Debt can affect every aspect of your life and cause you to feel completely overwhelmed at times. It leads to stress, depression, and even physical illnesses. We work with folks struggling with crippling debt every day, and many of them tried other debt relief options before finding us. One thing almost all of them say is that they feel like they wasted time and money with the other options, and they wish they would've decided to file bankruptcy sooner.
In this blog, we compare three popular debt relief options: Debt Relief, Debt Management, and Debt Consolidation. We review the pros and cons of each option, how they work, who they work for, and what factors to consider when choosing between them. By the end of this post, you will have a better understanding of which option is best for your unique situation so that you can make an informed decision about how to move forward.
Understanding Different Debt Relief Options
Debt relief options include debt management, debt settlement, debt consolidation, and bankruptcy. These options all attempt to reduce your overall debt through providing financial counseling, repayment plans, debt negotiation, or complete forgiveness. Although each option is capable of providing some level of debt relief, it's important to know that certain options aren't available to everyone, certain options involve more risk of debt collection lawsuits, and certain options are more strict and less forgiving when life gets in the way of the ability to repay.
Comparing Debt Settlement, Debt Management, and Debt Consolidation
Each of these options provides a distinct way for helping folks get out of debt. Likewise, each option has it's downsides that may discourage certain folks from pursuing them. The decision about which option is best for you to get out of debt is one that depends on your current financial situation, tolerance for risk, and preference for certainty vs uncertainty.
One thing to keep in mind is that debt settlement and debt management are typically only useful for addressing for unsecured debt, like credit cards, personal loans, and medical bills. Debt consolidation can offer help with certain secured debts such as car loans, but it's important to pay close attention to interest rates to make sure that including your car loan in your consolidation makes sense. If you're struggling with your mortgage you may need to consider refinancing or a Chapter 13 bankruptcy if you're behind on your payments.
Factors to Consider
When considering debt settlement, debt management, and debt consolidation, certain aspects of your financial situation and outlook for the future can help you choose the right option for you. In order to make the best decision for your situation, the basic pieces of information you'll want to have a really good idea about are (1) how much debt you have, (2) whether you're current or behind on your debt, (3) how much you pay in interest and fees for your debt each month, (4) your monthly and annual income and whether you anticipate any changes, and (5) your credit score. Evaluating your eligibility for specific options and exploring potential fees associated with each debt relief option can also help inform your decision.
Which One is Right for You?
Choosing the right debt relief option is a personal choice. It's important to know that what works for others may not be what's best for you. You need to be honest with yourself about your current financial situation and what your future earnings look like. There's no benefit in making such a big decision if it's not the right decision for you. It makes the most sense to carefully consider your options and make an informed decision the first time.
Debt Settlement: Is it Worth the Risk?
Debt settlement companies like Freedom Debt Relief, National Debt Relief, JG Wentworth, and others all attempt to negotiate with creditors to lower the total amount of your debt. Debt settlement can be appealing with it's claims to eliminate debt without the need for filing bankruptcy, but folks should be aware that there are consequences and risk involved with every attempted debt settlement.
How Does Debt Settlement Work?
Debt settlement companies have you pay them each month while they attempt to negotiate with your creditors. A portion of the monthly payments you make to the debt settlement companies are used to pay the their fees, while the rest is put into an account to accumulate enough funds to hopefully be successful in settlement negotiations. The idea with this is usually that your money accumulates while your debt falls behind, allowing the debt settlement company to offer a lump sum payment to the creditor for less than the full amount once the creditor is finally ready to negotiate (because you've finally defaulted on your debt).
Meanwhile, debt settlement companies require that you to stop paying on all of the debts you've hired them to negotiate. Otherwise, if you're current on your debt or still attempting to make payments then the debt settlement companies won't have any leverage to negotiate with the creditors. This means that you have to be in default on all of your debts in order for debt settlement to even begin to be a possibility. It's important here to note that your debts are still accumulating interest and fees while the debt settlement company attempts to negotiate on your behalf. Additionally, the creditors are free to use whatever legal means they choose to continue their attempts to collect on the debt during this time, which means that they can, and often do, sue folks who've hired debt settlement companies to negotiate their debts.
