negative entry on your credit report. And in certain situations, creditors may have the right to sue you to recover the money you owe. In some instances, when creditors win a lawsuit, they have the right to garnish your wages or put a lien on your home. Finally, the Internal Revenue Service may consider any amount of forgiven debt to be taxable income.

Take the time to read the whole publication including the complete discussion on debt negotiation programs. My best advice is for you to focus on getting out of this debt negotiation plan. If you have difficulty canceling the plan, talk to your state attorney general and/or hire an attorney. The National Association of Attorneys General (NAAG) provides contact information for each state's Attorney General.

From there you should go back to square one in managing your debt burden. It's possible, if some of these debts are old debts, that you no longer owe them because the statute of limitations (SOL) has expired on the credit agreement. The Bankrate feature, "State statutes of limitations for old debts," explains this in greater depth. Beyond that, you should consider credit counseling or bankruptcy as a solution to your credit problems. 

The FTC guide, "Knee Deep in Debt," referenced earlier in this column, has more information for you on these topics.

Bankrate.com's corrections policy-- Posted: July 11, 2007
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