Debt settlement can change the terms or amount of your debt so you can get back to financial control.
It isn’t a fix-all, and it’s important to understand what the consequences might be.
Debt relief could involve wiping the debt out altogether in bankruptcy; getting changes in your interest rate or payment schedule to lower your payments; or persuading creditors to agree to accept less than the full amount owed. You may be able to get debt relief through:
Bankruptcy and debt settlement have been able to reduce and in some cases eliminate debts, but they also effect your credit score. Of course, continuing to struggle is not ideal, and generally doesn’t allow you to get rid of the debt. Debt Management Programs doesn’t reduce debts, but its effect on your credit is a bit less severe. Secured loans typically can’t be erased or reduced: federal student loans, child support, and secured loans on cars and homes.
If you’ve cut expenses and you’re still finding it difficult to make payments, debt settlement may very well be your best option.
Seeking debt relief – when?
If your debt can be repaid through spending habits, this is the best way to go.
Debt Management, bankruptcy, or debt settlement may be considered when:
- You’ve made an effort to cut spending and still have no hope of repaying unsecured debt (medical bills, credit cards, personal loans)
- The ratio of unpaid unsecured debt to income is greater than 50%
Dangers of debt relief
Not everyone who enters into debt relief programs completes them. It’s possible to end up with more debt than when you started.
Done correctly, debt relief can provide you the opportunity you’ll need to finally make real progress.
Make sure you clarify the following points before entering any debt relief agreement:
- Whats needed to qualify
- The total fee’s that are incurred
- How creditors are paid, and how much
- If there are tax implications
- How long the program might take
If you do not plan on making payments to a debt relief program, you’re likely better off with bankruptcy.
Chapter 7 liquidation may erase most credit card, unsecured personal loans and medical debts. It’s possible to complete in 3 or 4 months if you qualify. Realize the following:
- It doesn’t erase taxes owed, child support, and student loan debt (unlikely)
- Your credit scores will take a hit and it stays on your credit report for up to 10 years even as you restore your credit history. Poor credit history can affect your ability to get a job, approval for housing, and even increase insurance payments.
- You cannot file another Chapter 7 bankruptcy for at least 8 years.
- Depending on the state, you may have to sacrifice property you want to keep. Certain types of property are exempt from bankruptcy, but you usually have to give up a second car or truck, vacation homes and any valuable collections.
Not everyone with high debt will qualify. Depending on your income, or if you have a home you want to save from foreclosure, Chapter 13 may be a better option.
Chapter 13 is a 3 or 5 year repayment plan, based on your income and debts. It takes longer than Chapter 7 — but if you’re able to maintain the payments, you will get to keep your property. A Chapter 13 bankruptcy stays on your credit report for 7 years.
Debt Management Plans
Debt management plans allows you to pay your unsecured debts in full, but at a reduced interest rate and with fees waived. You make a single payment each month to a credit counseling agency which will then distribute it among your creditors. Credit counselors and credit card companies have agreements in place to help debt management clients.
Your credit card accounts will be closed and, in most cases, you’ll have to live without credit cards until you complete the plan.
Debt management plans themselves do not affect your credit scores, but closing accounts can hurt your scores. Once you’ve completed the plan, you can apply for credit again.
It’s important to pick an agency accredited by the National Foundation for Credit Counseling or the Financial Counseling Association of America. Make sure you understand the fees and what alternatives you may have for dealing with debt.
Debt settlement should be considered for those who face overwhelming debt but cannot qualify for a bankruptcy.
Debt settlement companies may ask you to stop paying your creditors and put the money in an account they control. As the money accumulates in your account each creditor is approached and a settlement is negotiated.
Not paying your bills may result in collections calls, penalty fees, and potential legal action against you. Debt settlement does not prevent this during the negotiation process. It may take 4 to 6 months before the settlement offers begin. The process may take 24-48 months.
Something many people don’t know is that you may face a bill for taxes on the forgiven amounts as the IRS sees this as income. Lawsuits may result in wage garnishments and property liens.
You can always attempt to settle the debt yourself, or you can hire a professional. It’s very important to properly vet the debt settlement company you choose, as there are many unethical companies.
There are some great debt settlement options out there, you just have to find the right one.
Do-it-yourself debt relief
There is always the option of doing the above yourself, if you have the time and patience to do so.
For your own debt management plan: Reach out to your creditors and explain why you fell behind. Most credit card companies have hardship programs, and they may be willing to lower your interest rates and waive fees.
You can attempt debt settlement on your own, and negotiate an agreement by contacting creditors yourself.
More traditional strategies are also available. For example, if your credit score is still strong, you may be able to apply for a credit card with a 0% balance transfer offer. Or you may find a debt consolidation loan with a lower interest rate than your current creditors have on you.
Those options won’t hurt your credit. As long as you make the payments, your credit score should rebound.
Of course, it’s always important to have a plan that will prevent the situation from occurring again.
Things NOT to do
These are things we suggest you avoid doing:
- Borrowing against the equity in your home is not advised. Your home will be at risk of foreclosure and you may be turning unsecured debt that could be wiped out in bankruptcy into secured debt that can’t.
- Withdrawing from your retirement savings in order to repay unsecured debt is never advised..
- Borrowing money from workplace retirement accounts may be a bad idea. If you lose your job, the loans can become inadvertent withdrawals and trigger a tax bill.
- Making decisions based on which collectors are pressuring you the most may lead to actions that aren’t in your best interest. Rather, take time to research your options and choose the best one for your situation.
- Paying a secured debt late, such as a car payment, in order to pay an unsecured one, like a credit card – is not a good idea. You could lose the collateral that secures that debt.