Debt Relief Programs: Pros and Cons

Debt relief programs help people manage overwhelming bills, pay dues efficiently, and potentially reduce what they owe. As consumer credit card debt grows, the number of people who seek debt relief is increasing.

There are many different types of debt relief – debt consolidation loans, debt settlement, credit counseling, or even bankruptcy. You can do it yourself or work with an outside agency. Each method has its own benefits – reduced interest rates or waived fees – and drawbacks – your credit score takes a hit. What method you choose depends on your individual circumstances and goals.

This article explores the pros and cons of debt restructuring. We’ll walk you through the different strategies, tactics, and services out there so that you can choose the one that speaks to you.

How a debt relief program works

Debt relief is a broad term covering a range of measures used to pay off what you owe. It can be a formal structured program or simply strategies you employ. Some methods reduce the total amount you need to repay, while others provide a plan that makes repayment more manageable.

Is a debt relief program a good idea? Yes, it can be a good idea for anyone with overwhelming debt. Most debt relief companies help with unsecured debts. They can help you pay off what you owe more effectively and in less time than if you did it on your own.

Before choosing a debt relief program, consider the advantages and drawbacks. Understanding the debt restructuring pros and cons is critical. Not every program is for everyone. The right program depends on your current debt level, income, ability to make disciplined payments, and credit score. Most options will initially negatively impact your credit score – some, like debt settlement and bankruptcy, have a long-term negative effect – and cost money. It’s essential that you thoroughly read what each method entails and make an informed decision that aligns with long-term financial goals.

Types of debt relief programs

Relief programs come in various forms, each with unique benefits and drawbacks. Common types include:

• Debt consolidation
• Debt settlement
• Credit counseling
• Debt management plan
• Bankruptcy

Each debt relief strategy suits different financial situations and requires careful consideration. Understanding the debt restructuring pros and cons of each method, including their effects on credit scores, costs, and repayment terms, can help in choosing the right one for your circumstances. Assessing factors such as the total amount you owe, income stability, and long-term financial goals is crucial in making an informed decision.

Debt consolidation

Consolidation is when you roll two or more bills into one. It can simplify your monthly debt payments and, when done right, will lower your interest rate, saving you money. Fees may apply, and you’ll need to be sure to secure a lower interest rate for it to work.

Pros: Simplifies payments, lowers interest rates, and improves credit score if managed well.

Cons: Initial score dip, may extend repayment period (increase total interest), additional fees, need a very good score.

There are no debt consolidation companies. Consolidation is something you do on your own or through a credit counseling agency. If you go through an agency, it’s considered a debt management plan.

Apply for a debt consolidation loan

The most common way to consolidate debt is to take out a debt consolidation loan. You apply for a personal loan with a lower APR (annual percentage rate) and use the money to repay your creditors. This leaves you with one monthly payment that should be lower than what you were paying previously. Most personal loans have lower APRs than credit cards, but the exact interest rate you secure will depend on your credit score. The single monthly payment will simplify your finances and make it less likely to have missed payments or late fees.

Use a balance transfer credit card

Another option is to use a balance transfer credit card with a promotional 0% APR (or simply a lower APR). You transfer your high-interest credit card balances onto the new card and pay it off before the promotional period ends. The reduced interest rate can save you money and help you pay off your balances faster. Balance transfer fees may apply and you have to pay off your total balance before the promotional period ends.

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Debt settlement

Debt settlement or credit card modification involves negotiating with creditors to make a lump sum payment that is less than you owe. This approach can significantly lower the amount you need to repay but is inherently risky.

Pros: Reduces total amount paid, provides a quick resolution.

Cons: Severely impacts credit score, potential tax implications, late fees can add up, fees from settlement companies, not guaranteed to work.

Most people choose to work with a debt settlement company as they have expertise. Many debt settlement companies will ask you to stop paying your creditors and instead make payments into a dedicated account. Once enough funds have accumulated, the company negotiates with your creditors to accept a smaller lump sum payment. The idea is that the creditor will agree to a lower amount as they’d rather receive something than nothing. Most debt settlements occur when an account is more than 150 days past due.

As with anything else, credit card modification has pros and cons. Yes, you can pay less than you owe, but creditors have no legal obligation to negotiate. While you’re working on your debt settlement plan, you stop making payments. This means the amount you owe will grow, and late fees and missed payments will all add up, hurting your credit score. If the forgiven debt exceeds $600, it is considered taxable income by the IRS. Debt settlement does not cover secured debt. Lastly, the debt settlement company will charge a fee of 15% to 25% of the original amount for their services.

Debt settlement certainly is a way to get out of what you owe and save money, but it’s inherently risky and can do a lot of damage to your score.

Credit counseling

Credit counseling and debt management services are offered by both for-profit and nonprofit credit counseling agencies. If you can, go with a nonprofit credit counseling agency accredited by the Financial Counseling Association of America (FCAA). These agencies provide financial education, money management advice, budgeting tools and more to help people with their personal finance issues.

Pros: Professional guidance, structured debt repayment plan, potential lower interest payments and waived fees, no more calls from collection agencies.

Cons: Requires closing credit accounts, initial credit score dip, monthly fees for counseling services.

Debt management plans

A debt management plan (DMP) is one of the services offered by credit counselors. The counselor will look at what you owe, your income, and your expenses. They will then create a payment plan tailored to your budget. They may negotiate with credit card companies for a reduced interest rate and waived fees. You make one payment each month to the credit counseling agency, and they distribute the money among your creditors according to the agreed-upon schedule. The idea is to make your monthly payments affordable.

For a DMP to work, you have to stick to the plan and may be required to close credit card accounts.

