Which Debt Relief Option Is Best for You?
Navigating the world of debt relief can be confusing, frustrating, and downright scary—but it’s a swamp worth wading through. Although scammers are known to prey on those who’ve fallen on hard times, there are many legitimate routes to getting on a more manageable payment plan or having your debt discharged.
There’s no one-size-fits-all solution, though. Different options work best for people in different situations, and each has its pros and cons. Our goal is to clearly explain the differences, benefits, and drawbacks to several popular debt relief programs.
Do you have unsecured or secured debt?
Your options will be determined, in part, by whether you have secured or unsecured debt.
Many debt relief programs can help with unsecured debts, such as credit card debt, medical bills, and personal loans. While creditors can sue you for past-due amounts and may be able to garnish your wages, that can be an expensive and time-consuming process. Creditors may benefit from working with you to find a more manageable arrangement.
With a secured loan, such as a mortgage or auto loan, the creditor can take your property if you fall behind on payments. That can still be difficult and expensive for creditors, which is why there are also debt relief options for secured loans. But creditors may feel less pressure to accommodate borrowers.
|Secured vs. Unsecured Debts|
|Secured Debt||Unsecured Debt|
Student loans are an outlier because they’re unsecured loans, but special rules apply. For example, it’s difficult to get student loans discharged in bankruptcy. However, there are also special repayment and assistance programs for federal student loans. You may be able to temporarily pause payments, or bring your monthly payment down to a few dollars a monthly—sometimes down to $0.
Your credit and income can also impact your options as some routes are only available if you can qualify for new loans or afford monthly payments.
Common debt relief programs and options
Debt relief can come in different forms. Sometimes, debt piles up so high that you need to wipe it away and start over. Other times, you may be able to afford a partial repayment, or you want to lower monthly payments, even if that means paying more in the long run.
Here are several popular debt relief options. You may be able to arrange some of them on your own, while others often require professional assistance.
- Debt consolidation loan: If you have good credit and income, but you’re struggling with your monthly payments, a debt consolidation loan may be able to help. Essentially, you take out a new, lower-rate loan to pay off your existing debt. A debt consolidation loan can work particularly well when you can qualify for a low-rate personal loan to pay off high-rate credit cards. You can find these loans from a variety of online lenders and major banks.
- Debt management plan: Nonprofit credit counseling organizations create and run Debt Management Plans (DMPs). The credit counselor will try to negotiate fee waivers, better terms on your unsecured debts (primarily credit cards), and lower monthly payments. Once on a DMP, you’ll make a single payment to the organization, which will distribute the money to your creditors. DMPs generally result in repaying the included unsecured debts in full within three to five years.
- Debt settlement: If you’ve fallen behind on unsecured debt payments, some creditors may be willing to settle your account for less than the full amount you owe. Debt settlement can save you lots of money, but it’s also a risky option. You’ll have to let your bills go unpaid, which can hurt your credit and lead to closed accounts. And creditors may decide to sue you for unpaid debt rather than agreeing to a settlement.
- Chapter 7 bankruptcy: A Chapter 7 bankruptcy can temporarily stop collection calls and foreclosure, and wipe away qualified unsecured loans in a few months. It may be the best option if you’re overwhelmed by debt and don’t see any way out. However, the court may sell your possessions to repay your creditors, and filing bankruptcy can severely hurt your creditworthiness.
- Chapter 13 bankruptcy: If you have enough income (and low enough debt) to qualify for a Chapter 13 bankruptcy, you may be able to keep your possessions and get on a court-approved repayment plan. The plans often last for three to five years, and any remaining unsecured debts that are part of the bankruptcy will be discharged (i.e., forgiven) at the end. Similar to a Chapter 7, filing for a Chapter 13 bankruptcy can stop foreclosure proceedings and collection calls, but it’s also terrible for your credit.
- Creditors’ hardship programs: Some creditors will work with borrowers who are having trouble affording all their bills, especially when there’s been an unexpected hardship, such as a lost job, death in the family, or medical emergency. Creditors may waive fees, lower interest rates, decrease monthly payments, or temporarily pause payments. Generally, it’s best to reach out to your creditors right away—even before you miss a payment—to explain the situation and ask about their hardship programs.
We’re going to take a closer look at debt consolidation loans, DMPs, and debt settlement as the intermediary options that you may want to pursue when creditors don’t offer you a hardship program, and bankruptcy seems too extreme.
