Debt is a serious problem faced by Americans, with the average personal debt being $90,460. However, many people keep doing the same things they’ve been doing, expecting a different result; maybe it’s ignoring their debt, blaming others, or doing nothing. Unfortunately, that’s a recipe for disaster. Without looking inwards to discover where your finances went wrong and how you can fix it, then you’re likely to remain in debt for a long time moving forward.
Debt relief offers a way through which you can get rid of your debt. To get the most of it, there are things you need to know. That’s why we’re going to briefly explore the four types of debt relief and some tips on how to efficiently harness them.
Types of Debt Relief
Depending on your situation, there are four types of debt relief options to get you to become debt-free. Here’s an overview of what you might consider.
Sometimes, debt relief is as simple as building a budget to observe how money comes and leaves. This helps you to know where you can cut back excessive spending. This can be very useful if making monthly payments is a constant struggle.
Aside from helping you create a budget, credit counselors can also work out a debt management plan for you. With the arrangement, the non-profit credit counseling agency works with your lenders to significantly lower the interest rate on your debt and even lower your monthly payment to a level that you can afford.
You make just one payment to the credit counseling agency for your unsecured debt obligations and they help make payments to your creditors.
In debt consolidation, all your unsecured debts, like credit card bills, are consolidated into one monthly payment. A common strategy for debt consolidation is to apply for a new loan or credit card to pay off existing debt.
It’s only advisable to do it if the loan or credit you get is at a lower interest rate than what you’re currently paying. Moreover, you need a good credit score to be successful.
As you can notice, debt consolidation best works if you have manageable debt and a high credit score.
In this debt relief option, debt settlement companies negotiate on your behalf with your lenders to settle a debt for less than what is owed.
During this process, you are typically advised to stop making payments on your loans. Instead, you save it with the debt settlement company. When it is substantial enough, they go to your lenders to see if they can cut a deal where you pay less than what you owe. For instance, if you owe $10,000, a debt settlement plan can help reduce it to a one-time payment of $6,000.
Lenders are primarily concerned about getting their money so they may be inclined. However, they are under no obligation to agree. If that happens, you would have racked up thousands of dollars in fees because of the payments you stopped making. Therefore, this path should be tread with caution.
If you’re in a financially dire situation where there’s no possibility of clearing your unsecured debts in the next five years, then bankruptcy might be your last option. There are two types of consumer bankruptcy: chapter 7 and chapter 13. In chapter 7, your nonexempt assets are sold off to pay a fraction of your debt after which the remaining are forgiven. In chapter 13, a debt repayment plan is reorganized to make payments more affordable and it should be discharged within the next 3 to 5 years.
Declaring bankruptcy will hurt your credit score and will remain on your credit report for 10 years (chapter 7) or 7 years (chapter 13). However, it allows you to restart your financial life.
Special Tips on Debt Relief
We’ve explored the four types of debt relief; how they work and their advantages and drawbacks. But before you decide on which to opt for, here are some special tips to bear in mind:
- There’s no guarantee that your interest rate on debt consolidation and debt management will be lower than your current rates. That’s why they are preferred if you can get a lower interest rate. This helps you save money on interest charges and makes it easier to clear off your debt on time.
- In debt settlement, there’s no guarantee that the debt settlement company will be able to come to a successful negotiation. And if they don’t, your credit takes a massive hit. That’s why debt settlement is not a recommended deft relief strategy.
- Working with a credit counseling agency or debt settlement company isn’t free. You may make monthly payments of about $30 to a credit counseling agency. Debt settlement companies typically take 15 to 20% of the settled amount.
- With debt settlement, the amount saved may be considered taxable income. So if you’re able to renegotiate to pay $6,000 out of your $10,000 debt, you might be required to still pay tax on the $4,000.
- Beware of scammers! Some companies offering debt settlement programs may engage in deception and fail to deliver on their promise. For instance, they may “guarantee” to settle all your credit card debts for 30% to 60% of what you owe. But as you’ve seen, there are no guarantees when it comes to debt settlement. By the way, those firms may try to collect their fees before they settle any of your debts.
- With bankruptcy, you get to pay just a fraction of what you owe but this will have a significant negative impact on your credit score and financial life many years down the line.
At the end of the day, the debt relief method you choose is highly dependent on your specific situation. But as a general guide, having a debt management plan or debt consolidation should be the first line of action. Draconian measures like debt settlement or bankruptcy should only be used if you’ve carefully assessed the risks (preferable with a professional) and that seems like the most viable option for you.
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