Just because a debt settlement company is hired to negotiate certain debts doesn't mean they'll successfully negotiate each of those debts. People who use debt settlement companies often find that when the debt settlement company is finished, there are still one or more debts that haven't been resolved. When this happens, the debt has usually grown significantly because (1) the debtor hasn't paid on it in months, if not years, and (2) high fees and interests have accumulated on the account monthly.
Impact on Credit Score
Debt settlement services frequently leads to a negative impact on your credit score, due to the accumulation of monthly negative remarks for nonpayment as well as the settled accounts being reported as "settled" or "paid, settled" on credit reports. These comments stay on your credit report for 7 years.
Taxable Forgiven Debt
When a creditor forgives debt in a settlement, they typically write if off as a loss for accounting purposes and then report it as income to you. That means at the end of the year when they're getting their accounts in order in anticipation for preparing taxes, they'll likely prepare a 1099 for you in the amount that they forgave as part of the settlement. When this happens, you have an obligation to report that amount as income when you prepare your taxes, which means that in this situation you have to pay taxes on the amount of debt that was forgiven. It's important to seek advice from a tax professional if your considering debt settlement, because the tax implications can sometimes come as a shock the unexpecting.
Pros and Cons of Debt Settlement
Debt settlement has the potential for debt reduction and resolution of certain debts. This option is best for folks who may not be completely overwhelmed by debt just yet, but they're beginning to recognize that if they don't do something soon then they will end up in an even worse-off situation.
There are serious consequences involved that everyone should be aware of before choosing this option. Particularly, folks should know that not all creditors may agree to a settlement, and that could lead to owing that creditor even more than you did when you began seeking a settlement in the first place. It's also common to end up owing taxes on the money that gets forgiven in any agreed settlements. Finally, debt settlement usually isn't great for your credit due to certain remarks and account statuses that result from the negotiation. And, there's always the opportunity for the creditor to ignore the negotiations or get annoyed by them and decide to just sue you instead. We've talked to several client's who luckily found out there was a problem with their debt settlement when they began receiving collection calls due to the credit card debt they thought was being handled by the company they hired.
Debt Management: A Closer Look
Debt management is similar to debt settlement but has some key differences. Primarily, debt management requires you to repay your debts while receiving a break on interest and late fees, as well as any other fees the creditor may charge (the company you work with will negotiate this break with each of your creditors). You'll complete credit counseling to begin the process, and each month you'll pay make one payment to the debt management company you work with and they'll pay each of your creditors. The repayment period usually last three to five years. While debt management can help some folks climb out of debt, the plans are often very strict and offer little to no room for renegotiation if your circumstances unexpectedly change during the plan.
The Process of Debt Management
Debt management begins by sitting down with a credit counselor who reviews your income and expenses, helps you build a budget, and calculates a monthly payment so you can repay your debt within the life of the plan, which is typically three to five years. This repayment plan, along with the budget, is called a "Debt Management Plan" or "DMP." After your meeting with the credit counselor, your plan begins and you start making monthly payments to the debt management company you're working with. Meanwhile, the company begins negotiating with your creditors to reduce interest and fees. Creditors don't receive payments until an agreement is reached, and the debt management company holds your money in an account until that time.
Benefits and Drawbacks of Debt Management
Debt management plans can absolutely help folks get out of debt through repayment. Many of the debt management companies secure very favorable interest rates for repayment and take care of a lot of fees that have been added to the account. Additionally, for folks who manage to stick to the DMPs they put together a long track record of timely payments, which can have a positive impact on your credit score. There are, however, certain things that you should consider if you're thinking that a debt management plan may be right for you.
The first thing you'll want to know before entering into debt management plan is that there typically isn't any opportunity to renegotiate if that becomes necessary. I frequently meet with folks who have experienced unexpected changes to their income or family (loss of job, new baby, etc.) and can no longer afford repayment according to the agreement. Even in these situations, they're stuck in their plan no matter what. They usually have a short period of time to begin making full payments again before going into default, and if they default then they're left owing the amount they owed prior to the agreement minus what they paid during their DMP.
