If you’re struggling to repay your debt, it may be time to consider debt relief programs and other financial help. While debt relief can be beneficial, a long-term commitment and changes in your financial habits are often required. Not all debt relief programs are equal, and they may not be necessary for people who can manage their own debt or when other alternatives are present.
Is debt consolidation a good idea? It depends on many factors related to your financial situation such as the type and amount of debt and the available relief options. Read on to understand what debt relief is, what types of debt relief are available and how to determine which solution is best for your financial situation.
Who needs debt relief and when?
Even if having a lot of debt is overwhelming, debt relief isn’t always right for everyone. Some relief solutions can ultimately cost more than the debt they’re trying to remove. And while that may be necessary in cases when you need immediate debt relief, in other situations it might be better to pay off the debt over time. In addition, some debt relief can affect your credit score, which may end with the same result as keeping your original debt.
In general terms, sticking with a long-term debt repayment plan will help your credit score. But, at the same time, certain types of debt relief can have temporary negative impacts. For example, applying for debt consolidation loans could cause a slight decrease in your credit score. In addition, missing a debt payment and taking out a new collections account can have a long-term effect on your score.
Therefore, debt relief is best suited for people who have stopped accruing debt and are able to commit long term to paying off debts and make fundamental changes to their spending habits.
No other way to pay
If you can’t pay your unsecured debts — credit cards, medical bills, and other debts that don’t have assets as collateral — within five years, then debt consolidation may be a good idea. But before deciding on debt relief, make sure you’ve tried any options available to you, such as:
- Tracking your spending habits and creating a realistic budget
- Finding additional income streams
- Consulting nonprofit credit counseling agencies that offer free resources and consultations.
You may be able to avoid debt relief if some of these changes help improve your financial situation and speed up your debt repayment. If not, then debt relief is the way to go.
Total amount due is more than gross income
If the total amount of your unsecured debt is more than half of your gross income, you may want to consider debt relief. If your debt-to-income ratio (DTI) is too high or you don’t have a steady income, it can be extremely difficult and sometimes even impossible to pay off your debt. Consider debt relief if you are experiencing any of the following:
- You’re struggling to afford monthly payments.
- You’re already missing debt payments.
- You’re making minimum payments, but high interest rates make it difficult to decrease your balance.
- You must choose between paying your debt and paying for necessities.
What is a debt settlement company?
Debt settlement companies — sometimes called debt relief or debt adjusting companies — try to negotiate with your creditors to reduce how much you owe. While they are many legitimate options in the industry, there are risks associated with using debt relief companies including high fees, the possibility of scams, late payments to creditors, and even tax implications
Before deciding to work with a debt settlement company, you should do some research on them. Use government resources such as your state’s Attorney General’s office or consumer protection agencies to see if any complaints have been filed against the company. If your state requires licenses, you can also contact your state regulator to make sure the company is appropriately licensed. The Federal Trade Commission (FTC) is also an excellent resource for learning about potential scams and predatory financial products.
How does debt relief work?
Debt relief companies seek to negotiate with creditors and debt collectors to get them to settle for less than what you owe. However, the company generally doesn’t start negotiations until they know you have enough money to make the settlement payment. Therefore, they typically tell you to stop making payments to your creditors and instead put the money into a dedicated savings account they manage. Once you make a certain amount of payments, they then negotiate the settlement and make payments if they are successful.
As you may suspect, this strategy carries risk, which is why it’s important you understand all its implications and whether it’s the best solution for your financial situation. For example, if the company is unsuccessful in negotiations with your creditors, you’re stuck with additional interest and late payments. Further, the nonpayment does more harm to your credit score.
Look at your financial situation thoroughly
Know your financial situation before working with a debt relief company or seeking expensive debt management help. Identify every aspect of your situation, from how much you make to how much you need to save for retirement. In terms of your debt, you should consider the following:
- How much unsecured debt do you owe? How does this compare to your income?
- What is your credit score?
- What is the interest rate for each of your debt accounts?
By knowing the ins and outs of your financial circumstances, you’ll be better prepared to make decisions on how to seek relief.
Decide if you need help or not
The answers to the questions above greatly influence whether you should seek debt relief. If you feel that you’re too deep into debt, have exhausted other options and don’t have any way to repay the debt within the next five years, you may want to do research on debt relief options.
Determine what type of relief you need
Your financial situation determines the type of debt relief you need. However, another factor that impacts your debt relief choices is the type of debt you have. The chart below provides examples of available relief options based on types of debt.
|Type of Debt
|Debt Relief Options
|Credit card debt
|Do-it-yourself debt management, such as forbearance, interest rate negotiation, credit consolidation, personal loan, workout arrangement or settlement agreement. Debt relief services, such as debt consolidation programs or debt settlement programs
|Federal student loans
|Deferment, Forbearance, Federal Direct Consolidation loan, Federal repayment plans, Public Service Loan Forgiveness
|Private student loans
|Student loan refinancing, Private student loan settlement
|Currently Not Collectible (CNC) status (deferment), Installment Agreement (IA) (consolidation or repayment plan), Offer in Compromise (OIC) (settlement), Penalty Abatement (interest rate negotiation)
|To prevent foreclosure: Forbearance, refinancing, workout arrangement or loan modification. To exit quickly: Deed-in-lieu of foreclosure, deed-for-lease or short sale
|Auto loan debt
|Forbearance, Refinancing, Auto loan consolidation, Voluntary vehicle surrender
|Payday loan debt
|Debt settlement programs or part of a debt management program with other types of debt
|Debt settlement programs
What types of debt relief are available?
