We don’t like to talk about it, but most of us need debt relief. According to a 2015 report by the Pew Charitable Trusts, 8 out 10 Americans have debt. The median debt amount? $68,000. It’s even worse among people born between 1965 and 1980. Nine out of ten Generation X Americans are in debt, and the median amount is a $104,000. Of course having debt is not necessarily a bad thing. A mortgage, for instance, can be a sound investment. The same applies to student loans. So how do you know if you have too much debt?
Do any of these situations apply to you?
- You are afraid to answer the phone because the caller may represent a collections agency.
- You are unable to pay the minimum payments due on your credit cards.
- You are barely scraping by from paycheck to paycheck.
- You are relying on payday loan advances to make ends meet.
- You owe more than half your gross income, and by your calculations, you will not be able to get out of this level of debt in five years.
- You feel hopeless about getting out from under the debt you owe.
If you can identify with any of these situations, you might want to consider looking into debt relief options. Living under a staggering load of debt is stressful and unhealthy. If you take appropriate action to get your debt under control, your stress levels will be more manageable, and your wallet will thank you.
What is debt relief?
Simply put, debt relief is a restructuring or reorganizing of your debt that helps you pay off what you owe more easily. It involves negotiating to settle your debt for less than the full amount you owe. Debt relief is designed to help you lighten the financial load you are carrying and get back on the road to financial health.
There are a variety of reasons that you may need debt relief. Sometimes it can be due to reckless spending habits. But in many cases, it may be attributable to circumstances beyond your control, such as the loss of a job, a death in the family which reduces household income considerably, or a medical emergency that depletes your finances.
Whatever the reasons for your current financial difficulties, debt relief offers a way for you to make your situation more manageable.
What types of debt can be handled with debt relief settlements?
The most common type of debt that is handled with debt relief settlements is credit card debt. This is not surprising, considering that revolving credit in the U.S. is $960.8 billion, according to the Federal Reserve. If you divide that figure by America’s 122 million households (source), that means that the average U.S. household owes $7,875 in credit card debt.
Debt relief settlement works well for removing credit card debt. This is because creditors are private lenders rather than government agencies. Another reason is that credit card debt is unsecured debt, meaning that it is not secured by property like a mortgage or car loan is.
Unsecured personal loans can be handled with debt relief settlements. If you have delinquent medical bills, utility bills, cell phone bills, or private student loans, you can include these when you pursue debt relief options.
However, federal student loans are not generally eligible for debt relief settlements, since the federal government is not usually open to settling for a lump-sum payment of less than you owe.
If you have secured loans like mortgages or auto loans, in rare cases lenders may work with you to negotiate a debt settlement. This is an unlikely scenario, however, because these lenders have the option of seizing your property to satisfy your debt instead of settling for less than the full amount owed.
Can you negotiate your own settlement with creditors?
You always have the right to negotiate a settlement with your creditors on your own. You may find, however, that negotiating with creditors is a messy affair. It takes a great deal of time and patience to effectively negotiate a settlement.
Often, finding a debt relief company to do your negotiating for you will result in a better deal for you and a quicker resolution to your financial worries. Good debt relief companies know the ropes of debt settlement. They know who to speak with, what to say, and how to best handle your creditors. Furthermore, debt relief companies are not afraid or timid when it comes to negotiating the best possible terms on your behalf.
How do debt relief firms negotiate a debt settlement?
Once you begin working with a debt relief firm to negotiate a debt settlement with your creditors, it is a good idea to let your creditors know the name and contact information of the debt relief firm. In some cases, this may stop the collection calls you receive from creditors, at least until they verify the information you provide.
As your debt relief firm begins its work of negotiating with your creditors, the firm will require that you put a certain amount of money each month into a dedicated, FDIC-insured bank account. This bank account will be in your name, but it will be overseen by a trustee or account administrator.
The goal of your debt relief firm is to lower the principal balance owed on your account. In some cases, debt relief firms can convince a creditor to accept up to 50 percent less than the amount you currently owe to settle your debt in full.
After consulting with you about your current financial situation and your ability to make future payments, your debt relief firm will make a formal proposal outlining a settlement offer to each of your creditors. Your creditors then have the right to decide whether to accept or reject the settlement offer.
It is important to remember that your creditors have no legal obligation to accept a settlement offer. However, some creditors are willing to negotiate if they feel that collecting the full amount owed is not likely to happen or if they feel that hiring a collections agency or pursuing litigation against you will cost more than they are willing to spend to handle the matter.
Once a settlement agreement is reached, your debt relief firm will make sure that all agreements are in writing and signed by both you and your creditors. This ensures that there is no misunderstanding among all interested parties.
Why do debt relief firms ask you to stop making payments to your creditors?
Though it may seem strange to you, many debt relief firms will ask you to stop making payments to your creditors while they negotiate a settlement agreement. This serves two main purposes.
First, remember that your debt relief firm will be requiring that you make deposits into a bank account dedicated toward settling your debts. It is highly unlikely that you can afford to make these deposits while also trying to repay your creditors individually. Realistically, if you have enough money to do both things at the same time, you likely do not need debt relief settlements in the first place.
Second, by not making payments to your creditors while your debt relief firm is in the process of negotiations, you put a bit more pressure on your creditors to accept a settlement offer. No creditor wants to run the risk of not collecting anything on an outstanding balance. And creditors may decide that accepting a settlement offer will ultimately be more beneficial to them than pursuing alternate ways of collecting the debt you owe.
