Which Debt Relief Option Is Right For You?

Debt relief is the process of reorganizing your debts to make repayment more streamlined, simple or affordable. You can explore different debt relief options depending on your level of debt and goals. Credit counseling can help you decide what approach fits best.

For example, debt management helps you approach existing debts more strategically. Consolidation doesn’t eliminate debt but may lower your monthly payment. Debt settlement and bankruptcy may eliminate or reduce your debts but will also damage your credit score.

Types of debt relief

You have four main types of debt relief: debt management, debt settlement, debt consolidation and bankruptcy. The first three all help you pay off the debt. 

Bankruptcy is the most extreme and can hurt your credit score in the long run, but it could help you discharge debt that you have no way to manage otherwise. There are also debt relief companies that can help you pursue different debt relief options — for a fee.

Debt management

Debt management involves using financial tools and planning to help lower — and eventually eliminate — your current debt. You can go through a credit counseling agency, or you can set up a management plan on your own.

• Self-led debt management: Creating a debt payoff plan for yourself often involves using repayment methods like the avalanche or snowball approach. This may be a good relief option for those with a handle on their spending habits and are confident in negotiating with creditors.
• Credit counseling: Credit counseling is a low-cost option offered by nonprofit organizations or agencies. You’ll be partnered with a credit counselor who will review your finances to help you find debt relief solutions. For example, a counselor may advise starting a debt management plan (DMP).

What is a DMP?

A DMP is a three-to-five-year plan designed to help you exit debt sooner. You will make a monthly payment to the agency, which will pay your creditors.

When to consider debt management

If you want a plan that looks at your entire financial profile and all of your existing expenses, you may want to consider setting up a debt management plan.

Michael Sullivan, a personal finance consultant with Take Charge America, says, “When a consumer has significant debt and can afford to pay it off, albeit with some help, debt management is the best solution (and usually the place to start).”

Debt settlement

Debt settlement involves working with a third-party settlement company to resolve your unpaid debts. They will negotiate on your behalf with creditors in hopes of getting portions of your debt forgiven.

Once you’re approved for settlement, the company you’ve selected will help you handle the repayment process. You’ll be responsible for depositing a monthly payment into an account the debt settlement company sets up.

The process typically takes between 12 and 48 months. These companies charge a percentage of your settled debts as a fee — typically between 15 percent and 25 percent.

This approach comes with big drawbacks. The debt settlement company will tell you to stop paying your creditors to give it negotiation leverage, which will massively reduce your credit score. Creditors are also under no legal obligation to work with settlement companies. If the debt settlement fails, you will be left with the same debt and a worse credit score.

When to consider debt settlement

When there are no other options available and you don’t wish to turn to bankruptcy, settling your debts may be the best — and only — option for taking care of overwhelming balances.

Debt consolidation

Debt consolidation combines multiple debts under a new personal loan or credit card to streamline repayment. Consolidating makes the most sense if you qualify for a lower rate than what you had on one or more of your previous debts.

Another debt consolidation pro-tip: It can make the repayment process easier. You’ll only have to make one monthly payment instead of multiple. In the case of a debt consolidation loan, that monthly payment will be fixed. But keep in mind that it will include added interest.

When to consolidate your debt

If you have multiple high-interest debts and good credit scores or a cosigner who can help you qualify for a better interest rate or terms, consolidating could be a smart financial move. Start by prequalifying with multiple lenders. Prequalification lets you see your predicted interest rates and eligibility odds before applying, so your credit isn’t impacted.

“Debt consolidation may be the best option for a consumer who falls into debt due to an illness or accident but has good money management skills,” Sullivan says. “Some consumers who do not qualify for a debt management plan because a budget analysis indicates they don’t need it might benefit from the reduced costs of a consolidation loan.”

Look for a lender that meets your needs and offers lower rates than your existing loans. However, only apply or accept the loan if you’re certain you can comfortably make the monthly payments for the entire term.

“Consumers who have spending issues often get in more trouble if they create new credit and should avoid consolidation,” adds Sullivan.

Bankruptcy

Bankruptcy is the legal process of disputing outstanding debts or financial obligations. Once approved by a judge and court-appointed trustees, you can either qualify for Chapter 13 or Chapter 7 bankruptcy. Unlike with settlement, creditors legally can’t take action against you until the process is over.

Bankruptcy offers a fresh start to those with unmanageable delinquent debts — but it comes with some major risks. Your assets are measured during the process and may be seized to satisfy your delinquent debt.

What’s more, bankruptcy stays on your credit report for up to 10 years. It significantly reduces your credit score and makes it harder to get approved for other loans or financial opportunities in the future.

When to declare bankruptcy

Declaring bankruptcy should be a last resort due to the potential costs and the long-term financial consequences. Declaring bankruptcy may be the best solution if all the following are true:

• You have large amounts of unpayable debt
• You are already at risk of losing essential assets — such as your car or home
• You don’t qualify for other forms of relief
• We recommend consulting a bankruptcy attorney before starting this process

Natalia Brown, chief compliance and consumer affairs officer at National Debt Relief, adds, “Bankruptcy is something to consider when your debt has gotten to the point where you can’t afford basic things like rent, food, or bills, and none of the other options, like debt settlement or debt consolidation, are working for you.”

Which debt relief option is best?

There isn’t one single best debt relief option. What’s best for you ultimately depends on your debt burden and how long you’ve been unable to repay your balances.

However, the most efficient method of paying down your debt while having the smallest impact on your credit is likely the best option for you. Just remember that most debt relief options aren’t immediate and will need to fit your long-term financial goals.

Explore all the relief methods and consider the full impact of each before making a final decision. Research companies’ reputations and beware of potential scams on the market as you pursue a path to relief.

To avoid scams, Brown says, “A big red flag is if a company contacts you first, as legitimate debt relief companies will not cold call.” Debt reduction and credit repair also take time. “It’s easy to fall for pressure to decide quickly, but make sure to avoid companies that won’t clearly explain costs, timelines or credit impacts,” Brown adds.

Bottom line

To manage and pay off your debt, you can choose from debt settlement, management or consolidation. Each option has its own benefits and drawbacks to consider before starting along a path. Settlement and bankruptcy should be saved as last resorts, as they can damage your credit for an extended period.

Frequently asked questions

• Is debt relief a scam?
  

  There are plenty of reputable companies that can help you pay off your debt or reduce how much you owe. But you must keep an eye out for scams. Red flags include guaranteeing debt elimination, saying your credit score will improve or demanding fees upfront.    

• What are alternatives to debt relief?
  

  You can find several alternatives to debt relief. For instance, while not ideal because of the risks of losing your home and adding more debt, home equity products could mean lower monthly payments.  

• Can you DIY debt relief?
  

  Yes, it’s possible with a good plan and financial discipline if your debt is not too high. You might work on adjusting your budget on your own, such as putting your savings into paying down debt. You can also try negotiating a payment plan with your creditors.