Debt Strategies - A Plan of Attack on Your Debts
Debt strategies include a variety of options designed to help people with debt problems. You might choose to consolidate high-interest credit card debt with a personal loan to save on interest and accelerate repayment. Or you could choose to pay it off with a home equity loan to lower the payment to an affordable level. For bigger problems, debt relief companies, credit counseling agencies, and bankruptcy lawyers offer serious solutions like debt settlement, debt management, and bankruptcy.
Types of Debt Strategies
The sections below describe several forms of debt strategies. Each has its pros and cons. Learning about these approaches can help you make the right choice for your situation.
Debt Consolidation
You may have multiple forms of debt – credit cards, student loans, car loans, a mortgage, etc. Debt consolidation entails taking out a new loan to pay off two or more existing loans.
The key to debt consolidation is finding a new source of credit you can use to replace your existing debt. This could be a personal loan, home equity financing, a cash-out refinance, or a 0% balance transfer credit card. Unfortunately, if you have a lot of debts you may have difficulty qualifying for new credit.
Debt consolidation doesn’t reduce the amount you owe. If you have five credit cards with balances totalling $14,000, and you refinance them with a $14,000 home equity loan, you still owe $14,000. Debt consolidation can make sense if your new loan offers a better interest rate or lower payments – and you’re disciplined enough to avoid running up credit card balances again while you also have a consolidation loan to repay.
Credit Counseling
Credit counseling is often offered on a not-for-profit basis through organizations like the National Foundation for Credit Counseling and the Financial Counseling Association of America. It can be a valuable source of advice on how to handle your debt situation.
Credit counseling involves discussing your financial situation in detail with experts who will then lay out your options for you. Those options may include budgeting and financial management techniques to help you manage your debt, as well as some of the other debt strategies discussed in this article.
By itself, credit counseling won’t reduce or manage your debt for you. However, it may give you a better sense of next steps you can take to get your debt under control.
Debt Management Plan (DMP)
A DMP involves elements of debt negotiation and credit counseling. A credit counseling organization will advise you on options for handling your debt. Then you make a single monthly payment to that organization, which will distribute the money to your creditors. Your credit counselor may be able to convince your creditors to reduce your interest rate or waive penalties.
A DMP can be a good option if you don’t have good enough credit to qualify for a debt consolidation loan, or if you don’t want the negative impact on your credit score of debt settlement.
However, a DMP will not reduce the amount you owe and may even entail a monthly fee. It’s important that you work with a credit counselor you can trust and keep an eye on your debt balances to make sure your payments are going toward those balances as planned.
Debt Negotiation
Debt negotiation is a process of bargaining with creditors to try to make your debts more manageable.
This can entail lowering your interest rate, giving you a period of forbearance (an extension before you have to make payments), or stretching payments out over a longer period to make the monthly burden more manageable. These methods do not reduce the amount you owe, but they can make it easier to pay that amount.
Debt negotiation can result in repayment terms that are easier to handle without damaging your credit score. However, the process of negotiating with creditors can be lengthy and difficult, especially if you have multiple debts. Also, plans that involve giving you more time to pay often cost more in the long run because you incur more interest charges during that additional time.
Debt Settlement
The debt strategies discussed so far do not immediately reduce the amount you owe. They are focused instead on finding ways to make it possible for you to pay your debts.
If your financial situation has gotten to the point where there is no way for you to pay your debts, you may have to consider more drastic action. Debt settlement is one such option.
Debt settlement means convincing your creditors to accept less than what you owe as payment in full. You can negotiate with creditors yourself, or have a debt relief company do it for you.
Why would creditors do this? If they recognize that your financial circ*mstances make it impossible for you to pay your debt in full, they will want to make the best deal they can. It may be better for them to accept less money upfront, rather than to wait for the results of a lengthy collection process or bankruptcy proceeding only to get less than what they are owed anyway.
For your part, debt settlement may give you more flexibility than you’d get from a bankruptcy court. Also, debt settlement is a more private process than bankruptcy, which involves public filings that may damage your reputation and your career.
Debt settlement can reduce the amount you owe and give you a workable solution to your financial difficulties. This can be the start of a process towards getting your finances back into better shape.
Even so, debt settlement is not a free lunch. Debt settlement specialists charge a fee, usually somewhere between 15% and 25% of any debt enrolled in the program. Reputable debt settlement companies operate under strict laws and will not charge you upfront fees.
The fee for debt settlement cuts into the value of any debt reduction that is achieved. In addition, creditors are not obligated to accept any settlement offer, so settlement is not guaranteed. Reputable debt settlement companies will never guarantee a result.
Also, according to the Internal Revenue Service, obligations cancelled through debt settlement may be considered taxable income and thus subject to taxation.
One final consideration is that according to Experian, a credit reporting firm, reported debt settlement stays on your credit report for seven years. Though this might not matter as much if your credit is already bad, it can lengthen the time it takes you to rebuild the health of your credit. Still, this reporting window for settled debt is shorter than the ten years that bankruptcies stay on your record.
Bankruptcy
Bankruptcy is a formal legal process to resolve unpaid debts. A court will look at your assets and sources of income and rule on a plan to use those resources to pay as much of your debts as possible.
The two most common forms of bankruptcy are Chapter 7 and Chapter 13. With a Chapter 7 bankruptcy, the bankruptcy court takes all of your assets except “exempt” assets, like work tools, sells them, and gives the proceeds to your creditors to wipe out your unsecured debts.
With a Chapter 13 bankruptcy, the court considers your income and decides how much you have to pay toward your creditors. This amount can be adjusted every year – if you get a raise, your payment can increase as well. At the end of (usually) five years, any remaining balances are forgiven.
An advantage of going through bankruptcy is that your creditors have to go along with the bankruptcy court’s decisions. Another plus is that Internal Revenue Service rules do not require debt that is cancelled as part of a bankruptcy case to be included in taxable income.
On the negative side, you may have to pay a significant amount of your income and property as part of a bankruptcy court order, plus any legal fees you incur. What you pay is not up to you. The filing is public and can make you ineligible for work in certain fields.
Also, according to the US Consumer Financial Protection Bureau, a bankruptcy will stay on your credit report for ten years, and is likely to adversely affect your credit score in the meantime.
DIY Debt Strategies
The options described above often involve working with professionals, whether it’s credit counselors, debt relief providers or bankruptcy lawyers. Those efforts often involve some fees -- sometimes pretty hefty ones. Can you save money with DIY debt relief?
There’s no reason you can’t try to save some money by following various steps yourself, from finding a debt consolidation loan to negotiating with creditors or even filing for bankruptcy yourself. Just be aware that the process does take some expertise and can become very time consuming.
Also, if you handle debt relief yourself, get any deal you’ve reached with a creditor documented in writing. This includes agreements to delay payments or reduce the amount you owe. Otherwise, your legal liability will remain the same and making anything less of your original payment obligations could reflect badly on your credit report.
You can always start by trying to take some steps yourself, and then if that doesn’t work engage a professional to take you the rest of the way.
Whichever debt strategies you choose, be sure any outcomes are agreed to by all parties and documented in writing.
In any case, working with your creditors (either directly or through an intermediary) is much better than simply ignoring the problem. Your creditors won’t simply go away, and they will continue to contact you. If you don’t face up to your debt, you’ll still have to deal with it in the long run.
