Debt Relief: What Are the Options & How Do They Work?

What Is Debt Relief?

Debt relief is a process that helps individuals struggling with debt find a way to reduce or manage their financial obligations more effectively. This can include negotiating lower interest rates, consolidating multiple debts into one, or even settling debts for less than what is owed.

When Should You Consider Debt Relief?

You should consider debt relief if you find yourself consistently unable to make minimum payments on your debts, your total debt amount is overwhelming compared to your income, or you're facing financial hardship that makes it impossible to pay off your debt in the foreseeable future.

What Are the Most Common Debt Relief Options?

The four most common debt relief options are:

• Debt management plans facilitated by a nonprofit credit counseling agency for a small monthly fee

• Debt consolidation via a personal loan or credit card balance transfer to a card with an introductory 0% interest rate

• Debt settlement, where you negotiate a lower repayment amount with the debt collector on debts that have been sent to collections

• Bankruptcy, where you file court papers to have your unsecured debts (credit cards, medical bills, personal loans, payday loans, past-due utilities, etc.) discharged

This and other articles online provide general insight into how to decide which debt relief option is best for you. But everyone's situation is different, so the best first move is usually to schedule a free consultation with a nonprofit credit counselor. Credit counselors will look over your income and debt and ask about your financial goals. With this information in hand, they can give you a professional opinion on the best debt relief option for you. Make sure your credit counselor is accredited by the National Foundation for Credit Counseling.

How To Use a Debt Management Plan for Debt Relief

A debt management plan (DMP) is a way to pay off your debts with one monthly payment. It's set up by a credit counselor who works with your creditors to lower your interest rates. The main goal of a debt management plan is to simplify the payoff process and potentially pay less on your debt over time through reduced interest.

What Are the Pros and Cons of a Debt Management Plan?

Each debt relief option will have its strengths and weaknesses. When it comes to DMPs, the pros are:

• Simplified repayment process: Your eligible debts are essentially consolidated by a credit counselor, so you only have one monthly payment to focus on making. The credit counselor will also work to negotiate this payment down so your total monthly payment is lower than what it was before the DMP.

• Lower debt amount: While it's not guaranteed, most credit counselors will work to reduce the interest rate on your high-interest credit card debt, which saves you money in the long run. Experienced credit counselors often also have success getting creditors to waive past-due fees or other charges related to late payments.

• Support and guidance: Credit counseling agencies provide financial education and support to help you manage your finances better today and in the future. Being in debt can be overwhelming, and it helps to have an experienced pro on your team.

Here are the major downsides of a DMP:

• Time to complete the plan: DMPs usually take 3–5 years to complete, so this isn't a quick solution. It also means you have to stay committed to repayment for an extended period of time to see the benefits of the program. If you don't stick to the plan as agreed, your creditors usually have the right to stop participating, which puts you back at square one.

• Impact on credit: DMPs are most commonly used to repay high-interest credit card debt. As a condition of most DMPs, you usually have to agree to close the accounts that are included in the plan. Closing credit accounts can hurt your credit score. The impact on your credit score will depend on several factors, including whether you have a history of late or missed payments. If you do, you may have already damaged your score more than signing up for a DMP will.

• Limited to unsecured debts: You can only include unsecured debt like credit card bills, medical bills, and personal loans in a DMP. Unsecured debt is any debt that's not backed by collateral or otherwise tied to personal property. Car loans and home loans are two common types of secured debt that can't be included in a DMP.

Bottom line: It's free to talk to a credit counselor to see if you're a good candidate for a DMP. While these plans may hurt your credit score, this is often temporary, and they can also save you a lot of money over time — and give you peace of mind in the meantime. Enrolling in a DMP can also help you get debt collectors to stop calling and save you from a potential debt lawsuit.

How To Use Debt Consolidation for Debt Relief

With debt consolidation, the borrower takes out a new loan and uses the funds to repay other debts. Then they repay the consolidation loan according to the terms specified in the loan agreement. 

Similar to a debt management plan, debt consolidation allows you to combine multiple debts into one loan with a single monthly payment. The new loan ideally has a lower interest rate than the combined rates of your previous debts. The goal is to make payments more manageable and to pay off debt faster.