Bankruptcy is not technically a debt relief program, and you should explore all other options before filing for it. However, it may be time to file for bankruptcy if you have talked with your creditors and debt collectors, contacted a credit counseling service and exhausted all other debt repayment methods.
If you file for Chapter 7 bankruptcy, all or most of your personal debt could be forgiven. However, Chapter 13 bankruptcy helps you create a plan to repay your debts. Both options have long-term effects on your credit score, making it difficult to get loans in the future.
While you don’t technically need a lawyer to file for bankruptcy, it might be of considerable help to use the services of a bankruptcy lawyer who can assist you and offer professional advice on the long-term effects of filing.
Debt consolidation programs allow you to roll all of your debts into one single debt for which you make one payment each month. There are different ways to consolidate debt, including debt consolidation loans, credit card balance transfers and home equity loans.
A debt consolidation loan makes it easier to pay your debt off with one payment. While you might be able to get lower interest rates, find out how long those interest rates last and how long you’ll be in repayment. If the interest rate rises after a certain amount of time, or if your loan term lasts longer than your original debt, you might end up paying more in the long run.
Credit card balance transfers occur by moving your credit card debt onto another card to take advantage of a lower interest rate. However, that introductory offer may only last for a short while and interest rates may go up considerably over time. It’s extremely important to understand the terms and conditions of a balance transfer (including the fine print) before committing to it.
Home equity loans allow you to borrow against the amount of equity in your home and use that cash for any purpose, including paying off other types of debt. There is significant risk in this, however, because late payments on the loan could put you at risk of losing your home.
Debt consolidation may be the right choice for you. However, explore your financial situation and other repayment options first and always read the fine print and make sure you understand the terms.
Refinancing a loan means replacing an existing loan with another loan with more favorable terms. For example, you could use a new loan that has a shorter repayment time or lower interest rate. Additionally, you may be able to reduce your monthly payment, but this might lengthen the repayment time and increase how much you pay in the long run.
Be aware of prepayment penalties when refinancing mortgages and auto loans. Some loans will charge you a fee for paying off your loan early, which could cancel out the potential savings from refinancing.
Payment management plans
A payment management plan, or a debt management plan, is created by a nonprofit credit counseling agency that evaluates your finances and budgets your income to set aside a specific amount each month for a single debt payment. Although creditors need to approve the plan, agencies may be able to negotiate a reduction in interest rates and aim to have the debt paid off in a specific amount of time.
These plans have many advantages, such as reducing payments to one per month, eliminating the need for more debt and potentially helping your credit score by addressing problems with existing debt before it’s too late. However, payment management plans are only intended for unsecured debt, and you must close current accounts to avoid taking on more debt. In addition, some creditors may deny participation, so you will need to continue making payments to them as usual.
Credit counseling agencies are typically non profit organizations that can provide many different services and advise you on how to repay debt as well as learning essential money management skills. For example, credit counselors might help you create a budget, get copies of your credit report, provide free education or offer the debt management plans discussed above.
Credit counseling should be one of the first steps on your debt repayment journey. You may be able to find a counselor near you by searching with the Financial Counseling Association of America or the National Foundation for Credit Counseling. Local credit unions may also be a good resource for multiple types of debt relief and education.
Reducing interest rates
In some cases, you might be able to do debt relief work yourself. Instead of paying a debt management company to reduce interest rates for you, you might consider contacting creditors on your own to learn about your options. Negotiating effectively with debt collections can help you get reduced interest rates and more convenient payment terms.
Reducing interest rates can be especially helpful when paying hard-to-manage credit cards and loans. You can make bigger dents in your debt if interest isn’t constantly bringing your balances back up.
What to watch out for when applying for debt relief
Unfortunately, many suspicious companies make exaggerated claims about how to get out of debt, so beware of companies that do the following:
- Charge fees before settling your debt
- Claim that they can settle all of your debt or reduce it by a certain percentage
- Boast about new government programs that eliminate personal credit card debt
- Encourage you to stop communicating with creditors
- Claim that they can stop debt collection and lawsuits
Be clear about how urgent your debt relief needs are. There are instances when some individuals might be exempt from debt collection if a debt’s statute of limitations has passed. In addition, individuals who live on fixed government benefits or limited income might be judgment-proof, which means debt collectors can’t file suit against you.
Find the best financial solution for your situation
Managing debt can be overwhelming, but understanding how different types of debt relief work is necessary for choosing your best option. First, consider factors such as your debt-to-income ratio, types of debt carried and your ability to repay in the near future. Then, you can select the most beneficial debt relief plan for you.