Key takeaways
- Debt settlement, debt management plans and debt consolidation are among the most popular debt relief options.
- If you work with a credit counselor to create a debt management plan, ensure it’s with a non-profit counseling agency.
- You can consolidate debt through a 0 percent APR credit card or a debt consolidation loan.
Debt relief programs and strategies aim to resolve credit issues caused by built-up debt. But, much like the debt itself, the relief option you choose will impact your future finances. You could be left with hefty fees or even more damage to your credit score.
Hanna Horvath, certified financial planner and Bankrate senior editor, explains that these programs offer benefits and downsides for those struggling with high-interest debt.
While these strategies can offer a lifeline, they’re not a get-out-of-jail-free card for your debt. Most types of debt relief involve paying fees, and may negatively impact your credit score. In some cases, you may be able to handle your debt on your own by using a balance transfer card or taking out a debt consolidation loan. The best option for you depends largely on the amount of your debt and your specific financial situation.
— Hanna Horvath, CFP
Explore each debt relief method and carefully consider the pros and cons to minimize further credit damage or debt accrual.
Debt consolidation
Debt consolidation occurs when you combine two or more existing debts into one new debt. You might use a debt consolidation loan or a balance transfer credit card.
You’ll still owe the amount you started with. However, you’ll only need to make one monthly payment instead of multiple.
Consolidation is a popular choice among borrowers. There are numerous benefits and minimal risks compared to other options — provided you can keep up with payments.
Pros
- Consolidating debt with a balance transfer credit card can get you 0 percent APR for up to 18 months.
- Debt consolidation loans can offer lower fixed interest rates, a fixed monthly payment plan and a set repayment schedule.
- You’ll only have to make one debt payment per month rather than several.
- Debt consolidation options may help you save money on interest, pay down debt faster or both.
Cons
- Balance transfer cards’ 0 percent APR periods typically last 12 to 18 months. After that period, you’ll face a variable interest rate on any remaining balance.
- Consolidation doesn’t eliminate or make progress toward paying down your debt.
- You may owe fees, such as balance transfer fees if you use a card or an origination fee on a loan.
- You need good or excellent credit to qualify for loans with the best rates and terms.
Debt settlement
Debt settlement is a process that lets you settle large amounts of debt for less than you owe. It is offered through for-profit debt settlement companies. However, you can also DIY the debt settlement process and avoid the fees.
Debt settlement is inherently risky. Creditors aren’t required to work with debt settlement companies and could deny the negotiations altogether.
Typically, these programs ask you to stop paying your creditors as they negotiate your debt with them. If this happens, your credit will have taken a massive hit (as you stopped making payments). And you’ll be left with the same amount of debt.
If the creditor agrees to the settlement company’s negotiation, you’ll pay the debt company directly using a specified account rather than paying the creditor.
While the companies take on the negotiation work, the services come at a price.
Settlement fees differ depending on the company but typically range around 15 percent to 25 percent of the settled debt amount. Remember that settlement companies are prohibited by law from asking for an upfront fee.
Pros
- May be able to settle your debt for less than you originally owed.
- If settled through a debt settlement company, you don’t have to communicate with creditors directly.
- Could pay off your debts sooner than you would otherwise.
Cons
- Creditors are not legally required to settle for less than you owe.
- Stopping payments on your bills (as most debt relief companies suggest) will damage your credit score.
- Debt settlement companies can charge fees.
- If over $600 is settled, the IRS will view this debt as a taxable income.
Credit counseling
Credit counseling agencies help manage monthly debt expenses.
These companies can help you manage your finances. You’ll be assigned a counselor to examine your current debts and income. They will tailor a debt management plan to your monthly budget.
Since the counselors are professionals in debt management, they can also offer suggestions on debt relief strategies and programs that fit your needs.
While both for-profit and nonprofit options exist, you’ll want to opt for nonprofit. Nonprofit counseling agencies typically charge lower fees than for-profit agencies, with some offering the services for free. Debt relief companies may charge higher rates and be incentivized to sell you their services.
Some agencies also offer long-term financial health assistance and immediate debt management services, such as free training and workshops on improving your relationship with money.
Pros
- Services can be free or low-cost.
- Get debt management advice tailored to your specific debts and finances.
- Access resources that promote immediate and long term financial health.
Cons
- Credit counseling typically isn’t free, although fees vary.
- Not all credit counseling agencies are reputable, so you’ll have to do your research.
- Credit counseling doesn’t eliminate or pay back your debts.
Debt management
In some cases, credit counseling companies also recommend and oversee debt management plans. These plans have you make a single payment to an account in your name each month, and the credit counseling agency uses this money to pay bills on your behalf.
With debt management plans, the company will also work with your creditors to negotiate lower interest rates and more preferential terms.
Like working with any third-party relief company, creating a management plan could devastate your credit score, and creditors aren’t required to work with your counselor.
Pros
- Simplify your finances with just one debt payment to make each month.
- Get third party help creating a debt payoff plan.
- Potential to save money and get out of debt faster.
Cons
- Debt management plans require you to stop using credit cards.
- Most plans last between three to five years.
- These plans are not free and the fees can be steep.
Bankruptcy
Bankruptcy should be a last resort when other debt relief options fail. It’s a long, expensive process with long-term negative impacts on your credit score. However, bankruptcy can be helpful as it provides a break from creditors and may result in forgiven debt.
There are two main types of bankruptcy: Chapter 7 and Chapter 13. Both types of bankruptcy can help you discharge certain debts and get a fresh start.
Chapter 7 bankruptcy requires you to liquidate most property to pay off your creditors. Remaining qualified debt is discharged. Chapter 13 bankruptcy puts you on a three- to five-year court-approved payment plan, which may have lower rates or smaller payments compared to your current debt.
Pros
- Get relief from overwhelming amounts of debt.
- Stop collection calls and harassment.
- You may be able to keep your home or a car.
Cons
- Bankruptcy goes through the court systems, and it can be rather costly.
- Chapter 7 stays on your credit report for up to 10 years, and Chapter 13 stays for up to 7 years following the filing date. Both types cause significant credit score damage and may make it difficult to qualify for new credit.
- Not all debts qualify for bankruptcy. Secured loans and federal student loans are typically excluded from discharge.
The bottom line
If you have found yourself overwhelmed with debt, moving forward with the debt relief process can be the right move, financially and personally. However, not all routes are created equal. Some may charge steep fees or refuse to manage the debt you have incurred.
To minimize the risk of future issues, consider all options available and compare debt relief companies to ensure you find the right fit for your needs.
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