How Does Debt Relief Work?

Quick Answer

Debt relief involves consolidating or negotiating your debt to make it more affordable. Depending on your situation, you may consider debt consolidation, a debt management plan, debt settlement or even bankruptcy.

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Debt relief can come in a handful of forms, ranging from debt consolidation to bankruptcy, with the ultimate goal of making your debt more manageable. If you're overwhelmed with debt, pursuing debt relief can create an opportunity to improve your financial situation.

What Is Debt Relief?

Debt relief involves reorganizing or negotiating your debt in a way that makes it easier to repay. Depending on the type of debt relief you choose, you may be able to accomplish one or more of the following objectives:

  • Combine multiple monthly payments into one
  • Reduce your interest rate
  • Lower your monthly payment
  • Extend your repayment term
  • Settle for less than what you owe
  • Have your debts wiped out altogether

If you're in need of debt relief, lenders are often willing to work with you, especially if the alternative is default. However, the types of debt relief that are available to you and the best path depend on your situation.

Types of Debt Relief

There are four types of debt relief you can use to work toward becoming debt-free. Depending on the severity of your financial situation and your ability to repay what you owe, one method may be better than the others. Here's a quick summary of each and when you might consider them.

Debt Consolidation

Debt consolidation involves applying for a loan or balance transfer credit card and using it to pay off existing debts. This strategy works best if you can qualify for a loan or credit card that offers a lower interest rate than what you're currently paying. That typically requires good or excellent credit, which means a FICO® Score of 670 or higher.

Options include:

  • Balance transfer credit cards: These cards offer introductory 0% annual percentage rate (APR) promotions that allow you to pay down your debt interest-free over a period of a year or more. This is an excellent strategy as long as you can pay off the transferred debt before the promotional period ends. But if you're complacent, you could end up back where you started.
  • Personal loan: A personal consolidation loan may offer a lower interest rate than what you're paying now and a fixed repayment term. However, it could also result in a higher monthly payment, so make sure it fits in your budget.
  • Home equity loan or line of credit: If you own your home, a home equity loan or home equity line of credit could be worth considering. They often charge lower interest rates than personal loans, and you can also use them for other reasons, such as home improvements. However, these loans can also have high closing costs, and because you're using your home as collateral for a loan, you risk losing it if you can't keep up with loan payments.

Debt consolidation is best for borrowers who have a manageable amount of debt and a relatively high credit score, which is necessary to qualify for favorable rates on a consolidation loan or credit card.

But moving debt from a credit card to another card or a loan could create an opportunity to rack up more debt on the original card, so have a plan in place to avoid making your situation worse.

Debt Management Plan

If you're having trouble making your monthly payments and your credit is less than perfect, working with a credit counseling agency could be a good next step.

A credit counselor can not only help you with basic things like creating a budget, but they can also put you on what's called a debt management plan to help you pay off credit card debt. With this arrangement, the credit counselor can negotiate lower interest rates and monthly payments with your creditors, and you'll make just one monthly payment to the credit counseling agency.

However, you may be required to close your credit card accounts, and you generally can't apply for new credit until you complete the debt management plan, which typically lasts three to five years.

If you're considering a debt management plan, make sure you're working with a nonprofit credit counseling agency, which can be more reputable and offer lower costs. You can find a nonprofit agency in your area through the National Foundation for Credit Counseling or the Financial Counseling Association of America.

Debt Settlement

If you've already missed some payments and a debt management plan isn't the right fit, you may consider debt settlement.

With this option, you'll attempt to negotiate with your creditors to settle your unsecured debt for less than what you owe. You can do it on your own or with the help of a debt settlement company or law firm.

Debt settlement can help you eliminate debt, but if you don't have enough cash to pay the lump-sum settlement amount, it's not a viable option. And if you work with a debt settlement company or law firm, their tactics could further damage your credit and cost you more money.


If your debt situation is so dire that you can't even afford to make modified monthly payments, bankruptcy may be the last resort option. There are two types of consumer bankruptcy—Chapter 7 and Chapter 13:

  • Chapter 7: With this option, most of your assets are sold to pay off whatever you can, after which the remainder of your debt is wiped out. It's designed for people with low incomes who can't afford a restructured debt repayment plan.
  • Chapter 13: With this type of bankruptcy, your debt repayment plan is reorganized to make it affordable for you, and you must complete the new court-mandated repayment plan. The remaining balances left over at the end of the restructured repayment plan—which typically takes three to five years—are discharged.

Like debt management plans and debt settlement agreements, filing bankruptcy typically won't get rid of your mortgage, auto or student loans.

Bankruptcy can be worth considering if you've exhausted all other options. But keep in mind that it will do serious damage to your credit and will factor into your credit score for up to 10 years.

Is It a Good Idea to Use a Debt Relief Company?

Debt relief companies specialize in facilitating a debt settlement arrangement between a borrower and a creditor.

Because the settlement amount is typically a lump sum, for-profit debt settlement companies often encourage you to stop making payments on your debts and instead make payments into an account with the company until you have enough to settle.

Missing payments for an indefinite period of time can damage your credit score significantly and cost you hundreds or even thousands of dollars in fees—and that's on top of the fees you'll pay the company or law firm.

There's also no guarantee that you'll get the results you're looking for, and you could fall victim to a scam. As a result, it's generally best to pursue other options or attempt to settle on your own.

Does Debt Relief Affect Your Credit Score?

Regardless of which type of debt relief you pursue, it'll likely have an impact on your credit score. However, that impact can vary depending on what you choose and how you proceed:

  • Credit inquiries: When consolidating debt, applying for a new loan or credit card will typically involve a hard inquiry on your credit reports, which can knock a few points off your credit score.
  • New account: Opening a new loan or credit card account to consolidate debt will affect your length of credit history.
  • Credit utilization: If you move a balance from one credit card to another or pay off a card with a loan, the change in your credit utilization rate can either help or hurt your score. However, if you get on a debt management plan and need to cancel your cards, your utilization rate will spike, damaging your credit.
  • Closing accounts: If you have to close credit cards for a debt management plan, they'll no longer contribute positive information to your credit reports.
  • Positive payment history: If debt consolidation or a debt management plan can help you avoid missing a payment, they can contribute positively to your credit score.
  • Missed payments: If you've missed payments leading up to a debt management plan, debt settlement or bankruptcy, they'll remain on your credit report for seven years from the original delinquency date. If a debt settlement firm encourages you to continue missing payments, the damage to your credit score can increase over time.
  • Settlement or default: If you ultimately default on a debt or settle for less than what you owed, that means you didn't pay the debt as you originally agreed. As a result, these items will remain on your credit report for seven years from the first missed payment.
  • Bankruptcy: Bankruptcy can damage your credit score significantly. A Chapter 7 bankruptcy will stay on your credit reports for 10 years from the filing date, while a Chapter 13 bankruptcy will fall off your reports after seven years.

Consider Both Short- and Long-Term Effects

Getting out of debt sooner than later is always appealing, but depending on the potential negative long-term impact, it may not be worth it. As you consider which debt relief approach to use, think about the trade-offs for each one.

Check your credit score and credit report to get a better understanding of your situation, and research your options to determine the best one for you. If you're having trouble figuring out the best path forward, consider reaching out to a credit counseling agency to get some basic advice based on your situation. While they can help with a debt management plan, they can also tell you whether one of the other debt relief methods would be a better fit.