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Understanding the pros and cons of debt relief

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By Andrew Housser

Many Americans struggle to rein in their debt. Whether it is student loans, car financing, medical bills or credit cards, countless people find their income barely stretches to cover the payments. Many struggle month after month year after year. Others are able to change their ways and get out of debt on their own.

Still others find that they cannot make monthly payments. They might even be at risk or suffer through having a car repossessed or facing foreclosure on their home – not to mention the daily struggle of having creditors and collectors ringing the phone.

Fortunately, people have many options to get out of debt. Here is an explanation of the pros and cons of three common paths to finding debt relief.
 

1. Debt negotiation.

Debt negotiation (sometimes called debt settlement) companies negotiate directly with creditors to resolve people’s unsecured debt balances. While they are in a debt negotiation program, consumers do not make payments to creditors. Instead, they deposit savings into a dedicated account. Once the debt negotiation company negotiates, or settles, a debt, the consumer uses the saved funds to pay the creditor.

The pros of debt negotiation are that people can get out of debt, typically in 24 to 48 months; debt balances may be reduced by almost half (before fees); the monthly program payment usually is significantly less than minimum debt payments; and the impact on credit profiles often is less than that of a bankruptcy filing. The cons of debt negotiation are that creditors may continue calling during the negotiation process or even pursue legal action; your credit rating will be negatively impacted due to not making minimum payments; you must pay a fee to the debt negotiation company for its services; and, as with any forgiven debt, you might have to pay income tax on the forgiven debt amount (although this tax can be waived for people whose debts are greater than assets).

Bottom line: Debt negotiation is a viable option for people who are struggling to make minimum payments, and who are willing to dedicate themselves to a process lasting two to four years.
 

2. Credit counseling.

In credit counseling, companies help consumers repay debt on a set schedule. Some credit counseling agencies are nonprofit, but many are for-profit. Credit counseling agencies generally set up a debt management plan (DMP) that reduces the consumer’s monthly payment obligation. The agencies can do this through pre-arranged agreements with credit card companies that allow them to lower interest rates on existing debt to a creditor-issued "concession rate." With a DMP, the consumer deposits money each month with the credit counseling agency, and the agency then uses those funds to pay creditors. Consumers will pay back 100 percent of the debt they owe, plus interest, at the reduced concession interest rate.

The pros of credit counseling are that collectors will stop calling as long as you are on track with the program; the monthly payment is often less than creditors’ minimum payment obligations (but higher than a debt negotiation program payment); and having one monthly payment can simplify the debt repayment process. The cons of credit counseling are that the fees can be expensive ($10-$15 per month, per enrolled debt); you will pay back 100 percent of the principal amount of the debt, plus interest (at the reduced concession rates); it can have a negative impact on your credit profile and access to credit while enrolled in the program (which can be up to five years); and the success rate often is low – in large part driven by the relatively high monthly payment obligation.

Bottom line: Credit counseling can be a good option if you only need a lower interest rate, and have the discipline to stick with the program while not incurring additional debt.


3. Debt consolidation.

Debt consolidation is the process of compiling multiple debts into one loan, with one monthly payment. Some people undertake this process on their own, whether through balance-transfer credit card offers, a home equity loan (using the proceeds to repay other debts) or a personal loan. Others opt to work with debt consolidation services, who help consolidate debt for a fee on top of the interest on the loans.                                              

The pros of debt consolidation are that the process has one predictable monthly payment and one predictable interest rate. Debt consolidation loans often have a fixed amortization period, which provides the ability to pay debt down in a specific time period. Interest rates on debt consolidation loans typically are much lower than interest rates on credit cards; and in the case of using a home equity loan to consolidate debt, the interest may be tax-deductible. The cons of debt consolidation are that the option might not be available to people with poor credit or no income; the monthly payment may be higher than credit card payments, even with a lower interest rate (given a shorter payback period); and loans secured against a home or vehicle put those assets at risk if you fail to make timely payments on the loan.

Bottom line: People who are not in a hardship, and who have the ability and self-discipline to pay down their debt and resist charging up balances on other credit cards, might find debt consolidation useful.
 

Whichever method you choose to get out of debt, it is important to ensure that you work with a credible company. One way is to choose an accredited member of the American Fair Credit Council (AFCC). The AFCC’s code of conduct is even stricter than the FTC’s. It also can be helpful to choose a firm that requires counselors to receive certification from the International Association of Professional Debt Arbitrators.

 

Andrew Housser is a co-founder and CEO of Bills.com, a free one-stop online portal where consumers can educate themselves about personal finance issues and compare financial products and services. He also is co-CEO of Freedom Financial Network, LLC providing comprehensive consumer credit advocacy and debt relief services. Housser holds a Master of Business Administration degree from Stanford University and Bachelor of Arts degree from Dartmouth College.
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