Losing at balance-transfer roulette

Next, Murphy's Law of Money kicked in, as reliably as the law of gravity: If you're on the edge financially, brace yourself for the fall.

After a major work dispute, Colleen quit her job. "Suddenly, I had no money and I couldn't make the minimum payments."

Not only did she get hit with a slew of late fees, but because she was so close to her limit, now she faced over-limit charges from her creditors. And the interest rate on all three cards shot up to 33%.

Colleen's financial paralysis

Colleen says her minimum payments were hiked into the hundreds of dollars -- and she simply stopped paying those bills. "One was so high, I just started laughing," she says. Another sent her a letter demanding that she pay her balance in full.

The irony: Colleen's total debt load is a relatively manageable $12,000. But with those stratospheric rates, there's no way she can keep up.

Looking back, she says, "I was looking for a way to beat the system. I thought, if I could transfer my debt to a zero-interest card I would pay it off and never pay any interest."

Like Kim, she can't turn to her parents for help, and she's living on a waitress' salary of about $2,000 a month while she looks for a full-time job. In the meantime, she says, she just doesn't pick up the phone.

Cleaning up the balance-transfer mess

Despite the similarities of their situations, the two dilemmas require very different solutions, says Gerri Detweiler, author of "The Ultimate Credit Handbook."

Although Kim has a great deal more debt than Colleen, she's kept her accounts current and her interest rates low. She's able to maintain her payments.

For those reasons, Detweiler pretty much rules out either a debt-consolidation loan or a credit-counseling service. Here's why:

• Kim isn't likely to get a loan with a lower interest rate than what she has now.

• She has already accomplished most of what a credit-counseling service would do: She is paying the lowest rate possible and making steady payments. "There's probably not a lot of relief there," Detweiler says.

• Besides, if Kim signed up for a debt-repayment plan with a credit-counseling service, her battered credit rating would take another hit -- and she would be forced to close her existing accounts, which won't help her credit in the long run.

Keeping your head above water

Still, Detweiler says, Kim can keep this ball rolling for only so long. "She'll be OK in terms of not going into collections, but it doesn't take a late payment or a default for her creditors to raise the interest rates." Creditors can raise your rates simply because your debt levels are too high, Detweiler says.

Detweiler's advice to Kim:

• Quit using the cards and buckle down on any extraneous spending.

• Get a second job and put every penny toward debt. (This step is key, given the additional pressure student loans will bring.)

• Use the Debt Evaluation Calculator to determine how quickly she can pay down her credit cards.

If there's no way Kim can bail herself out of the hole in three or four years, her best bet may be to reconsider the services of a credit-counseling agency -- especially if her interest rates have jumped or the card payments plus the student loans are unmanageable.

The National Foundation for Credit Counseling and the American Association of Independent Consumer Credit Counseling Agencies help people find referrals.

Settling your debts

Colleen, on the other hand, could be a prime candidate for a debt-consolidation loan or the help of a credit-counseling agency -- "but she'll still have to pay off 100% of her debts," Detweiler says, "just at a lower rate."

But given Colleen's financial straits and her rapidly mounting bills, Detweiler thinks her best bet might be to negotiate a settlement with her creditors. Because Colleen literally cannot afford to pay her bills at this point, her creditors may consider an offer to pay, say, half of what she owes rather than lose all the money.

"Settlement" is a dirty word to some, notes Charles Phelan, a former debt-settlement lawyer who now runs an educational Web site for consumers at ZipDebt.com. But for people like Colleen who have defaulted on their debt, settling is a far better option than bankruptcy.

"There are two ways to do it," says Phelan. "You can hire a third party to negotiate for you, or you can do it yourself."

Having worked in the debt-settlement business for many years, Phelan believes consumers can do this themselves. (His site offers a detailed audio CD program and coaching service for about $400).

Otherwise, consumers who hire a third party can pay fees as high as 15% of their total debt -- and they face steep minimum payments. (One debt-settlement law firm Colleen spoke to said she would have to pay them $25 for every $100 they knocked off her total balance.)

Settlement tips from a pro

Here are some reasons Colleen might consider negotiating a settlement -- and the pros and cons she should weigh:

• "Credit is important, but debt is life threatening," says Phelan, who points out that the sooner Colleen can pay off her debt, the sooner she can get on with life.

• A debt settlement shows up as a black mark on your credit history -- but it's not as long-lasting as a bankruptcy. "She's young enough to recover from that," Phelan says.

• Negotiating a settlement may be unsettling to consumers, but Phelan points out that "settling your debt in the range of 35% to 50% is not out of the ordinary for these companies. It's just part of the business of debt and credit."

• That doesn't mean settlements come easy. Colleen could call her banks, explain her situation and make them an offer -- but the situation might take months to resolve. "Success has a lot to do with the timing of your offers," says Phelan.

• Communication is key, he emphasizes. "Be forthcoming about the nature of your financial hardship, and that your intention is to work out something that works for both sides."

Last, he notes, get everything in writing. "It's not a settlement until you do," he says.

Updated Jan. 21, 2008

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