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Debt relief companies, also sometimes referred to as settlement or adjustment companies, offer a number of services to help make it easier or less expensive to pay down large amounts of high-interest debt.
Debt relief is often a last-resort option. And, depending on your relief method, debt relief can be expensive and risky. However, it can significantly reduce the amount of debt you have to pay down, can make your debts more manageable and can help you get back on financial track much faster than if you were to pay down your debts without assistance.
6 types of debt relief and how they help
There are six types of debt relief that you could be offered. Much like every other financial tool or institution, not every company will offer every single option, so shop around to find the company that offers exactly what you’re looking for.
1. Debt settlement
- Your entire balance could be forgiven.
- You no longer have to keep up with your creditors.
- Could result in more manageable monthly payments.
- There’s no guarantee of settlement with your creditors.
- You could end up paying more than you originally owed in fees.
- Your credit score will be damaged.
Debt settlement is when a relief company negotiates your debts with your creditors on your behalf to either reduce or eliminate your debt. If the creditor agrees to work with the company, your assigned representative will notify you when each debt is settled and will create a repayment plan for you if necessary.
Debt settlement can be a great tool, but it comes at a potentially high price; typically a flat fee between 15 percent to 25 percent of the enrolled debts. There’s no guarantee that the creditor will agree to work with a third-party company and if the creditor’s refuse, you’ll have to recoup the missed payments.
You’re also often required to stop making payments, so your credit score will take a large hit regardless of if your creditors agree to work with the debt relief company.
2. Debt consolidation
- Could help put you on a faster repayment track.
- Lower interest rates can lower your total amount paid.
- You could see a significant credit score boost.
- There could be fees and upfront costs.
- Missing payments will negatively impact your credit score.
- You need to have a good credit score to qualify for a low interest rate.
If you have multiple streams of high-interest debt and are looking to lower your interest rate, then you may want to consider consolidating your debt.
Debt consolidation is when you take out a consolidation loan with a new lender that replaces your preexisting loans. If you have a less-than-stellar credit score or a thin credit history, it may not make sense to consolidate — it’s most beneficial if you can lower your overall monthly payment through a lower interest rate.
3. Debt forgiveness
- It takes the responsibility of negotiation off of your shoulders.
- Your entire balance could get forgiven.
- Your monthly payments may be more manageable.
- Your forgiven balance could be subject to taxation.
- Your credit score will likely take a hit.
- There’s no guarantee of forgiveness.
Some creditors or lenders offer financial hardship forgiveness options and you can seek this option out on your own or through a relief company. However, working with a company is likely to make the process much more simple.
Depending on your lender or situation, you may qualify for a partial or full forgiveness of your debts through a settlement agreement. This agreement will also include the forgiven amount, although it will not be collected.
4. Credit counseling
- Legitimate credit counseling typically charges few, if any, fees.
- You have the opportunity to work one-on-one with a counselor.
- You’ll get access to alternative plans, like debt management.
- Counseling won’t eliminate or forgive your debts.
- It won’t solve any of the underlying issues or habits.
- Some agencies may limit your free session amounts.
Credit counseling is offered by nonprofit organizations and third-party companies or agencies, often free of charge. This method of debt relief is a bit different from the rest, as it is often done at little or no cost.
When you work with a counselor, you’ll have an initial consultation where they’ll review your financial portfolio and credit health. From there, the counselor will create a plan based on your needs, whether it be to pay down debt, increase your credit score or grow your savings.
5. Debt management
- You’ll work closely with your counselor throughout the process.
- Your debt will be paid down in a maximum of five years.
- The DMP will be tailored to your specific situation and needs.
- Your creditor may not agree to work with your DMP.
- You likely won’t be able to apply for credit until the plan is repaid in full.
- Your credit score will be negatively affected.
A debt management plan (DMP) is a plan that lasts around two-to-five years and is geared toward helping you get out of debt faster. With a DMP, you’ll work with a credit counselor who will negotiate with your creditors to lower your interest rates or total amount owed.
However, much like a settlement or forgiveness plan, your creditors need to agree to work with your DMP and there’s no guarantee that they will. Plus, you won’t be able to apply for new lines of credit until your plan is complete, as your creditors will more than likely close your accounts upon enrolling in a DMP.
- You’re given a fresh start if your debts are discharged.
- It can stop lawsuits and wage garnishments for your delinquent balance.
- Your credit score will take an immediate hit.
- It can stay on your credit report for 10 years.
- You’ll likely be charged legal fees for using an attorney.
Bankruptcy is a debt relief method that should only be used as a last resort. There are two common types: liquidation (Chapter 7) and reorganization (Chapter 13). Both forms will have detrimental effects to your credit, with Chapter 7 remaining on your credit report for up to 10 years and Chapter 13 for up to seven.
You’ll only have to give up your assets in the case of a Chapter 13, but you’ll have to undergo a three-to-five-year repayment plan until your debts can be discharged. Because of this, it’s imperative that you consult with a bankruptcy attorney before making a final decision to file.
Risks of debt relief
While debt relief can be a helpful — or even life-changing — tool, there are inherent risks associated with working with a relief company. Here are some of the risks you’ll need to consider before making a decision.
- Scams that closely resemble legitimate businesses.
- Long-lasting negative credit ramifications.
- Hefty fees and agency costs.
- Taxation of the forgiven balances.
- Could result in your creditors filing a debt collection lawsuit against you and the company you use.
- Your creditors may refuse to work with a third-party company.
- Generally, you’ll have to stop making payments when signing on with a settlement company.
- It’s unlikely that the relief company will be able to settle or negotiate your entire balance on your behalf.
How to know if a debt relief company is legitimate
Unfortunately, debt relief scams are common and it can be easy to unknowingly fall into a trap. However, there are some telltale signs that can make it easier to spot a scam versus a legitimate company.
For one, a legitimate debt relief company will never charge upfront fees. You’ll be charged a flat-rate fee only after the debts are settled or forgiven and this will be explicitly stated within the terms. Plus, if any company advertises that complete forgiveness or settlement is guaranteed, it’s almost certainly a scam.
Another sign to look for is the lack of an initial consultation. If a debt relief company doesn’t require an initial in-person, online or phone consultation, then you’ll likely want to find another company to do business with. These meetings are used to identify if you meet the general relief requirements, and if so, what method would be best for you.
When it’s best to seek debt relief
You may want to consider working with a debt counselor or relief company if any of the following describe your current situation:
- You have large amounts of unmanageable, high-interest debt.
- Creditors are constantly contacting you about overdue balances.
- You don’t qualify for a traditional debt consolidation loan.
- Your interest rates are so high that you’re not making any progress toward paying down your principal.