Ask Dr. Don By Don Taylor, Ph.D., CFA • Bankrate.com

Debt-free in 2005

Dear Dr. Don,
I am getting ready to use a debt consolidation program to get out of credit card debt. They said that in 27 to 30 months I will be debt free from a total of $23,000 to $13,000 on their program. Is this OK to do?
Mary Myriad

Dear Mary,
A debt consolidation plan takes your existing debts and repackages them as one loan. It's not a partial payment of the debts, it's a financial restructuring. Consumers benefit from a lower monthly payment even if as a net result they end up spending more in interest expense by extending their loans over a longer period.

Debt consolidation plans work best when you can tap into your home's equity with a cash-out refinancing, a home equity loan or a home equity line of credit. The downside to tapping your home's equity is you're trading unsecured debt for secured debt.

What you're describing sounds more like a debt negotiation than debt consolidation. Debt negotiators offer a service where they negotiate with your unsecured creditors to accept a partial payment. Debt negotiators assert that they will attempt to get the creditor to list the accounts "paid as agreed" on your credit report but they can't guarantee that result.

If you're current on your bills, your creditors won't see much reason to negotiate. If the debt negotiator withholds payments to your creditors to give them a reason to negotiate you've successfully trashed your credit history, and your best hope is that the negotiator is then successful in getting the companies to list your accounts as "paid as agreed" while accepting partial payment. That's taking a big risk.

Another solution is to sign up with a credit counselor. A credit-counseling agency will act as an intermediary between you and your unsecured creditors to arrange a debt-management plan. The credit counselor may be able to negotiate a lower interest rate, but there's no debt forgiveness. Your credit report will typically note that you are repaying the debts under a repayment plan.

A debt-management plan won't affect your credit score but could affect your ability to get new credit. Negative information about an account will stay on your credit report for seven years. This Bankrate feature has more about debt management plans and another feature helps you interview credit counselors. The FTC guide Fiscal Fitness: Choosing a Credit Counselor is also required reading before hiring a counselor.

Bankruptcy is another alternative. In a Chapter 13 Bankruptcy filing you work with the bankruptcy court to establish a repayment plan over three to five years. Upon successful completion of the plan the bankruptcy court will discharge all remaining eligible debt. A Chapter 13 bankruptcy filing stays on your credit report for seven years.

While a Chapter 7 bankruptcy filing liquidates all nonexempt assets to form a bankruptcy estate, you get to keep all exempt assets. The bankruptcy estate proceeds are used to pay your creditors. All eligible debts are discharged by the bankruptcy court. At that point you no longer owe anything on the discharged debt. A Chapter 7 bankruptcy filing stays on your credit report for 10 years.

My recommendation is to choose between a debt consolidation loan and credit counseling when you're confident you can turn things around. Choose either a Chapter 13 or Chapter 7 bankruptcy when you don't think you can turn things around without the help of the bankruptcy court. Don't consider debt negotiation without looking hard at these other choices first.

-- Posted: Jan. 27, 2003