American household debt stands at a record high — more than $17.80 trillion, according to the New York Fed. That’s not too surprising when you consider the high inflation over the past several years and the fact that not everyone’s wages have kept pace.
Not only have rising prices put people into consumer debt, but many people don’t have enough savings to navigate a financial emergency without debt. The Federal Reserve reports that 37% of Americans can’t handle a $400 emergency. If you get hurt, lose your job, get divorced, or experience some other problem, debt often feels like the only option.
Unfortunately, once you get into debt, it can often be challenging to get out. While budgeting can get you part of the way there, you may eventually need to rely on other options, including debt relief programs. Here’s what you need to know about the different debt relief options and how to decide which is right for you.
What is Debt Relief and How Does It Work?
Debt relief can refer to any steps you take to reduce your debt burden. It often involves helping you to get out of debt by restructuring your debt or negotiating the terms to help reduce the amount of debt you owe, the interest rate you owe, or your fees to make your debt more affordable.
While it’s possible to DIY your debt relief, many people choose to enlist the help of third parties, including private companies and nonprofit organizations. Some types of debt relief include:
- Credit counseling
- Debt consolidation
- Debt management plan
- Debt settlement
- Bankruptcy
For the most part, the main idea is to structure your debt in a way that allows you to get rid of it faster and at less expense than if you followed through with the terms to the very end. We’ll examine different types of debt relief below. However, each type of debt relief does this in a different way.
Types of Debt Relief
There are several different types of debt relief, each of which is best suited to certain situations. The amount of debt you have, your credit score, your ability to repay your debt, and other factors can all help determine the best type of debt relief for you.
Credit Counseling
When you work with a credit counselor, you get help sorting through your situation and understanding your options. The credit counselor reviews your situation and your budget. They can help you make a plan to pay off your debt, improve your credit, and get back on track, as well as help you review other debt relief options.
Making a plan with your credit counselor is likely to take less than a month — it’s the execution of the plan that takes more time. In many cases, it can take between two and five years to complete the actions provided by your credit counselor.
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With credit counseling, you might be able to salvage your credit score. If you get help early enough, before you start missing payments, you could actually maintain or even improve your credit score. By implementing a plan to reduce your debt and manage your finances, you could avoid big drops.
If you’ve already missed payments and your credit has already been impacted by your situation, credit counseling can help you slowly improve your credit. When you follow the plan laid out by your counselor, you should be able to get on track and start seeing improvements over time.
Who It’s Best For: Credit counseling might be right for you if you can afford to make your debt payments but feel like you need a bit of help laying out the best plan and improving your credit.
Debt Consolidation
Simply put, debt consolidation is the act of taking out one bigger loan and using it to pay off your smaller loans. Now, instead of having several payments and interest rates, you have one rate and one monthly payment. This is often easier to manage, and if you have a lower interest rate on the debt consolidation loan, you can save money on your debt.
Debt consolidation is often done using an unsecured personal loan. However, you can also use a secured loan, including a home equity loan or home equity line or credit (HELOC). Additionally, if you have solely credit card debt, you may consolidate it using a balance transfer card.
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In many cases, the initial impact on your credit will be pretty small. You might lose some points because of the new debt, but, for the most part, your debt consolidation loan will result in better credit utilization, and you’ll see improvements as you make on-time payments.
The main concern with a debt consolidation loan is if you fail to make payments or if you run up more debt on your credit cards. If these things happen, you could see a drop in your score.
Who It’s Best For: Debt consolidation is a great choice if you can afford to make your debt payments but want to lower the cost or speed up the process a bit by consolidating it (ideally at a lower interest rate).
Debt Management Plan
With a debt management plan, also referred to as a DMP, a third party manages your debt for you, usually negotiating lower interest rates and getting rid of fees. You agree to pay the remaining principal, but often other charges are removed, making it easier for you to manage your payments. You make one payment to the debt management program, and the company disburses payments to your creditors.
A debt management plan often allows you to pay off all of your debt in between three and five years. Your credit counselor can work with the debt management plan to figure out the best course of action and work out a budget that allows you to handle payments. Some debt management plans are offered by for-profit companies, while others are offered by non-profit organizations.
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Generally, you’ll see a positive impact on your credit over time using a debt management plan. You might see an initial drop when you enter because many creditors close accounts when you enter a debt management plan. However, the net impact should be positive over time because many of these plans use a “paid as agreed” notation if you keep up with payments.
Who It’s Best For: You may consider a debt management plan if you have significant debt and can’t afford your current monthly payments but you’re willing to pay it off over time and want to avoid harming your credit.
Debt Settlement
Debt settlement is similar to a debt management plan in that a company — often a for-profit company, in this case — negotiates with your creditors on your behalf. The goal is to settle your debt for less than you actually owe in exchange for you making one lump sum payment. In some cases, the debt relief company might set up monthly payments with creditors.
Debt settlement often requires you to stop making payments on your debt. You’ll start making payments to a debt settlement company. They keep the money and it builds up, providing a way to offer a lump sum settlement to your creditors.
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It’s tough to hear, but your credit will often be destroyed by using a debt settlement program. Your accounts will go delinquent and are likely to be closed. You could see your score drop by quite a lot. However, unlike bankruptcy which can remain on your report for up to 10 years, delinquent accounts fall off after seven years from settlement.
Over time, as you rebuild your finances, your score will gradually improve. However, expect to be unable to qualify for new credit in the meantime.
