Debt Relief 101: How To Get Out Of Debt
Updated July 5, 2018
When you are swimming in debt, it may seem impossible to find an out or even know where to start when trying to pull yourself out of deep debt. Debt relief is an option that has many rules, loopholes, and nuances, and we are here to break it down two popular methods of relieving your debt: debt consolidation and debt settlement.
While you may want to use the terms interchangeably, debt consolidation and debt settlement are two completely separate entities that rely solely on your current financial situation and preferences.
Let’s begin with debt consolidation. This is a method in which you combine high-interest debts into one lower-interest debt, which helps reorganize your debts to have one interest rate to pay off methodically. This tackles debts with different rates, payments, and due dates to make it more manageable.
There are several ways to go about this:
- Balance-transfer credit card: These cards usually have 0% APR for a certain period of time before the interest rate is greatly increased.
- Personal loan: A fixed-rate personal loan allows you to use your loan to pay off your debt before paying it back with loan installments. There are personal loans available for consumers with both good credit and bad credit.
- Home equity loan and 401(k) loan: Although these loans are valid options, they pose some risk to your home and retirement.
Debt consolidation is a great option if:
- You have unsecured debt that needs to be paid off. This includes credit cards, medical debt, and personal loans. This does not include mortgages, student loans, or auto loans.
- Your credit score allows you to receive a 0% APR credit card or low-interest personal loan. You can check your credit score with these top rated credit monitoring services.
- Your debt-to-income ratio is not over 50%. This means that your total (unsecured) debt should be less than half your gross annual income.
- You have enough funds to cover your debt consolidation payments and you are able to pay it off within five years.
- You have a plan to remain debt-free once your debt is paid off.
If you are still on the fence about pursuing debt consolidation, here are a few reasons you may NOT want to pursue it:
- You have a small amount of debt.
- If you can pay off your debt in less than a year with your current payments and only save a negligible amount, then it isn’t worth your time.
Let’s move onto debt settlement. This process allows a debt settlement company to negotiate your debts with creditors.
When you enroll with a debt settlement company, you are provided an FDIC-insured savings account where you contribute a monthly sum. Once you have reached a specified amount, the company takes your current debt and negotiates with creditors to lower your interest rates and monthly bills before accepting the lump sum that you have accumulated as payment. Your loan principal remains the same and your debt is considered paid off when you have taken care of the settled debt by paying your original creditors. This process takes anywhere from 2 to 4 years.
Debt settlement companies are paid once they have settled your debts, so be wary of any company that charges upfront fees, since this is an illegal practice. The amount they are paid is based on the percentage of your initial debt or a cut of the amount of debt they saved you.
Alternatives To Debt Consolidation and Debt Settlement
If you do not want to explore either of these options, or your creditors initially refuse to negotiate with a debt settlement company, you can try directly negotiating with creditors on your own.
Because of the extreme damage that was done to your credit and the amount of time it takes to settle your debt, you may choose to file for bankruptcy. This also has a devastating effect on your credit score, so weigh your options carefully before choosing.
Consumer credit counseling services offer debt management plans for a monthly fee to the counseling service. They negotiate a lower interest rate and monthly bills, then pay your creditors for you, which reduces the interest rate on credit cards but does not reduce your total debt. You generally can’t use your credit cards while using these services and (unfortunately) most of the consumers that enroll don’t complete this service. Make sure the company you enroll with is a reputable and legitimate service since there are some scam artists within the industry.
What To Look For In A Debt Relief Company
- As a rule of thumb, avoid companies that charge fees before providing services.
- Look for accreditations -- the more, the better. Common accreditations include the American Fair Credit Council (AFCC), the Better Business Bureau (BBB), the International Association of Professional Debt Arbitrators (IAPDA), US Organization of Bankruptcy Alternatives, and the FTC.
- A free consultation is not a necessity, but definitely a plus.
- Read real customer reviews to gain perspective on customer service and results. All companies have complaints, but if most of the reviews are negative, steer clear.
- Check to see how many years the company has been in business. Reputable businesses last longer.
- Look for companies with competitive rates and low fees.
- Most companies have a minimum amount of debt they accept before taking on your case -- it is generally $7,500 to $10,000, but they may accept slightly lower debt too.
- Look for a company with transparency. If a company lists their rates, requirements, and states where they perform services upfront, that is usually a great sign. Their website should be easy to navigate and have information clearly listed. As an added bonus, many companies choose to have additional information like blogs, educational articles, and FAQs.
- Debt settlement programs usually last two to four years (24-48 months), while debt consolidation loan terms can be up to five years (60 months). Any company that can work within that timeline is a good bet.
- Look for a company that can handle a variety of debts, including credit card, medical debt, student loans, and even secured debt.
- Customer support should be easy to get ahold of through phone and email, and some companies even offer a chat feature.
- The company should have professional consultants and certified financial experts.
- Many companies have a money back guarantee in the case that their services do not work for you.
- Companies must disclose the rates, terms, and length of the program when you undergo debt settlement.
What To Avoid
- Avoid any company that asks you to pay upfront fees. The Federal Trade Commission (FTC) banned this business practice in 2010, specifically for those that only do business over the phone.
- Stay away from any company that guarantees results, since this is an illegal practice. A company can only promise to do their best to help you with your debt, not make guarantees.
- If a company seeks you out rather than the other way around, this could be a sign of a scam artist.
What Are The Advantages Of Pursuing Debt Relief Options?
- Debt settlement is a legitimate option for taking care of unsecured debt (which does not require collateral like secured debt). However, many companies do not deal with student loan debt, even though it is technically unsecured.
- A balance transfer credit card has a 0% APR for a period of time before it is raised, meaning you initially save much more on your payments.
- Personal loans allow you to pay off your high-interest debt and then pay back your loan in installments.
What Are Some Disadvantages Of Debt Consolidation And Debt Settlement?
- If you don’t fix the habits that caused your debts (such as overspending), debt relief won’t help you in the long run.
- Debt settlement has high fees that the company charges after they settle your debt.
- You must save extra funds to pay your debt relief company while staying on top of your bills and debts.
- During this process, you must still pay your debts or risk having late payments, which can damage your credit.
- Creditors can still sue you during the debt relief process.
- Your credit report might state that your debt was settled, which raises a red flag for future creditors and make them wary of lending to you.
- Any forgiven debt (if it is over $600 and less than your initial debt) is considered income by the IRS, and you must pay taxes on it unless you can prove you are unable to.
- If you are completely overrun by debt and can’t pay it off with a loan or lower-interest payment, it may be time to consider another solution such as bankruptcy.
If you decide to pursue debt consolidation and debt settlement, here are some of our top picks for debt relief services.
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