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Debt Relief: Know Your Options and the Consequences

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Debt Relief: Learn Your Options and Consequences

Debt relief can ease the burden of a massive debt, but it’s not right for everyone. There are many options to consider.

By Bev O’Shea personal finance writer | MSN Money, Credit.com, Atlanta Journal-Constitution, Orlando Sentinel Bev O’Shea is a former NerdWallet authority on consumer credit, scams and identity theft. She holds a bachelor’s diploma in journalistic studies from Auburn University and a master’s in education from Georgia State University. Prior to joining NerdWallet she worked for daily newspapers, MSN Money and Credit.com. Her work was featured in The New York Times, The Washington Post, the Los Angeles Times, MarketWatch, USA Today, MSN Money and elsewhere. Twitter: @BeverlyOShea.

7 January 2023

Edited by Kathy Hinson Lead Assigning Editor Personal financial, credit scoring, managing money and debt Kathy Hinson leads the core personal finance team at NerdWallet. Previously, she spent 18 years at The Oregonian in Portland in roles including copy desk chief and team editor and designer. Her previous experience includes the editing of copy and news for many Southern California newspapers, including the Los Angeles Times. She earned a bachelor’s degree in journalism and mass communications from the University of Iowa.

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Table of Contents

You’re not seeing progress in your debts, no matter how hard you try? If that’s the case, you might be facing an overwhelming amount of debt.

To get rid of debt, look into your options to reduce debt. These tools can alter the terms or amount of to help you recover faster.

But these programs aren’t the ideal solution for everyone, and it’s crucial to consider what the implications could be.

Debt relief may involve wiping the debt completely out through bankruptcy, obtaining changes to your rate of interest or payment schedule to reduce your payments or convincing creditors to agree to pay less than entire amount owed.

When should you seek debt relief

Consider bankruptcy, debt management or debt settlement if any of the following is true:

You have no hope of paying off unsecured debt (credit cards or medical bills or personal loans) within five years, even if you take extreme measures to cut expenditure.

The sum of your unpaid unsecured debt equals half or more of your income.

However, if you could potentially pay off your debt in five years, consider a self-help strategy. It could comprise a combination of debt consolidation appeals to creditors, and more strict budgeting.

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Be aware of scams, debt relief downside

The industry of debt relief is full of fraudsters who want to grab whatever little cash you have. A lot of people who enroll in debt relief programs fail to finish their obligations. You could end up with debts that are even more than you were when you began.

But debt relief may give you a fresh start or the breathing room you’ll need to get real results.

You must be aware of- and verify — these points prior to signing any agreement:

What you need to qualify.

What fees will you have to be required to pay.

What creditors are getting paid and at what amount; if your debt is in collections, be sure you know who is the owner of the debt, so that payments are made to the correct agency.

The tax implications.

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Debt relief through bankruptcy

There’s no point in signing an agreement to settle your debt or entering into a debt management program in the event that you won’t be able pay the amount the terms agreed upon. It is recommended to speak with someone first before you embark on any debt relief strategy. Consultations are generally free, and if you don’t qualify then you are able to move on to other possibilities.

The most popular type of , Chapter 7 liquidation, can eliminate the majority of credit card debt, unsecure personal loans and medical debt. The process can be completed within three or four months if you qualify. The things you need to know:

It’s not going to erase your child support obligations or the student loan debt is very likely to be paid back.

It will hurt and stay on your credit report for as long as 10 years even as you try to rebuild your credit score. However, when your credit score is already poor it is possible that bankruptcy will allow you to rebuild your credit sooner than continuing to try to pay. (Learn more about when .)

If you’ve used the services of a bankruptcy attorney , your bankruptcy filing makes the co-signer responsible for the obligation.

If your debts continue to pile up, you can’t file another for eight years.

This may not be the best choice if you would have to sell the property you would like to keep. The rules differ by state. In general, certain types of property are exempt from bankruptcy, such as vehicles that exceed a certain value, and a portion of the equity in your home.

It’s not necessary in the event that you’re «judgment proof,» which means you do not have any income or property that creditors can go after. Creditors can still be able to sue you and receive a judgment, but they won’t be able to get their money back.

Also, not everyone who has a lot of debt is eligible for. If your income is higher than the median for your state and your family size or you own property you’d like to avoid foreclosure, you may need to make an application to file Chapter 13 bankruptcy.

