Understanding Debt Relief: A Comprehensive Overview

Last Updated on November 21, 2020

What Is Debt Relief?

Debt relief or debt cancellation is the partial or total forgiveness of the debt of individuals, corporations or states. Debt relief can take many forms: reducing the outstanding principal amount, either in part or in full, reducing the interest rate on outstanding loans, or extending the term of the loan, among others.

Creditors may only be willing to consider debt relief measures when the repercussions of debt default by the indebted party (ies) are perceived to be so severe that debt relief is a better alternative. Debt relief can be extended to any heavily indebted party, from individuals and small businesses to large corporations, municipalities and even sovereign nations.

How Debt Relief Works?

In some situations, debt relief may be the only way to avoid bankruptcy. If, for example, a huge debt burden makes it difficult to service loans, lenders may be inclined to restructure debt and provide a relief rather than risk the borrower defaulting on its obligations and increasing overall credit risk. Refinancing a mortgage at a lower interest rate is one simple example of debt relief.

Another common form of debt relief involves consolidating debt or combining several higher interest rate loans into one lower interest rate loan. Consumers can consolidate their debts in several ways into one payment. One method is to consolidate all of their credit card payments into a new credit card, which can be a good idea if the card charges little or no interest during an introductory period. They can also use the balance transfer feature of an existing credit card (especially if it offers a special promotion on the transaction).

Home equity loans and home equity lines of credit (HELOC) are another form of consolidation that some people aspire to. Typically, interest on this type of loan is deducted for taxpayers who itemize their deductions. The federal government also offers several options for people looking to consolidate their student loans.

It is important to note that there are different rules for declaring bankruptcy, depending on the type of debt. If you are considering bankruptcy, it is wise to talk to a qualified attorney who specializes in bankruptcy laws in your state.

Types of Debt Relief

There are four major forms of debt relief;

1. Debt Consolidation

Debt consolidation is one strategy that exists that can make managing your debt far simpler by rolling all of your unsecured debts, generally credit card bills, and combine them into one monthly payment. If your credit score is good enough, you should lower both your interest rate and monthly payment.

2. Debt Management

If you have too much debt or are unable to repay your debt, a credit counseling agency may recommend that you pursue a debt management plan (DMP). With this approach, a certified credit counselor reviews your finances and develops the DMP. Each month, you send payments to the credit counseling agency and they use it to pay your creditors on an agreed-to schedule.

As part of the DMP, the agency may negotiate with creditors to waive certain fees or lower your interest rates. A DMP requires you to make regular, on-time payments, and you may make payments for several years. As part of the DMP, you may have to agree to not use or apply for any additional credit while you’re repaying your debt.

Credit scores are not a factor for joining the program, but if you miss payments, any concessions you received could be terminated.

3. Debt Settlement

With debt settlement, a company works on your behalf to convince your creditors to accept a reduced settlement instead of the full balance you owe. It may sound incredible, but the Consumer Financial Protection Bureau warns that debt settlement can be risky.

While the settlement process is underway, the debt settlement company will typically tell you to stop making payments to your creditors. During this time, late fees, penalty charges, and interest will continue to accrue, and your credit score can be negatively impacted. You could even end up in more debt than you started with.

Debt settlement companies typically charge high fees for their services. For example, the fee for National Debt Relief is 18% to 25% of your enrolled debt. And, the program can take up to four years to complete.

That debt settlement savings may make those fees and drawbacks worth it, but you should carefully consider your options before pursuing it. Also, keep in mind that there is a chance the debt relief company might not reach a successful negotiation. But they can only legally charge you if they have successfully negotiated your debt.

4. Bankruptcy

If you’ve exhausted your other options, declaring bankruptcy may make sense, but it should be a last resort. When you declare bankruptcy, the court will review your situation. If it agrees that you’re unable to repay your debt, it will issue a court order discharging the debt. That means you’ll no longer owe money on your credit cards, medical bills, or personal loans.

Because the debt is discharged, all debt collection activity stops. You won’t receive any more harassing phone calls or letters in the mail, and bill collectors can’t garnish your wages. However, bankruptcy has serious consequences.