How long does a debt relief settlement take?
There is no time-frame set in stone for how long it takes to settle a debt with your creditors. Your debt relief firm will submit proposals to your creditors. Typically, your creditors will respond to these proposals within a few weeks, though some creditors may take more than a month to reply.
The length of time it takes to pay your creditors depends on how much debt you owe and what the settlement agreement specifies. Once you have reached a settlement agreement with your creditors, your debt relief firm should be able to tell you exactly how long it will take to settle your debts according to the agreement.
In most cases, debt relief firms try to help you get out of debt within two to five years. If that is not possible through debt settlement, you might need to consider bankruptcy as an alternative.
What effect does debt relief have on your credit?
Even though debt relief is a way out of debt, it will have an adverse impact on your credit. Because you are not making regular payments to your creditors while your debt relief firm is in the process of negotiating your settlement, your payments will not be considered as current.
The Federal Trade Commission (FTC) warns that your creditors can still charge late fees and penalties and pursue other collections options while your debt relief firm is working to negotiate a settlement for you. Additionally, the fact that you are settling your account for less than the full amount owed will likely lower your credit score.
Some credit card companies will report your agreement as a settlement to the credit bureaus. If that happens, the settlement will appear on your credit report for about seven years. It is permissible to ask your credit card company to report the settlement as “paid in full” instead. If the credit card company agrees to this, your credit scores will not be affected as much. While there is no guarantee that the credit card company will agree, it never hurts to ask for this consideration.
It is a good idea to check your credit score periodically while you are enrolled in a debt relief settlement program. Check your score before entering into a debt relief settlement agreement, and then check it again after six months. At first, you may see your credit score dip considerably. In time, however, you should see your score begin to rise again as your debt relief firm begins to pay off your creditors one by one.
What effect does debt relief have on your taxes?
Depending on your total financial situation, the IRS may consider any savings you get from debt relief as income. Creditors can report settled debt to the IRS. Since the IRS classifies settled debt as income, it is taxable. The exception to this is when the IRS considers you to be insolvent. The IRS will give you an insolvency exemption in cases where your total debts are more than the fair market value of your total assets. A tax professional can help you figure out if you meet the qualifications for an insolvency exemption.
What are the pros and cons of debt relief vs. debt consolidation?
Both debt consolidation and debt relief settlements are designed to help you get out of debt and regain your financial freedom. However, the two approaches are very different, and each comes with its set of pros and cons.
Debt consolidation is designed to pool all your unsecured debt together. Pros of this approach are:
- You only have to make one payment per month instead of making payments to multiple creditors.
- Debt consolidation usually has a positive effect on your credit score, rather than a negative one.
- Ideally, a debt consolidation loan will have lower interest rate than your existing debt does, thereby saving you money in the long run.
- Since you are not reducing the total amount of money you owe, the impact of debt consolidation on your taxes is usually negligible.
However, debt consolidation comes with some downsides as well. Cons include:
- None of your debt is forgiven or reduced.
- A debt consolidation loan may take longer to pay off than simply making additional payments to your existing accounts would take.
- Debt consolidation does not necessarily help you avoid bad spending habits, meaning that you may end up increasing your debt rather than eliminating it.
Debt relief settlements, on the other hand, offer these advantages:
- Your total debt may be reduced by a significant amount, as much as 90 percent of what you owe.
Debt relief settlements offer a realistic alternative to bankruptcy.
Debt relief settlements can help you out of debt when debt consolidation is not an option.
Cons of debt relief settlements are:
- Debt relief settlements will have a negative impact on your credit.
- They may also have a negative effect on your tax situation.
- The settlement negotiation process may take time, during which penalties and late fees may accrue to past due accounts.
Which is better, debt relief settlements or bankruptcy?
Whether to choose debt relief settlement or bankruptcy can be a tough call. It is important to note that bankruptcy affects your ability to get credit, buy a home, get life insurance, or even get a job in some cases. Bankruptcy should always be your last resort when it comes to getting out of debt.
The exception to this general rule would be if debt consolidation or debt settlement will not eliminate your debt within five years. If you cannot realistically meet the terms of repayment as stated in a debt settlement agreement or you have no hope of getting out of the deep financial hole in which you find yourself, bankruptcy is a viable option.
A debt relief settlement impacts your credit score negatively, but a bankruptcy can have devastating effects on your credit score for seven to ten years, depending on the type of bankruptcy you file.
Here are some other ways debt relief settlements differ greatly from bankruptcy:
- Unlike Chapter 7 bankruptcy, debt settlement agreements do not require you to sell property to pay off your debt.
- It is often easier to come to a debt settlement agreement with your lenders than to qualify for bankruptcy.
- Fees for filing for bankruptcy are due upfront, and can be quite costly. By comparison, debt relief companies typically collect their fees after a debt account has been settled.
Where can you find a reputable debt relief firm?
Not all debt relief firms are reputable, so it is important to do your research before working with a debt relief company. A reputable debt relief firm will talk with you about the services they offer before they request your personal financial information.
Your debt relief firm should:
- Clearly explain fees and conditions associated with its services.
- Explain how much money you will need to put into a dedicated bank account before the firm will begin negotiations with your creditors.
- Explain how long it will take to get the results you need.
- Explain the consequences of any settlement on your credit score and taxes.
The best debt relief firms focus on helping you get and stay out of debt. Often, they can reduce the number of collection calls you receive. And they will help you figure out ways to avoid bankruptcy.