It is a three- or five-year court-approved repayment plan, based on your income and the amount of debt. If you’re able to adhere to the plan for its full duration, the rest of your unsecured debt is eliminated. It’ll be more time-consuming than a Chapter 7 bankruptcy, but if you are capable of making the payments (a large majority don’t) you are eligible to keep your home. A Chapter 13 bankruptcy stays on your credit report for seven years from the date of filing.

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Assistance through debt management programs

A allows you to pay your unsecured debts -usually credit cards- in full, but typically at a lower interest rate or with fees waived. The only payment you make is each monthly to an credit counseling organization that distributes the money among your creditors. Credit counselors and credit card companies have long-running agreements that help customers with debt management.

Your credit card accounts will be shut and, most of the time, you’ll have to live without credit cards until you’ve finished the plan. (Many people do not complete their plan.)

The debt management plans themselves will not impact your credit score But closing accounts may affect your score. Once you’ve completed your plan, you can make a new application for credit.

If you don’t pay on time, you could be kicked out of the plan however. And it’s important to pick an agency that’s accredited by the or the . Even then, make sure you know the charges and other options you could have for dealing with financial debt.

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Relief through debt settlement

is a last resort for those who face overwhelming debt, but aren’t eligible for bankruptcy or want to declare bankruptcy.

Debt settlement companies typically ask you to stop paying your creditors and instead deposit the funds into an Escrow account. Every creditor is approached because the money builds up in your account and you become further behind in payments. Fear of getting nothing whatsoever could prompt the creditor to accept an offer that is smaller in lump-sum and not seek to pursue you for the rest.

Not paying your bills can result in collection calls, penalty charges and, potentially, legal action against you. Debt settlement stops none of this while you’re negotiating. It could take months for the settlement to be implemented. In the case of how much that you have to pay, it can take years , and the continual late payments further damage the credit rating.

You could also be faced with tax bills on the forgiven amounts (which the IRS considers income). Legal actions can result in wage garnishments and property liens.

It is possible to try it , or you can hire a professional. The business of debt settlement is riddled with bad actors However, the Consumer Financial Protection Bureau, the National Consumer Law Center and the Federal Trade Commission caution consumers in the most stern terms.

Some of those companies also claim to be . They are not. Consolidating debt is something you can handle on your own and will not harm your credit score.

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Do-it-yourself debt relief

There’s no reason to think you shouldn’t take advantage of any of the above-listed debt relief options and create your own plan.

You can follow the same steps credit counselors use in their debt management plans: Contact your creditors, explain why you’re in debt and what concessions you need to catch up. The majority of credit card companies offer programs for hardship, and they may be willing to reduce your interest rate or waive charges.

It is also possible to educate yourself about debt settlement and reach an agreement with creditors yourself. (Learn how you can .)

If your debt isn’t unsurmountable alternatives to paying off debt could be possible. For example, if your credit score is still good, you may be eligible to apply for an account that offers a zero-interest balance transfer rate that could allow you to breathe. You could also find a credit card with a lower interest rate.

Those options won’t hurt your credit; provided you keep making the required payments your credit score will rebound.

If you choose to do this, however, it’s important to plan a strategy that will prevent you from getting into a cycle of debt. It can also be difficult to be eligible for new credit cards or a loan in the event that you’re heavily in debt. That frequently leads to late payments or high balances and they can harm your credit standing.

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What not to do

Sometimes, debts become overwhelming and come with devastating swiftness like a health crisis or job loss or a natural disaster. Or maybe it came in small increments but now creditors and collection agencies are pressing you to pay but you can’t.

If you’re experiencing financial stress There are some things to avoid:

Be sure to not neglect a secured obligation (like car loans) in order to settle an unsecure one (like a hospital bill credit or hospital bill). It is possible to lose the collateral to secure the debt, in this case your vehicle.

Don’t take out loans against the equity in your home. You’re putting your home at risk of being foreclosed upon and could be converting the debt you are unable to pay off and could be discharged by bankruptcy to secured credit that can’t.

Do not take money out of your . This cuts your chances of financial security in retirement.

Think twice about borrowing money from your retirement account at work and. If you lose your job the loans could result in accidental withdrawals and result in the tax penalty that is not the best thing you’ll need.

Don’t make decisions based on which collectors pressure on you most. Instead, look into your options and select the best one for your situation.

Ready to conquer your debt?

Keep track of your spending and balances in one place to see how you can get rid of debt.

About the author: Bev O’Shea was a credit reporter at NerdWallet. Her work has been featured in publications such as the New York Times, Washington Post, MarketWatch and elsewhere.

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