What is Debt Relief?
Debt relief is a program or service that may help you get out of debt, usually by reducing your payments or canceling a portion of your balance due.
Photo by Pixabay on Pexels
As consumer debt rises to all-time highs, more Americans are searching for debt relief programs to help deal with debt. Debt relief broadly refers to a variety of options for managing your debt, including consolidating and settling your debts. Each option has benefits and drawbacks, so careful consideration is important to choosing the best approach for your debt.
Debt relief firms
Debt relief firms, also called debt settlement firms, aim to reduce your overall debt by asking creditors to accept a lower lump sum payment. If they agree, any remaining balance is canceled.
Accounts typically need to be past due before a debt relief firm can negotiate for you. They'll ask you to stop paying your creditors and make payments to a separate account instead. Once you've saved up enough to make a settlement offer, the company will negotiate on your behalf and pay the settlement if the creditor accepts the offer.
In exchange for their services, debt relief companies typically charge 15 to 25 percent of the total debt you have enrolled. You'll only be charged after a debt has been successfully settled.
There are some risks to working with a debt relief service:
- Not all debts can be settled, specifically secured debts like a mortgage or auto loan.
- Since settlement offers are made on delinquent accounts, you may incur late payments and experience a FICO® Score decrease.
- Creditors aren't obligated to agree to settlement offers. Some may choose not to work with your debt relief company.
- Settling debts may come with tax implications since canceled debts may be considered income.
Debt management plan
A debt management plans, or a DMP, is a service offered by credit counseling agencies. Under a debt management plan, you'll make a single monthly payment to the credit counseling agency, who then distributes payments to your individual creditors.
The debt management may include better terms—a lower interest rate or lower minimum payment. You'll still repay your full outstanding balance, but the goal is to make your payments more manageable.
Credit counseling agencies may charge a small fee for their services but should offer reduced fee options if you have low income. Since you won't be allowed to use credit cards until you complete the debt management plan, you'll have time to kick bad debt habits to the curb.
Debt consolidation combines multiple debts into a single balance with a debt consolidation loan credit card balance transfer. Instead of having to split your payments among several creditors, you'll have just one payment to make. However, since you'll need to qualify for a new loan or credit card, debt consolidation is a better option if you have good credit.
Consolidating could be more expensive if your debt consolidation loan interest rate is higher or your repayment stretches over a longer timeframe. Paying off your credit card balances also frees up your credit limits, which could tempt you to fall into a trap of spending again.
Emergency debt relief for natural disasters
If you live in a declared disaster area, you may be eligible for a low-interest rate disaster loan from the U.S. Small Business Administration (SBA). FEMA works with the SBA to provide loans to help cover damaged items or to prevent future damage. If you qualify, the loan can help you pay down debt you took on to recover from the disaster.
Many credit card issuers and lenders also offer payment assistance after a natural disaster. Your options will vary depending on the creditor but may include temporary decrease or suspension of your monthly payments. Contact your creditors directly to get information about your options and to apply.
Bankruptcy legally removes your liability for certain debts. Under the most common form of bankruptcy, Chapter 7 liquidation, most unsecured debts can be erased. That includes credit card debt, personal loans, and medical debt.
If you need to save a home from foreclosure or your income is higher than the median for your state, you can file Chapter 13 bankruptcy. You'll enter a three to five year repayment plan after which remaining unsecured debts are discharged.
Because it's extremely damaging to your credit, bankruptcy is often considered a last resort option. It may be worth consulting with a bankruptcy attorney if you think bankruptcy may be a possibility.
Which Debt Relief Option is Best?
To compare debt relief options, consider the amount and type of debt you have as well as how far behind you are. Limiting damage to your FICO® Scores is important, but you also have to choose an option you can afford and stick with for several years. Before signing up for a service, ask for a free consultation to help guide your decision.
Get your FICO® Score from FICO, for free. No credit card required.