Debt consolidation vs. DMP vs. debt settlement
|Debt Consolidation Loan||Debt Management Plan||Debt Settlement|
|Eligible Debts||Secured and unsecured accounts||Generally, only unsecured accounts||Generally, only unsecured accounts|
|Credit Required||Good to excellent||None||None|
|Potential Impact on Credit||May improve your credit||Temporary dip, but positive overall||Will likely hurt your credit|
|Cost||A potential origination fee and interest on your new loan||Potential startup and monthly fees||Potential startup and monthly fees for the bank account
A portion of the savings on the settled debt
Taxes on the discharged or forgiven debt
|Savings||Interest savings depending on your new loan’s rate||Potential waived fees and interest savings||Pay less than the full account balance|
|Timeline to Debt Freedom||You can choose your new loan’s term||Often three to five years||Often two to four years|
Debt consolidation loans
If you can qualify, a debt consolidation loan can save you money, lower your monthly payment, and consolidate multiple payments into one. Plus, you can use them for secured and unsecured loans.
Here’s how debt consolidation loans work
A debt consolidation loan describes how you’re going to use the proceeds of a loan rather than a specific type of loan. It’s a form of refinancing in which you can improve your finances by taking out a new loan with better rates and terms than your current loans.
Often, people will take out an unsecured personal loan to consolidate higher-rate loans. But you could use a home equity loan or home equity line of credit, two types of secured loans, to consolidate debt.
With a debt consolidate loan, you’ll use the money you borrow to pay off other loans. Afterward, you’ll have fewer bills to pay each month, which could make managing your finances easier. Depending on the terms of your new loan, you also may be able to save money and lower your monthly payments.
Pros of debt consolidation loans
- Makes managing your finances easier as you’ll have fewer monthly payments.
- You can save money if you qualify for a low-rate loan.
- Your new loan may have lower monthly payments than your total monthly payments before.
- It can improve your credit if you consolidate credit card debt with an installment loan.
Cons of debt consolidation loans
- You’ll need good credit and income to qualify.
- You might not get approved for a large enough loan to consolidate all your debts.
- You could wind up deeper in debt if you pay off your credit cards and then continue to use them for purchases you can’t afford to pay off in full.
- Lenders may charge an origination fee of around 1% to 6% of the loan amount that’s added to your loan.
What to watch out for with a debt consolidation loan
Aside from qualification requirements, be careful about using a secured loan to consolidate debts—especially unsecured debts. While falling behind on credit card payments can lead to interest, fees, and collection calls, if you refinance the debt with a home equity loan, you’re putting your home at risk if you can’t afford the payments.
Also, consider your overall cost when comparing debt consolidation loans. A longer repayment period can lead to lower monthly payments, but you may wind up paying more in interest. And read the terms carefully. Sometimes, you can’t use the funds from a personal loan to pay off student loans or other types of debt.
Debt management plans
Credit counseling agencies offer debt management plans (DMPs) as a service to clients. If you sign up for a DMP, a credit counselor will act as the intermediary between you and your creditors.
Here’s how debt management plans work
You’ll generally start with a free budget and debt counseling session where you’ll speak with a credit counselor about your finances. The counselor can then assess your situation and determine if a DMP is a possibility and a good option. If you decide to go forward with a DMP, the counselor will reach out to your creditors and negotiate on your behalf.
The counselor may be able to get your creditors to fees and offer more favorable repayment terms. If you’ve fallen behind on payments and can’t afford to pay the full past-due amount, the counselor may also be able to get the creditor to “re-age” the account and bring it current. As a result, your future payments will be on-time payments that can help you build credit.
Generally, DMPs are designed to last three to five years, and all the included accounts will be repaid in full when you’re done. Your monthly payment will stay the same the entire time, and if you pay off one account, your counselor will allocate that portion of your future payments to your other debts.
Pros of debt management plans
- No credit score or credit history requirement.
- Creditors may waive your account fees, lower your interest rate, and agree to lower monthly payments. However, your balances won’t be reduced.
- Simplifies your finances as you’ll have fewer payments to make each month.
- Can bring your accounts current to help you avoid more late payments.
Cons of debt management plans
- You’ll need enough income to afford the monthly DMP payments.
- DMPs are primarily available for credit card debt, although they can sometimes include other types of unsecured loans.
- Generally, you have to close all the credit cards in the DMP and agree not to use or open new cards.
- There may be setup (around $0 to $50) and monthly fees (around $0 to $75). Some agencies waive the fees for low-income clients.