Debt consolidation can be achieved through a consolidation loan from a bank, credit union, or online lender, or by using a balance transfer credit card that offers a 0% introductory interest rate.

This can give you, the borrower, a fresh start with your debts. It also helps simplify your finances since you only have to make one monthly payment. And as long as you can make your new payment, you won’t incur any more late fees or overdue notices. This helps improve your credit score and prove to lenders that you can handle your monthly payments. Debt consolidation loans can be used regardless of what type of debt you have or how much you owe. 

Keep in mind that if you are unable to pay this new loan off, your credit rating will be even further damaged. And many debt consolidation loans charge high interest rates and upfront fees, so borrowers need to be prepared for this when they apply. Avoid this option if you’re unable to reliably make the minimum payment every month. 

What Are the Pros and Cons of Debt Consolidation?

If you're considering debt consolidation, you'll want to know the upsides and downsides. Here are the biggest pros of getting debt relief through debt consolidation:

• Lower interest rates: If you can secure a lower interest rate, you can significantly reduce the amount of interest you pay over time. If you use a balance transfer credit card and repay the debt before the 0% APR rate goes away, you may be able to avoid interest payments altogether.

• Simplified payments: Merging multiple debts into one payment makes it easier to manage your finances.

• Improved credit score: Your payment history is one of the biggest factors in calculating your credit score. Making regular, on-time payments can improve your credit score over time.

• Straightforward and DIY: You don't need to hire a company or get outside help to consolidate your debts. You will need to apply for a loan or 0% APR credit card, but you won't have to work with a credit counselor or other financial professional to consolidate your debt.

Now for the downsides of debt consolidation:

• Qualification requirements: You'll need to have good credit to qualify for a good interest rate. If you can't get a loan with a lower interest rate than your current debts, it's probably not worth pursuing this option.

• Increased debt: If the consolidation loan has a long repayment term, you could end up paying more in interest in the long run. The upside is that your monthly payment will probably be lower than what you were paying before. You might also have to pay an origination fee to get the loan.

• Risk of falling into more debt: Consolidating debt frees up credit lines, which might tempt you to accumulate more debt. You aren't required to close your credit cards with debt consolidation like with a DMP, so you'll need to have good spending and credit management plans to ensure you stay out of debt long term.

How To Use Debt Settlement for Debt Relief

If you have past-due credit card bills or medical debt, you can try to negotiate a debt settlement. With debt settlement, you and your creditor or debt collector agree on an amount you can pay that's less than the full amount you owe.

For example, if you owe $10,000 on your credit card, you might be able to get the credit card company to mark it as paid in full for a one-time payment of $6,000. If the conditions are right, debt collectors are motivated to settle debts because receiving a partial payment is better than risking receiving nothing at all. If you file bankruptcy, the credit card company likely won't be repaid any portion of the debt you owe.

If you have courage, confidence, and persistence, you can DIY debt settlement by calling your creditors or debt collectors and negotiating over the phone. If you don't get a reasonable offer on the first try, hang up and try again a little later.

There are many for-profit debt settlement programs available. It's really important to be aware of potential scams in this debt relief service in particular.

What Are the Pros and Cons of Debt Settlement?

The biggest upsides to debt settlement are that you can save a lot of money and get out of debt more quickly than if you enroll in a debt management plan or take out a debt consolidation loan.

One downside is that debt settlement isn't guaranteed to work. Debt collectors are often more willing to settle debts that are older and settle with people they genuinely believe can't afford to repay the full debt. They may also be motivated to settle if they believe you will otherwise file bankruptcy.

Another downside is that you usually need to have access to a lump sum of money to make the settlement payment. This is often hard to do if you're in a bad financial situation. Finally, debt settlement can negatively impact your credit score (though you can negotiate how the debt is listed on your credit report to mitigate this) and may increase your taxable income.

How To Use Bankruptcy for Debt Relief

There are two types of personal bankruptcy: Chapter 7 and Chapter 13. Since Chapter 7 is the quickest, most common, and most straightforward, that's what we're covering in this section.

Chapter 7 bankruptcy was designed to help people with overwhelming debt get a fresh start. It's a relatively quick legal process — after you submit your bankruptcy petition to the court, you can get your eligible debts discharged in as little as 3-4 months.

