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Debt relief is an umbrella term describing a few techniques used to manage mounting debt. Debt relief actions may have an impact on your credit, but it depends on which method you choose.
Even if your credit score has taken a hit as a result of financial hardship or mismanagement of debt, it's not too late to get relief and prevent any further damage to your credit. Read on for more information about various debt relief options and how they can help—or hurt—your credit scores.
How Does Debt Relief Work?
Here is a breakdown of the different plans that fall under the debt relief banner.
- Debt settlement is a process in which you enlist an outside company to help negotiate and settle your debt with a certain creditor. In exchange for a fee, debt settlement companies will work to lower your overall debt and may negotiate a lump-sum payment with your creditors on your behalf. They will typically ask you to stop making payments to the creditor while they negotiate your settlement, which can hurt your credit. If the company succeeds in reaching a settlement, you will still pay your creditor a portion of your debt, but usually not all of it. In addition to the cost and impacts to your credit, there are tax implications with this method, as forgiven debt is typically reported to the Internal Revenue Service as income.
- Debt management is an approach that involves enlisting a credit counselor to help you plan and execute a responsible repayment plan. Once a credit counselor reviews your situation, they will help you develop and stick to a plan for managing all your debt. In most cases, debt management plans will outline how much you'll have to pay each month and for how long—and your counselor will hold you accountable for sticking to your plan. Some debt management plans may also require that you not apply for additional credit for a certain period of time and may want to make your payments on your behalf each month. Different from debt settlement, most debt management credit counseling agencies are nonprofits and charge a low monthly fee for their service.
- Debt consolidation is a method in which you consolidate various debts under one new loan. This allows you to save money on interest over time and can help you streamline repayment. There are two popular ways of consolidating your debt: using a new personal loan or debt consolidation loan to wrap your other debts into one, or using a balance transfer credit card to concentrate all your existing credit card debt onto one card.
- Bankruptcy is a last resort option that may help you find relief if you are overwhelmed with debt. Declaring bankruptcy is a complex legal process that involves going to court and in many cases requires you enlist the help of an attorney. Once you file for bankruptcy, a court will evaluate your debt and finances and will make sure you've exhausted every option before granting you a bankruptcy discharge. Depending under which chapter you file—Chapter 7 or Chapter 13 are the most common—a discharge will reduce or wipe out some or most of your existing debts and will make it so creditors can not contact you to pursue what you owe them.
The objective of each of these methods is to get a handle on your mounting debt by reducing or eliminating your outstanding balances—but that doesn't mean they are all good options. Debt can be stressful, but it is important to do research and understand your options so you don't choose a debt relief method that could hurt you even more in the long run.
How Do Debt Relief Plans Affect Credit?
Debt relief can be good and bad for your credit—it all depends on which method you choose and how far behind you let your debt fall. Ultimately, if you miss payments and let accounts fall past due, your credit score is going to suffer. It's possible to have a lot of debt at one time and still have a good credit score, but the trick is to make sure you manage your repayment responsibly to keep your credit health in check.
Here are a few ways each of the major debt relief options can affect your credit:
- Debt settlement is one of the more dangerous debt relief options when it comes to harming your credit score. Debt settlement companies typically ask customers to discontinue payment to creditors while they negotiate on your behalf. Payment history is the most important factor in your credit scores, and if you miss any debt payments, your credit score will take a dip.
Debt settlement companies are not chiefly concerned with your credit scores; they focus on lowering or eliminating what you owe. Be cautious when working with a debt settlement company and make sure to work with a reputable firm. You can check with your local consumer protection agency or state attorney general to find out if the company has had any complaints filed against it in the past. Also consider the full effect missing payments could have on your credit history and the tax implications that come with settling debt. Debt settlement should be one of your last options, only after you've tried remedying your debt with less harmful tactics, like debt management or consolidation, or one of the alternative methods mentioned below.
- Debt management is a great option for someone looking to relieve their debt woes without hurting their credit score. With this method of debt relief, your credit counselor works with your creditors to create a repayment plan that will work for you—and then you stick to it. As long as your repayment goes as planned—meaning you don't miss any payments—your credit score should remain unharmed. Refer to the list of credit counselors approved by the U.S. Justice Department when looking for a counselor in your area.
- Debt consolidation is a good option for finding some relief from creditors that shouldn't hurt your credit scores if you manage it responsibly. If you end up consolidating your debt with a new loan or credit card, chances are you'll incur a hard inquiry as a result of letting a new lender check your credit for your application. Hard inquiries can ding your credit scores, but the impact is typically small and short-lived. Also be sure to make all your payments on time, as payment history is the most important aspect of your credit scores; even one late or missed payment can bring your score down. And try not to apply for any new credit cards while you work to pay off your current debt.
- Bankruptcy will severely affect your credit scores and will remain a part of your credit history for seven to 10 years. It will also make obtaining credit in the future [difficult. If you're thinking about declaring bankruptcy, make sure to consider all other debt relief to see if your financial woes can be solved using another method.
Most likely, if you're looking for debt relief options, your credit scores have already suffered in some way. But that doesn't mean it's too late to prevent further damage. Debt relief can be helpful for relieving stress, and also for limiting the lasting damage your credit history could endure if you fall significantly behind on your payments.
Alternatives to Debt Relief Plans
If you're feeling swamped with debt and are looking for other ways to relieve the pressure, there are a few other actions you can consider. These options are alternatives to debt relief and may be good first steps if you're only having issues with one or two creditors, haven't gotten to a point where you are completely overwhelmed with your debt, or think you'll be able to manage your burden on your own. If you give these a try and feel that you need a more serious debt relief option, consider one of the more serious action plans listed above.
- Consider making a balance transfer. If you're dealing with a lot of high interest credit card debt, you may want to see if you're eligible for a balance transfer at a low interest rate with one of your existing credit cards or a new card. You may get an introductory balance transfer interest rate as low as 0% for a certain period of time (usually up to about 12 months), which will help you avoid interest as you work to pay off your debt. If you can't qualify for a new card, figure out which of your existing cards has the lowest annual percentage rate (APR), and then give the issuer a call to see if they offer a balance transfer option. Moving money from one card with a high APR to another card with a lower APR can save you money over time—as long as you don't continue charging on your cards with higher interest.
- Negotiate with your creditors on your own. If you're significantly behind on your credit card payments, you can try contacting your card issuers to negotiate a lump-sum payment or adjusted payment plan for a lower amount that you originally owed. The lender in this case lowers the amount owed so they can at least recoup some of what they were owed, instead of none at all. This won't be possible with every lender, and the outcome of this negotiation will vary greatly based on your specific scenario. But it's worth considering, especially because you won't have to pay a third party to do the work for you.
- Seek free credit counseling. Find a credit counselor or peer who can help you organize your finances and get them under control. Once you find someone who can help, work with them to create an actionable plan and stick to it. Use them to hold you accountable, and make sure to keep accurate and thorough records of all your debt and payments to make sure you're successfully working toward your goals.
If you're not sure what your debt situation is and want to find out more about your credit scores and current debt, consider getting a free copy of your credit report and score from Experian to find out what is in your credit file.
Paying down your debt when you're overwhelmed may seem impossible, but with the right strategy and determination to get back on strong financial footing, it can be within your reach.