5 Things People Get Wrong About Debt Relief
Digging out of debt is tough, and common myths about your options for getting there can make it even harder. That's the case with debt relief, one way to get debt free that people often misunderstand.
There’s a lot of misconceptions about debt relief, causing confusion about what it truly entails and how it can help. That confusion sometimes starts right in the name: “Debt relief” and “debt settlement” are often used interchangeably, but they can mean different things depending on the context.
Sometimes debt relief is used as an umbrella term that includes various strategies to get rid of credit card debt — debt settlement being one of them. The term can include other strategies, too, such as debt management plans or credit card hardship programs.
When debt relief and debt settlement are used interchangeably, they refer to a specific process where borrowers negotiate with creditors, sometimes by hiring a professional debt relief company, to reduce their debt.
It can be a complicated process, and it’s one rife with rumors that could hinder you from making an informed decision. Here are five debt relief myths, debunked:
Debt relief equals debt forgiveness
Debt relief sometimes involves agreeing to pay a lump sum that’s lower than your outstanding balance, often resulting in the remaining balance being forgiven. But fully eliminating your debts is not guaranteed, or even likely.
"Sadly, many people confuse debt relief with debt forgiveness when, in fact, there is a huge difference," says Bobbi Rebell, certified financial planner and personal finance expert at BadCredit.org. "Put simply, debt relief sets you up with more realistic terms to pay down the debt, but you are by no means off the hook."
Creditors might agree to accept a payment that's 30% to 80% of the total amount you owe, though the exact amount depends on your creditor's terms and willingness to negotiate. (Heads up: not all creditors are open to it.) So, if your debt is $10,000, the creditor may settle for a payment of around $3,000 to $8,000 and forgive the rest. Keep in mind, though, that the forgiven amount is considered taxable income, so you may need to pay taxes on that portion.
Debt relief will ruin your credit
Debt relief programs like debt settlement will lower your credit score — there’s no way around that. However, the drop in your score isn’t permanent, and you can potentially regain control of your finances by resolving your debt faster. That should ultimately improve your credit moving forward.
When you pursue debt settlement, your credit score will likely drop around 100 points or more within the first few months of the program. “This happens because debt settlement usually involves missing payments and settling for less than owed,” says Melody Brady, principal financial planner and founder at Beechmont Financial.
Late payments and settled accounts are considered negative items and stay on credit reports for seven years. During this time, they’ll lower your credit score, but their impact lessens over time, especially if you focus on positive credit habits. Brady says that you can often start rebuilding your credit within a year or two by paying your bills on time or keeping your outstanding balances low. Becoming an authorized user on someone’s credit card can also help — as long as they have a solid credit history.
Because debt settlement can be a lengthy process — it often takes two to four years — and it starts with your credit score dropping, it’s critical to know exactly what you're getting into. It’s not “a shortcut of any kind,” Rebell says. “However, in the long run, [debt relief] can give someone a clean slate to rebuild their credit without the burden of debt.”
Debt relief is a scam
There are predatory debt relief companies out there. There's no doubt about that. However, there are legitimate companies that offer effective credit card debt relief programs for those who don't qualify for debt consolidation, Chapter 7 bankruptcy or other options. The key is to do thorough research and choose a reputable company with a proven track record to avoid falling victim to scams. Look for companies that are transparent about their fees and are accredited by the industry group, the American Association of Debt Resolution.
Brady also suggests steering clear of companies that attempt to charge fees before resolving any debts or make lofty claims, like settling debts for just a fraction of the original amount. (Pro tip: It’s actually illegal for debt relief companies to charge you fees until they’ve successfully negotiated a settlement.) The fact is, no company can guarantee the exact amount they can lower your debt since settlements are determined on a case-by-case basis. She also suggests avoiding companies that promise they can remove negative items from credit reports.
You can’t negotiate debt yourself
It’s possible to negotiate a debt settlement with creditors or collection agencies without hiring a debt relief company to help you. You can do so by contacting creditors or collection agencies directly, explaining your financial situation and proposing a lower payment to settle the debt.
However, handling this process on your own can be difficult. For one, it’s time consuming, particularly if you’re trying to negotiate with multiple creditors at once. It also requires a solid understanding of both your finances and the creditors' policies. It's essential to be clear and concise when making your case and to prepare for potential counteroffers.
Also, there are certain considerations you need to keep in mind before starting the process. Brady says you likely need to be over 90 days late before creditors will be willing to settle and you should have enough funds saved up to offer creditors a lump sum of at least 30% to 80% of the balance you owe. You should also keep detailed records of all communications and request a settlement agreement in writing before sending any payments.
Debt settlement is the only option to get relief from your debts
There is no one-size-fits all debt solution, and depending on your scenario, credit card debt relief programs may not be the right solution for you. If you’re just starting to struggle with payments you might want to consider a debt management plan, debt consolidation loan or credit card hardship program. If, though, you’re dealing with overwhelming debt, debt settlement or bankruptcy may be a better fit.
Each of these strategies aims to reduce the financial strain of managing heavy debt. Their difference is in how they achieve this exactly, which may involve reducing your debt, lowering your interest rates, consolidating multiple debts into one, negotiating for lower payments or having certain debts dismissed by a court.
In fact, you can qualify for some debt relief alternatives if you’re up to date on your bills. With this in mind, it's better to seek help before you fall behind on payments. Brady recommends weighing your options as soon as your bills start consuming a significant part of your income, making it difficult to save money or pay for essentials.
"The sooner someone recognizes they need help, the more options they'll have. Waiting until they fall behind can limit what's available," she says.
Consider talking to a certified debt consultant, credit counselor or financial planner so you can make an informed decision that best aligns with your long-term goals. “Both can help clarify whether a specific option, like [debt] settlement or bankruptcy, is truly the best fit for the person’s situation,” Brady says.
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