Have you tried different approaches to paying off your debt, but not having much luck? Or maybe your monthly payments are too high for your budget. Either way, you’ve probably considered looking into debt relief options to get your finances back on track.
There are several methods to choose from, but not all of them may be ideal for your finances. Some might have negative financial consequences that might be difficult to overcome.
Why People Consider Debt Relief
Debt relief refers to a tactic that can be used to make your debt load more manageable. Many consumers are considering different forms of debt relief to get more affordable monthly payments, a lower interest rate, or to pay off what they owe faster. Some debt relief methods involve settling with creditors for less than you owe, or you can file for bankruptcy to wipe the slate clean in some cases.
Why Debt Relief Services Can Hurt Your Finances
Unfortunately, debt relief services can often mean bad news for your finances. Some consumers enter debt relief programs that they cannot complete or fall victim to the tactics of scammers. Either way, you could find yourself in an even deeper debt hole. Some debt relief programs can also hurt your credit scores, especially those that suggest you stop paying while you sign up or pay only a fraction of what’s owed to settle the outstanding balance.
Types of Debt Relief
Not all forms of debt relief are suitable for all consumers. it depends on your current indebtednesscredit rating, interest rate and financial situation.
Debt Consolidation is to merge multiple accounts into one to streamline the repayment process, save on interest, and possibly pay off your debt sooner. This approach can work if you have good or excellent credit and may qualify for a debt consolidation loan or a balance transfer credit card.
Ideally, the debt consolidation loan will have a better interest rate than what you are currently paying on all your debts. If you choose to use a balance transfer card, it’s best to pay back the amount you transfer within the promotional APR period. It usually lasts between six and 21 monthsand the remaining balance will start earning interest at the card’s variable rate after that period.
You can negotiate with your creditors to settle your debts or hire a company to do it for you. If you choose the latter, the debt settlement company will ask you to make a fixed monthly payment into a dedicated account. These funds will pay creditors and cover their costs as settlement offers are made.
In the meantime, some debt settlement companies will also advise you to stop paying minimum monthly payments to creditors to speed up the process. In turn, your credit score will be hit when missed payments show up on your credit report. However, there is no guarantee that your creditors will accept settlement offers, whether you negotiate alone or that a debt settlement company handles the negotiations.
Your credit score will be negatively affected as accounts are settled, as they will appear on your credit report as “partially paid” instead of “paid in full”. That being said, this approach can be risky for your finances.
Some creditors and lenders offer debt forgiveness options for borrowers facing financial difficulties. You may be eligible to have all or part of your balance on your student loan, credit card or mortgage canceled. When you enter into a settlement agreement, this also constitutes debt forgiveness on the portion of the balance that the lender will not recover.
Debt cancellation may sound attractive, but it can also have disastrous consequences. Your credit health could take a hit and you could get a tax bill if the amount handed over is subject to tax.
Credit counseling is available through non-profit agencies, often free of charge. You will meet with a credit counselor to review your finances. During the meeting, they will also work with you to create a plan to better manage your income, expenses, and debt. They may also suggest other alternatives, such as a debt management plan, to get your outstanding debt under control.
Debt management plan
A debt management plan (DMP) is a two to five year roadmap designed to help you get out of debt faster. You will repay the full amount you owe, but the credit counselor will work with your creditors to negotiate concessions, including fee waivers or reduced interest rates.
If creditors accept the plan, you will begin making the monthly payment specified in the DMP to the credit counseling agency. They will divide this amount between the creditors each month according to the payment schedule of the agreement. You should also be aware that creditors will most likely close your accounts when you register for a DMP. Also, you probably won’t be allowed to apply for new credit until the plan is complete.
Bankruptcy is a type of debt relief that should only be used as a last resort. The two most common forms of bankruptcy are chapter 7 (liquidation) and chapter 13 (reorganization).
Chapter 7 often requires debtors to liquidate personal assets to repay creditors. You won’t have to give up your assets under Chapter 13, but you will enter a payment plan that lasts three to five years before your debts under the bankruptcy filing can be paid off.
Be sure to consult a bankruptcy attorney before filing. Both will have serious consequences for your credit. Chapter 7 lingers on your credit report for up to 10 years, and Chapter 13 stays on for up to 7 years after the filing date.
Common Debt Relief Scams
Fraudsters know that consumers looking for debt relief may be desperate to find the help they need. Thus, they take advantage of the vulnerability of those who need help to scams it could cause even more damage to their financial health.
When looking for companies that provide debt relief services, avoid those that require upfront payment or make promises about debt settlement offers. It is also a red flag if the company:
- Tells you to cease all forms of communication with your creditors and lenders
- Promises to make your unsecured debt disappear or help you pay it off for pennies on the dollar
- Suggests you use a ‘new government program’ to eliminate your credit card debt balances
You can also avoid scams by checking the company’s accreditation status with the National Foundation for Credit Counseling and the Better Business Bureau. Both platforms allow consumers to read the complaints they have received (if any). And be sure to visit your attorney’s office and research the company to confirm that it is licensed to operate in your state.
What not to do when seeking debt relief
If you decide to go ahead with debt relief, weigh the pros and cons of each option to make an informed decision. Even if you’re inundated with constant calls and letters from collection agencies, do your research to minimize your chances of reaching a deal with a debt collector or creditor that doesn’t work for your finances or falling victim to ‘a scam.
Another caveat: avoid favoring unsecured debt over secured debt. Unsecured debts, such as credit cards, personal loans, and medical bills, are not secured by collateral. However, secured debts, such as auto loans and mortgages, are secured, meaning you could lose your assets if you fall behind on payments.
You also want to avoid taking out a home equity loan or home equity line of credit (HELOC) to pay off unsecured debt. These debt products use your home as collateral, putting it at risk of foreclosure if you fail to repay the loan.
Borrowing or withdrawing funds from your nest egg is also not a smart financial decision when looking to pay off debt. The more money you withdraw from your retirement savings, the more you’ll miss the opportunity to let compound interest work in your favor. If you borrow funds from your 401(k) and you lose or quit your job, the loan will become a withdrawal and you may have to pay taxes on the balance.
At the end of the line
If you are drowning in debt, there are debt relief options that can help. But not all offer the same benefits or suit your long-term financial health, and you could hurt your credit rating or end up worse off than you started. It is therefore essential to understand how each debt relief option works and weigh the pros and cons before choosing the best strategy for your financial situation.