What to watch out for with a debt management plan
A DMP can be a good option if you have enough income to manage the monthly payment, particularly because there’s no credit score or history requirement.
However, you’ll also be limiting your short-term financial options because you may have to close all your credit cards to get started. Sometimes, you can keep a credit card for emergencies. But your current creditors may monitor your credit reports and withdraw from the DMP if they see you’re frequently using credit or opening new cards.
Also, make sure you’re working with a reputable organization. One option is to find an agency through the National Foundation for Credit Counseling (NFCC). All member agencies are nonprofits that are accredited by a third-party organization, and member agencies’ counselors must receive and maintain certifications. They’ll all also offer you an initial debt and budget session with a counselor for free.
There are for-profit credit counselors and services that sound similar to credit counseling and DMPs but aren’t. If something sounds too good to be true, or you’re being given a hard sales pitch rather than non-judgemental advice, you may want to keep looking.
Settling your debt is when you pay less than the full amount you owe, and the creditor forgives the remainder of your debt. If you’re already behind on unsecured debt payments, debt settlement (sometimes called debt relief) could save you money.
Here’s how debt settlement works
If you’ve fallen behind on payments, creditors know there’s a chance you may never pay off the account. Once you’re far enough behind, creditors may sell your debt to a collection agency for a few cents on the dollar. For example, a collection agency may buy your $2,000 past-due credit card debt for $50, and then try to collect the money from you.
Rather than selling your debt or paying for an attorney to sue you, creditors may accept a settlement offer. If you could pay them $1,000 of the $2,000 you owe, they’ll still make more than they could from a collection agency. Similarly, if the agency already bought that debt for $50, it will make money if you settle the account for less than the full balance.
You can try to settle your own debts with your creditors. Or, you can hire a debt settlement company. In either case, you’ll stop paying your credit card bills—after all, the company won’t accept a settlement offer if it believes you’ll pay in full.
If you’re working with a debt settlement company, you’ll usually transfers money to a third-party bank escrow account each month. There may be a setup and maintenance fee for the escrow account.
Once the settlement company feels you have enough money in escrow to settle an account, it will reach out to your creditors and make a settlement offer. If the creditor agrees, you can settle the account for less than the full balance. The settlement company will usually charge you a fee based on how much money you saved by settling the debt.
Pros of debt settlement
- It can save you money versus repaying the debt in full.
- Settling debts can ease concerns about lawsuits and help you avoid bankruptcy.
- Settled accounts may be better than collections accounts for your creditworthiness.
- You may be able to make your settlement payment over time or with a lump sum payment.
Cons of debt settlement
- You’ll have to stop paying bills, which can hurt your credit and lead to additional fees and interest.
- You’ll still need to save enough money to pay the settlement amount.
- Creditors aren’t obliged to accept settlement offers, and you may wind up owing more money if you stop making payments.
- Your savings are limited by the debt settlement company’s fees and the growing balance during the non-payment period.
What to watch out for with debt settlement
Debt settlement experts and attorneys frequently deal with creditors and may know how much to offer, when to make the offer, and which creditors you shouldn’t bother sending settlement offers to. These professionals may be able to save you money, even after you pay their fee.
However, continuing to let bills go unpaid can hurt your credit, lead to additional fees and interest, and spur a creditor to sue you and garnish your wages (especially if you owe the creditor a lot of money). You also need to watch out for unscrupulous debt settlement companies that take your money and never work with your creditors to settle your accounts.
You can look for reviews of companies online and steer clear of companies that promise they can get creditors to agree to a settlement offer. Although there may be initial and monthly fees for the escrow account, debt settlement companies also can’t charge you an upfront fee for debt settlement services—that’s a red flag.
Finally, know that any forgiven debt could be considered taxable income for the year. Say your credit card company accepts $3,000 on an account with a $5,000 balance. Regardless of the fees you paid to the settlement company, you may need to pay income taxes on the $2,000 of discharged debt.
What’s best for you?
Figuring out which debt relief option will work best can require a close analysis of your finances, credits, and goals.
For example, a DMP might cost you more than filing Chapter 13 bankruptcy or debt settlement, but it’s also likely a better option if you’re concerned about your credit in the short-term. Conversely, a Chapter 7 bankruptcy might be terrible for your credit, but it can wipe away debts and offer you a fresh start.
If you’re looking for unbiased assistance, Credit Squad members can reach a US-based credit representative. We will help examine your credit history and finances and explain why different debt relief options may make more or less sense for someone in your situation.