Who It’s Best For: Debt settlement may be the right option if you’re already behind on your debt payments and can’t afford to pay back the full amount. However, you have to be okay with taking a hit on your credit.
Bankruptcy
Often considered a last resort, bankruptcy can help you get a fresh start. But it comes with consequences.
There are two types of bankruptcy. Chapter 7 is what we think of as a “fresh start.” Most of your debts are wiped away, so you can move forward. However, in exchange, most of your assets are liquidated to help repay your creditors.
Chapter 13, also known as a wage earner’s plan, allows you to come up with a repayment plan to cover at least part of what you owe. It’s not quite as much of a “fresh start” as Chapter 7 in that your debts aren’t discharged. However, you’re able to keep more of your assets. It also remains on your credit report for a shorter period, allowing you to recover more quickly.
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It should come as no surprise, but your score will be ruined, and the bankruptcy will remain on your report for up to 10 years (seven years, in the case of Chapter 13 bankruptcy). Over time, you can recover, and your credit will slowly recover, but it will likely be several years before you can get meaningful credit again.
Who It’s Best For: You may resort to bankruptcy if you have considerable unsecured debt and can’t afford to pay it back, even if you negotiate better terms or a lower amount. At the same time, you understand the long-term impact it will have on your credit. This is usually a last resort.
When You Should Consider Debt Relief
Debt relief is about helping you get on top of a situation that is starting to feel hopeless. If you feel like you’re not making any progress in getting rid of your debt, and if creating a debt paydown plan isn’t working for you, debt relief can help.
You can arrange debt relief on your own, but many consumers feel too overwhelmed to do it by themselves. As a result, many people choose to work with a debt relief company or program. Carefully consider your situation and determine whether you can handle debt relief options on your own, or whether you need help.
How Debt Relief Impacts Credit
The way debt relief impacts your credit depends on the method you choose. Some debt relief options, like a debt consolidation loan, can actually help you improve your credit. Other types of debt relief, like bankruptcy or debt settlement, can significantly damage your credit.
Before you choose a debt relief strategy, it’s important to understand how it’s going to affect your credit in the short term, as well as how it might impact you in the long run.
No matter what you choose, though, you can improve your credit over time when you stick with the program.
Which Debt Relief Program is Right For You?
The best debt relief program for you depends on several different factors, including the amount of debt, your credit score, and whether you’re able to make consistent debt payments.
If you have good credit and can comfortably make monthly payments, you may benefit more from debt consolidation. You could qualify for a low interest rate on your debt consolidation loan and lower your monthly payments while being able to pay off your debt more quickly. Additionally, you’ll be able to maintain your good credit, in all likelihood.
On the other hand, if you have an overwhelming amount of debt or no income and aren’t able to make consistent payments, you may need to consider more drastic measures, such as debt settlement or bankruptcy.
Finally, if you’re able to make consistent payments but don’t have good enough credit to qualify for a decent debt consolidation loan, then you might want to consider a debt management plan. It won’t damage your credit like debt settlement will — and may even help it — and doesn’t require good credit upfront like debt consolidation does.
How to Avoid Debt Relief Scams
When you look for a third-party debt relief program, it’s important to be aware of the red flags. There are reputable debt relief companies out there, but you’ll need to be on your toes. There are some unethical companies on the market, and the debt relief industry is one that’s often a target for scams.
Here are some red flags to watch out for when evaluating your debt relief options:
- Promises to boost your credit score
- Guarantees the removal of negative items from your credit report
- Insists that your debt will disappear
- High monthly fees, or a high percentage fee for the amount your debt is reduced by
- Requires upfront payment for entrance into the program
- Claims to be part of a “government program” aimed at helping consumers
- Promises that it can stop lawsuits
Debt relief programs often charge monthly fees, but the fees should be reasonable. Additionally, realize that no program can remove negative marks from your credit report if they belong there. Understand, too, that the government doesn’t offer these types of programs, and that lawsuits from your creditors can happen at any time until the debt is taken care of.
Be wary of anyone making claims that they can just “fix it” for you. Debt relief just doesn’t work that way.
FAQs
What is the best debt relief option?
There’s not necessarily one type of debt relief that’s best for everyone. Instead, the best type of debt relief depends on the type and amount of debt you have, your ability to repay your debt, your credit score, and other factors. Debt settlement or bankruptcy may be the best option for someone with considerable debt, poor credit, and an inability to repay the full amount they owe. However, someone with good credit who can afford to make debt payments may benefit more from something like debt consolidation.
What types of debt can be forgiven?
While there aren’t many situations where a creditor will forgive your debt, you may be able to have your debt forgiven (aka discharged) if you file for bankruptcy. This helps to eliminate unsecured debt, including credit cards and medical bills. You may also be able to have your student loans forgiven if you qualify for one of several government loan forgiveness programs.
Is there a government debt relief program?
There aren’t any widespread debt relief programs, especially for credit card debt and other forms of consumer debt. There are government relief options for federal student loans under certain circumstances. There may also be more targeted relief programs depending on the type of debt, where you live, and other factors.
Does debt relief ruin your credit?
Debt relief can hurt your credit, but that’s not always the case. It largely depends on the debt relief method you choose. Debt settlement often requires stopping payments on your debt while a debt relief company negotiates with your creditors. In that case, your credit can be severely negatively impacted. Bankruptcy will also negatively affect your credit for up to 10 years. However, other forms of debt relief, including debt consolidation and credit counseling, can have a positive impact on your credit.