Debt relief programs are packages designed by third-party debt settlement companies to help consumers stuck in expensive debt restructure their financial plans. In its simplest form, a debt relief program tries to make debt affordable for these consumers by negotiating with the creditor for lesser pay than what they owe as payment in full.
This article will discuss everything you need to know about debt relief programs.
How does Debt Relief Work?
Before committing to a debt relief program, it is essential to understand your options and their consequences. There are two ways to approach debt relief.
The first is by hiring a debt relief company that acts as the middleman between you and the creditor. The company assigns you a financial advisor who explains the workable options and then negotiates with the creditor on your behalf for lesser pay. This option is great if you want a faster way to get out of debt. However, experts warn that debt relief programs can be more expensive since the companies are more profit-driven.
Typically, the debt settlement company expects to earn 15% to 25% of what you owe and a service charge which can be hefty. When you enroll in a debt repayment plan, you may be required to stop making payments directly to the creditor. Instead, the counselor may advise you to channel monthly payments into their account until the amount is enough to give your creditor a settlement offer. On the other hand, the debt relief company handles the negotiations and waits for their cut.
Alternatively, you can take the DIY approach, which involves asking the creditor to accept a lesser pay, and agreeing on new payment terms. This option may be affordable compared to relying on third-party debt settlement companies, but it will require a lot of financial discipline.
What are the Benefits and Risks of Debt Relief?
The primary goal of debt settlement is to pay off debt and avoid bankruptcy; however, various risks are involved. Here are the primary pros and cons of debt settlement:
- It may help you pay down high-interest debt
High-interest loans have led many people to the pits since they are expensive and unsustainable. However, settlements can save you up to 50% of the owed balance, translating into 30% of your saving if you factor in the debt settlers’ fees.
- Helps pay off debt faster.
Debt settlement helps you speed up the repayment process by cutting short the timeline. As with large debts, it could take years or even decades to pay them off completely. This means a higher risk to your finances. Debt settlement could significantly help by cutting short the repayment period.
- May help you avoid Bankruptcy.
Filing for bankruptcy comes with serious consequences. It may stay on your credit report for as long as a decade, making it harder or, at times, impossible to get a loan, buy a car, find housing, or even get employment. Therefore, debt settlement could help you avoid it altogether,
- May put a stop to collection calls.
Debt collectors can be very persistent and annoying; however, getting a settlement plan may put a hold on the frequent calls. It is wiser to get the agreement in writing and remember the date you signed it.
While debt settlement may seem like the glim of light you need, it is imperative to keep the following risks and consequences in mind:
- It hurts your credit score
The debt settlement company will require you to stop making payments to the creditor for a while as you save up for the settlement. This may lead to penalties and other fees that temporarily lower your credit score. Of course, if debt settlement is a viable option, your credit score has already declined.
- It may lead to tax consequences.
While settling is regarded as a “forgiving” part of your debt, the IRS may consider the forgiven amount as taxable income, increasing your annual tax burden.
- The process can be expensive.
Aside from the agreed settlement amount, you will have to part with several fees to facilitate the debt negotiation process. They may include set-up fees, third-party fees, and other monthly fees.
- Creditors may refuse to settle.
The creditor may not agree to the settlement. Thus you may not be able to settle your debt. Unfortunately, you may lose the money saved in the debt settlement company’s accounts, leading to a worse financial situation. It is wise to avoid companies that advise you to stop communicating with the creditor or those that charge upfront fees.
While debt settlement could be a great way to get out of debt, exploring alternatives such as enrolling in a debt management plan, seeking non-profit credit counseling, balancing transfer credits, or debt consolidation is smarter.
However, if you choose debt settlement, it is vital to do some due diligence on the debt settlement company. You can start by checking with your consumer protection agency for their credibility. Also, take your time to understand the terms of the debt relief program and the state’s attorney general office fees. The process should take a significantly shorter duration, depending on your debt.