DIY debt relief

You can DIY (do it yourself) debt relief like you can with anything else. Most people start with strict budgeting and strategies like the snowball method (prioritize smallest amounts first) and the avalanche method (pay off highest interest rates first). The right choice depends on the type of motivation you need. The snowball method will give you quick wins, while the avalanche method saves you money.

Pros: Full control over repayment plan, no fees, improved financial literacy.

Cons: Requires strong discipline and negotiation skills, no professional support.

You can also negotiate directly with credit card companies to reduce the amount you owe. Call your creditor and request that they waive fees, lower interest rates, reduce monthly payments, or even settle for a smaller sum. Creditors are often willing to work with you if it means they’ll receive some payment rather than none. It helps if you’ve been a good customer in the past and are polite and honest.

The main advantage of DIY is you’re not paying any fees to a third-party. The drawbacks are that you must keep yourself motivated and don’t necessarily have the negotiation expertise a professional debt settlement company or credit counselor does. DIY can be a good place to start and then determine if you need extra help.

Avoiding bankruptcy

Bankruptcy is a last resort. While it can offer a fresh start it comes with significant long-term consequences. Your credit score will take a huge hit – bankruptcy remains on your credit report for up to ten years – and can impact future borrowing abilities.

Pros: Discharges most unsecured debts, offers a fresh financial start, stops calls from collection agencies.

Cons: Long-term negative credit score impact and potential loss of assets.

Bankruptcy is a long and costly legal proceeding and it’s not even guaranteed to work. Yes, credit card debts and personal loans can be forgiven, but not all qualify, and legal fees add up. If you file Chapter 7 bankruptcy, you may lose your assets. Chapter 13 bankruptcy lets you keep your assets, but you have to follow a court approved repayment plan that can last three to five years.

Talk to a credit counselor and try other options before you resort to bankruptcy.

Impact on your credit score

Once again, the impact on your credit score depends on the method chosen. In general, your score will suffer initially and then rebound as you establish responsible financial habits.

Consolidation: Any time you apply for a new credit account your score will take a dip due to the hard inquiry. As you consistently make on time payments on your new loan or balance transfer card, your score will go up. A positive payment history will negate any initial credit score dip.

Debt Settlement: One of the significant disadvantages of debt restructuring is it will hurt your score. You have to stop making payments, which is the worst thing you can do. If the creditor agrees, the settled debt is reported as a negative item on your credit report. This can further lower your score and remain on your credit report for up to seven years.

Debt Management Plans: Enrolling in a DMP typically requires closing your credit accounts, which can hurt your score and as it decreases your credit utilization ratio and length of credit history. However, as you make consistent payments, your score will improve and typically ends up better than it was you you started the program.

Bankruptcy: Bankruptcy can cause your score to drop by 100 to 250 points and will stay on your report up to ten years. It will make difficult to open new credit accounts in the future.

Be aware of scams

Like with anything else, the debt relief industry has its share of scams. Common tactics include:

1. Unsolicited Offers: Be cautious of unsolicited phone calls, robocalls, or messages offering debt relief services. Legitimate companies typically do not reach out to consumers without their request or consent.
2. Upfront Fees: Scammers may ask for upfront payments or fees before providing any services. In many cases it is illegal to request upfront payments.
3. Guaranteed Results: Be wary of anyone that guarantees specific results or make unrealistic promises. No legitimate company can guarantee specific outcomes or immediate relief.
4. Affiliation Claims: Some scammers may falsely claim to be affiliated with financial institutions, lenders, or government programs to gain trust. Debt relief companies are typically third-party service providers and are not affiliated with lenders.
5. Lack of Transparency: Scammers may lack transparency in their operations, contracts, or fee structures. Legitimate companies are transparent about their services, fees, and the potential risks involved.

To protect yourself, research any company thoroughly before you sign up with them. Check for reviews with the Better Business Bureau (BBB) and verify the legitimacy of the company. Consider reaching out to consumer protection agencies like the Federal Trade Commission (FTC) or the Consumer Financial Protection Bureau (CFPB) if you suspect a scam.

Alternative relief strategies

If none of those seem like the right fit, there are several alternative strategies to consider to get out of debt faster.

Increase Your Income: Taking on a second job, freelancing, or joining the gig economy can boost your income and make it easier to pay off personal loans.

Reduce Expenses: Create a detailed budget and cut all non-essential expenses. This might involve lifestyle changes such as downsizing housing, eliminating subscriptions, or cooking at home more often.

Sell Assets: Selling unused or valuable items, such as electronics, jewelry, or even a second vehicle, can provide extra cash to cover bills.

Loans from Family or Friends: Borrowing money from family or friends at little to no interest can be a quick way to repay creditors without taking out additional personal loans. Ensure the terms are clear to maintain healthy relationships.

Financial Hardship Programs: Some creditors offer financial hardship programs that provide temporary relief, such as reduced interest rates or modified payment plans. These programs are typically designed for individuals facing temporary financial difficulties.

Home Equity Options: If you own a home, consider tapping into your home equity through options like a home equity loan or line of credit to pay off high-interest credit card balances.

Government Assistance Programs: Government programs can help with mortgages, utility bills, medical care, and more. Partaking in these programs – both state and federal – can free up funds to pay other bills.

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Bottom line

There are plenty of strategies to help you pay off what you owe effectively. Consider the various options from debt management to debt settlement. Think about what you can afford and how each method affects your credit score and financial health in the long term. Research companies to make sure anyone you work with a reputable. A good starting point is chatting with a nonprofit credit counselor with the financial education to point you in the right direction.

Ultimately, the goal is to regain control of your personal finances, pay all your dues, save money, and pave the way for a more secure financial future. There are plenty of ways to get yourself back on the right track.