You also have to close all of your credit accounts when you enter into a DMP. A lot of folks find that this leaves them with zero safety net since their debt management plan is designed for maximum repayment. Another thing to consider is that, like with debt settlement, all of your creditors may not agree to work with your debt management company, meaning they may essentially say "pay me the full amount + interest and fees or else we'll ramp up our collection efforts."
We work with folks who try debt management before filing bankruptcy. The most common complaints we here from these clients can be placed into two categories.
First, people feel like the plans are either unrealistic and impossible to stick to or clients are upset because they struggled through the plan until something happened to their income, at which point there was no opportunity to salvage the plan through renegotiation. The second category of complaints comes from folks who paid into their plans for some period of time only to later find out that no deal was ever reached so they're not on the path to debt relief they thought they were on. Almost all of our clients who try debt management first feel like they wasted time and money with it, and they wish they would've filed bankruptcy sooner.
However, to be sure, there are a lot of people who get rid of debt through DMPs. Our opinion is that to be successful you need a high level of discipline, job/housing/family stability, and a little luck to make sure nothing goes wrong during the plan.
Debt Consolidation: What You Need to Know
When you consolidate debt you combine multiple debts into a single new loan, turning multiple debts that accrue interest independently each month into a single debt and reducing your payments into a single monthly payment. It may be a good option if you can qualify for a loan large enough to pay off your existing debts, and if the new loan has a lower interest rate and lower payment than the combined total of your current payments.
Other options similar to debt consolidation that may be available to some folks home equity loans and credit cards that allow balance transfers with no or little interest for an introductory period of time.
The Mechanism of Debt Consolidation
Consolidating debt involves applying for and being approved for a loan large enough to allow you to pay off your existing debts, resulting in a single, manageable loan. This can reduce the amount you pay in interest and fees, and it simplifies things by reducing your multiple payments into a single payment.
Advantages and Disadvantages of Debt Consolidation
The advantages of consolidating debt can include lower monthly payments, a simpler way to repay, and sometimes getting out of debt sooner.
The downsides of debt consolidation are that most folks who are facing a debt avalanche are past the point where they can qualify for a consolidation loan. This option simply isn't available to many folks who could benefit from it. The other pitfall with consolidation is that folks sometimes get tempted when they get the funds from the consolidation loan and use the money for things besides paying off all their debt. This is a quick way to make a problem much worse really fast.
Ultimately, if you're struggling with debt and you qualify for a debt consolidation loan with a good interest rate then it's probably the best option you have. Unfortunately, most folks don't realize they could benefit from consolidating their debt until after it's too late and they already don't qualify.
How Does Bankruptcy Compare?
Bankruptcy allows individuals and businesses to eliminate or repay debt under the protection of federal bankruptcy court. Unlike debt settlement and debt management, creditors don't have a choice about whether they want to participate. Bankruptcy is also often a much faster process than these other options and it can save you a lot of money that you can use for things that you need or save it for the future. We regularly work with clients who try these other options before filing bankruptcy and almost without fail, they feel a greater sense of relief sooner with bankruptcy and wish they would've filed sooner.
Finding relief from debt is hard, and it frequently involves making difficult choices. It's important to consider the different options available to you. Debt settlement can provide a way to reduce your overall debt amount, but it comes with risks and potential tax consequences. Debt management offers a structured repayment plan and can help you regain control of your finances, but it may not reduce the total amount you owe and there isn't usually any room to renegotiate the plans if it becomes necessary. Debt consolidation combines multiple debts into one, making it easier to manage, but it's not an option that most folks qualify for by the time they realize their debt is out of control. Some folks end up trying other debt relief options before choosing bankruptcy, and they typically report wishing they would've skipped the other option and chose bankruptcy first. Many folks find that bankruptcy offers the simplest, swiftest, most straightforward path to getting rid of their debt and moving on with their lives.