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If you're in debt, there are a number of options you can pursue to get some relief. For example, consolidation of existing loans can help lower your interest rate and monthly loan payment. There are debt management companies who can help with all this. Some people might opt for bankruptcy, which will completely eliminate some types of debt, while others might take the middle ground and opt for debt settlement, where debtors negotiate with creditors to pay off a portion of what’s owed, with the rest being forgiven by the creditor.
Before deciding on a path to debt relief, it's essential to understand the consequences of each of these options.
Types of Debt Relief
If after assessing your finances, you decide that there's no realistic way for you to pay off your debt within the next five years, or if that debt exceeds half of your gross annual income, you might want to consider using some debt relief strategy to help you reclaim your financial stability. There are several paths you could take to help with your debt burden:
- Debt consolidation: Taking out another loan to cover all your existing loans. This is the most effective method if you can get a loan with a lower interest rate that helps to lower your monthly payments.
- Debt settlement: In this case, you can negotiate with your creditors to pay off a portion of your debts, with the remainder being forgiven. The downside to this path? You'll need to allow all of your debts to become past due before beginning the process, which will negatively affect your credit score.
- Debt management: Developing a budget and sticking to a payment plan, often by negotiating with creditors for more favorable terms, such as lower interest rates or extended repayment periods.
- Bankruptcy: A legal proceeding that can erase unsecured debts - but it should be a last recourse when looking for debt relief. A bankruptcy filing will stay on your credit report for up to ten years.
Let's discuss debt relief options in greater detail.
Debt consolidation loans
Debt consolidation allows consumers to restructure their existing debt, either by taking out a loan or a line of credit. The proceeds of the new loan are used to pay off the existing loan, often combining multiple debts into one loan with a lower interest rate. If your debt can be paid off before the lower interest rate expires, it can potentially lead to savings of several hundred dollars per year in interest payments. If you don't know where to start in building your debt consolidation strategy, debt consolidation loan providers can help you find the right path for your unique needs. One thing to keep in mind when consolidating your debt is that in order to get to a lower monthly payment, your loan term might be extended – meaning you end up paying off your loan for a longer period of time.
Debt settlement
Debt settlement, especially if done on your own, can be one useful way to reduce your debt burden. This debt relief option actually lowers the overall amount that you pay back to your creditors, and can significantly reduce the amount you repay, if done correctly. Debt settlement is done by contacting your creditors and negotiating with them to secure better repayment terms, which can include reduced fees, interest rates, or even deduct some of the principal owed. The downside is that you often need to let your loans go past due before creditors will negotiate. There are also companies that specialize in debt settlement, and while their negotiators are skilled, the high fees they charge (often as much as 25% of the total debt) typically offset any savings they secure through their negotiations. Furthermore, the debt settlement industry is susceptible to fraud and scams, so look out for companies who may be unlicensed or offering promises that sound too good to be true.
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Debt management
Debt management companies will often negotiate with your creditors on your behalf as well, and can reduce fees and interest rates on your debts. Most debt management plans last for three to five years, with a goal of completely eliminating your debt in that time. They will often require the person using their program to sign an agreement not to open up any new unsecured loans during the time that they are working to reduce the debts. These debt management programs typically have a start-up cost and ongoing monthly fees. Because of these monthly fees consumers should carefully monitor how long it will take to completely pay off their debts as some unscrupulous firms will extend the payment period in order to continue collecting their monthly fee.
Bankruptcy debt relief
Declaring bankruptcy to relieve debt should be a last resort, reserved for emergencies. The good news is that bankruptcy can eliminate all of your unsecured debt (credit cards, medical bills, and personal loans). The bad news is that it will also destroy your credit. You'll put yourself at great risk of not being able to apply to any new loans or lines of credit for at least a year after filing bankruptcy, and in some cases even longer than that. In addition, the bankruptcy remains on your credit report for up to ten years, making it difficult to obtain some types of loans during that time, and also increasing your interest rate on many loan types as well. If you are considering using bankruptcy to eliminate your debts you should be aware of this downside and think carefully before exercising this drastic option. There are two types of bankruptcy:
- Chapter 7: This is a liquidation bankruptcy through which assets are liquidated to pay off debts and remaining unsecured debts are discharged. To qualify, you must take a means test showing your income doesn’t exceed limits.
- Chapter 13: This is a repayment plan bankruptcy. Through it, you create a three- to five-year repayment plan, and once it’s completed, the rest of your unsecured debts are discharged.
Bankruptcy is not something you should do on your own. You should consult with a bankruptcy attorney to ensure that your filing meets the specific requirements of your local bankruptcy court.
Qualifying for Debt Relief
Each type of debt relief has its own requirements to qualify. If you are thinking about some type of debt relief program yourself keep in mind these following requirements:
Debt consolidation requirements:
- List all your debts and create a sustainable budget.
Debt settlement requirements:
- List all your debts and create a sustainable budget.
- You must be comfortable negotiating with creditors.
- Must be willing to play hardball with some creditors.
- Must have time to devote to negotiating and following up on agreements.
Debt management plan requirements:
- List all your debts and create a sustainable budget.
- Must be comfortable taking as long as 5 years to pay off your debts.
Bankruptcy debt relief requirements:
- List all your debts.
- Must pass a "Means Test" to prove your income doesn’t exceed limits for Chapter 7 filing.
- Must be comfortable taking as long as 5 years to pay off your debts under Chapter 13 laws.
Consequences of Debt Relief
While debt relief services certainly do provide a significant benefit, there are also consequences to debt relief, whether you choose to use debt settlement, debt consolidation, debt management, or bankruptcy debt relief. One of the most drastic consequences faced is the impact that many debt relief paths have on your credit score. You can expect at least a small hit to your score, but in the case of debt settlement and bankruptcy, your credit score could be significantly impacted. Expect to see your credit score fall by as much as 100 points, and take many months, if not years, to recover completely. You might also find yourself tied up in legal proceedings if creditors decide to take you to court over past due debts, or contest your Chapter 7 bankruptcy filing. Another consequence many people don’t consider is the tax implications of a debt settlement. If a creditor erases more than $600 of your debt they are required to report it to the IRS, and you are required to pay taxes on it. For these and other reasons it is always best to confer with a debt relief expert before beginning any type of debt relief plan.
Conclusion
As you can see, there are a number of options available to you if your debt has become insurmountable. Depending on your circumstances, you can choose to go the debt consolidation route, explore debt settlement options where you negotiate with your creditors, get some help from a debt management agency, or file for bankruptcy. Each has its own pros and cons. Do your research and be aware of the debt relief options available, and the consequences of each path. Remember that consulting with a professional debt counselor or even a bankruptcy attorney before making any commitment to one debt relief plan over another can potentially save you from some of the most drastic consequences associated with debt relief.
Article Topics
Debt Consolidation
Steve has been writing in the financial products space for over a decade, with interests ranging from personal loans to investing. He is also deeply into the blockchain space. In his free time, you can find him in the kitchen preparing delicious meals, or outside hiking and biking.