Bankruptcy information can stay on your credit report for up to 10 years and can make it difficult to get credit, buy a home, or even qualify for life insurance. Plus, the bankruptcy process can be expensive. You’ll have to pay court fees and if you hire an attorney, their fees can be costly.

If you decide to pursue bankruptcy, you must get credit counseling from a government-approved organization within six months before you file. You can find a list of eligible programs on the U.S. Trustee Program website.

It should be noted that not all debt relief programs are suitable for every consumer. The success of each program often reflects resources, goals, and consumer commitment. There is no one-size-fits-all program that solves all financial problems, so review and make sure you are comfortable with the requirements and responsibilities associated with your chosen debt relief program.

How to Find the Best Debt Relief Company

Finding debt relief means you identify a solution that minimizes the burden of debt repayment. The goal is to reduce or eliminate interest charges and fees so that you can pay off your debt faster. So how do you know which solution is right for you? The answer lies in consumer credit counseling.

Credit counseling is not a debt solution in and of itself. It’s an easy, free way to find the debt solution you need. A certified credit counselor evaluates your debts, credit and budget to see where you stand so they can help you find the right solution for your needs.

Credit counseling simplifies your repayment process, ideally making it easier to pay off your debt. In some cases, credit counselors can negotiate lowered interest rates, reduced monthly payments and more with your creditors, which could save you money.

The credit counselor’s job is to arm you with all the information you need to make an informed decision. It’s important to find a good credit counsellor who has your best interests at heart. In general, steer clear of for-profit credit counseling agencies. Nonprofit agencies are more likely to charge lower fees and provide unbiased advice.

The first step is to make sure the credit counseling agency is certified. You can find these agencies through any of the following:

Once you find a credit counselor, set up a meeting to talk about your situation and ask for advice. A good credit counselor will analyze your full financial picture before making any recommendations.

Because credit counseling can have an impact on your credit, it’s important to check your score regularly to understand how certain actions impact it and determine what you can do to improve it.

Also, consider checking your credit report before and during the credit counseling process. This can help you pinpoint areas you need to address, and can also help you identify potentially incorrect or fraudulent information on your reports. If you find something, you can dispute it with the credit reporting agencies to have it corrected or removed. Depending on the situation, this could help your credit score.

When Is The Best Time to Consider Debt Relief?

It makes sense to consider debt relief in the following situations:

  • You have significant consumer debt and can’t work out a repayment plan with your creditors on your own.
  • You have already cut your expenses and don’t have any extras to eliminate from your budget.
  • You are not able to boost your income.
  • You have no realistic expectation of being able to pay off your debt within five years.

If you’ve put together a detailed budget, tried your best to save money, tried to increase your earnings, but still can’t make ends meet, debt relief may be the best option for you.

How Does Debt Relief Affect Your Credit?

The effect of debt relief on your credit score depends on which option you use. Any solution that pays back everything you borrowed should have a neutral or positive impact on your credit. Reducing interest charges or eliminating fees does not result in credit damage. On the other hand, any solution that gets you out of debt for less than the full amount owed damages your credit score.

Consolidation will not damage your credit as long as you make all the payments as scheduled. The same is true of a refinancing or a modified loan. Negotiating a lower rate on a credit card will also not have any negative effect on your credit.

The impact of workout arrangements and credit card debt management programs is usually neutral or positive. These solutions help you avoid missed payments and build a positive credit history.  Most credit users don’t see any damage to their credit using these solutions. However, these methods will close the accounts. This can have a slight negative effect on your credit, but the damage is usually nominal.

Solutions like debt settlement damage your credit. You incur a seven-year negative remark on your credit report. Foreclosure and Chapter 13 bankruptcy also result in a seven-year credit penalty. Chapter 7 bankruptcy has a 10-year penalty.

Dealing with debt can be a grueling experience, but debt relief can help you achieve it. Before pursuing a debt relief program, be sure to do your homework to make sure you choose the path that best suits your finances and goals.

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