What Does Debt Relief Really Mean?
Debt relief is a complicated topic–one that involves understanding bankruptcy laws, settlement options, and the implications of each choice. Let’s break it down into simple terms: debt relief refers to reducing or restructuring your current debt load to make payments more manageable. This can happen through debt consolidation loans, credit counseling, debt management plans, debt settlement, or bankruptcy.
The goal is to find a solution that works for your unique situation. For some folks, that may mean working with creditors directly to change payment terms or interest rates. For others, it could require more formal debt relief programs that negotiate on your behalf or wipe debts away completely.
-Debt Consolidation
One of the most common forms of debt relief is consolidation. This involves rolling multiple debts into one new loan, often with a lower interest rate and single monthly payment. Banks, credit unions, and online lenders all offer debt consolidation loans. The benefit is simplifying payments and sometimes lowering interest costs. The risk is that you may be tempted to rack up more debt after consolidating, which can defeat the purpose. It takes discipline to not overspend.
A debt management plan offered by credit counseling agencies is similar to consolidation, but creditors agree to reduced interest rates and waived fees. You make one payment to the agency each month, which distributes funds to creditors. There’s usually a small monthly fee for this service.
Debt Settlement
Debt settlement firms negotiate with creditors to settle accounts for less than the full amount owed. This can reduce debts by 25% to 50% in some cases. The catch? Creditors will report settled accounts as “paid for less than agreed” which will damage your credit score. And the IRS may count the forgiven debt as taxable income.
Settlement firms often charge hefty fees too. Legitimate companies will hold your monthly payments in a secure account until enough is saved to make settlement offers. But scams do exist, so choose carefully if going this route.
-Bankruptcy
Declaring bankruptcy legally eliminates many types of debt, providing a fresh start. But it also wrecks your credit for years. Two main types exist: Chapter 7 bankruptcy wipes debts away completely through liquidation of assets. Chapter 13 sets up a 5-year repayment plan for debts.
Bankruptcy stays on your credit report for 7-10 years and can make it tough to get approved for future loans or credit. Many see it as a last resort option when other debt relief attempts fail.
Finding the Right Solution
Every debt relief option has pros and cons. There’s no one “best” approach. It depends on your specific situation–the types of debt you have, your income and expenses, credit score, and willingness to take a credit hit.
Nonprofit credit counseling provides free consultations to review your full financial picture. They help create a personalized debt relief plan. You can also contact creditors directly to request reduced interest rates or modified payment terms. Both options let you avoid expensive settlement fees while protecting your credit score.
The most important thing is acting sooner rather than later. Ignoring debt problems won’t make them go away. And waiting too long reduces the debt relief options available. Don’t be afraid to ask for help.
-Debt relief gives a second chance to regain financial control. But it requires commitment to change spending habits that led to debt in the first place. Otherwise, you risk racking up more debt and needing future relief. Use debt relief as an opportunity for a fresh financial start.
Common Questions
Let’s review some frequently asked questions about debt relief options:
How much does debt relief cost?
Costs vary based on the specific debt relief program:
-- Credit counseling services typically charge $25 to $50 per month.
- Debt management plans have monthly fees around $25 to $75, paid to the credit counseling agency managing the program.
- Debt settlement companies often charge 15% to 25% of the total enrolled debt amount, collected over the first half of the program.
- Bankruptcy legal fees range from $1,500 to $3,000 paid upfront, depending on complexity of the case.
- Debt consolidation loans have interest charges like any other loan. Rates are based on credit score and other factors.
When should I consider debt settlement?
Debt settlement makes the most sense when you have significant unsecured debts, like credit cards or medical bills, and can’t realistically pay them off through a debt management plan. If you have assets creditors could seize, like a house or car, settlement may be risky since you stop making payments while the firm negotiates on your behalf.
Will debt relief hurt my credit?
Most debt relief solutions will hurt your credit, at least temporarily:
- Debt management plans may note your accounts as “paid through credit counseling.”
- Debt settlement leads to accounts being closed or marked “paid for less than agreed.”
- Bankruptcy causes severe damage, lowering scores by 100+ points and staying on reports for 7-10 years.
After debt relief, focus on responsible credit use to gradually rebuild your scores over time. Get secured cards to establish positive payment history again.
Can creditors sue me if I stop making payments?
Yes, creditors and collectors can sue for repayment. However, they typically can’t sue once you begin a debt management plan with a credit counseling agency. Settling debts for less than owed also legally satisfies the debt. But until settlement offers are formally accepted, accounts will continue to accumulate late fees and creditors may pursue legal action.
Is debt forgiveness taxable?
Yes, the IRS often counts forgiven debt from settlement or bankruptcy as taxable income. There are exceptions, like insolvency during bankruptcy. But in many cases, you may owe taxes on the forgiven debt. Always consult a tax pro to understand if you’ll face tax consequences before pursuing debt relief.