You can eliminate most types of unsecured debt in Chapter 7. That includes credit card debt, medical bills, personal loans, payday loans, and past-due utility bills. Under special circumstances, you can also eliminate federal student loans.

What Are the Pros and Cons of Chapter 7 Bankruptcy?

Though Chapter 7 has some societal stigma attached to it, it's an important lifeline that's helped hundreds of thousands of people unburden themselves of debt they can never repay and get a financial fresh start. Many view it as a last resort, but there are several pros of Chapter 7 bankruptcy:

• Quick process: Most people see their debts discharged in 3–6 months with Chapter 7. This is much faster than other forms of debt relief, which often take years.

• Discharge of unsecured debts: Most unsecured debts are completely wiped out, freeing you from overwhelming financial obligations.

• Stops collections: Once you file your case, an automatic stay protects you from most collection actions, which offers immediate relief from harassing phone calls and letters. It can also stop wage garnishment and halt debt lawsuits against you.

• Fresh financial start: It provides a clean slate to rebuild your financial life without the weight of past debts. For many people, this eliminates a major form of stress and frees them up to start creating the life they want.

The biggest con of filing Chapter 7 bankruptcy is that it will impact your credit score. While this hurts in the short run, most people rebuild their credit over time.

You may hear Chapter 7 called "liquidation bankruptcy" because in some circumstances the bankruptcy trustee can sell your property to repay portions of debts you owe. While this is certainly a con for those it happens to, it's incredibly rare. Less than 10% of filers will lose any property.

You can hire a bankruptcy attorney to help prepare your case, but this can be costly. You can check to see if you're eligible to use Upsolve's free filing app to save money on an attorney. Click the phone image in the sidebar to get started.

What if You Can't Pay Your Car Loan, Mortgage, Student Loans, or Taxes?

The four debt relief programs we explored above can provide much-needed relief if you're drowning in credit card debt or medical bills. But, aside from Chapter 13 bankruptcy, none can help if you fall behind on your car loan or mortgage. And if you're struggling to repay past-due taxes or student loans, your options are also limited. But for all these types of debt, you still have options!

The first thing to do if you find yourself in one of these situations is to talk to your lender. Tell them you're having a hard time making your monthly payments. You don't have to tell them everything about your situation, but if you're comfortable it might be useful to say a little bit about why, such as unexpected medical bills, loss of a job, death of a family member, etc. The lender can then tell you about any financial hardship programs or assistance you might qualify for.

Debt Relief Options for Student Loans

If you’re a student loan borrower and become unable to make your federal student loan payments, you may be able to request a deferment or forbearance.

A deferment allows you to stop making payments for a set time frame until you’re able to make your payments again. The lender will still charge interest, but Uncle Sam will pay the interest during the deferment period. Borrowers must qualify for a deferment. Qualifying circumstances include a period of unemployment, unexpected medical bills, or other adverse conditions that can arise. 

Forbearance is similar to deferment, except that the borrower must pay the interest that accrues on their loan balance until they can start making full monthly payments again. Forbearances are usually easier to get approved for because of this reason.

Debt Relief Options for Home Loans and Car Loans

If you fall behind on a payment for a secured debt like a car loan or mortgage, you may be able to refinance your debt to improve the terms of the loan. If you're behind on your monthly payments, refinancing may allow you to avoid having to make up late payments, and it can also head off foreclosure.

Looking Into Debt Relief? Here's How To Avoid Getting Scammed

Unfortunately, scams are quite common in the debt relief world. Here are the major red flags you might be encountering a scam:

• Promises of drastically reducing your debt or getting rid of your debt overnight

• Upfront charges (this is illegal)

• Claims of being able to quickly fix your credit score

• A one-size-fits-all plan for all clients

Genuine debt relief providers create personalized plans without asking for sensitive financial information upfront or requiring payment before any services are rendered.

If you aren't sure if the agency you're dealing with is legit, search for customer reviews and ratings and see how they're rated by sites like TrustPilot and the Better Business Bureau.

Learn more by reading Upsolve's article on debt relief scams.

Let’s Summarize...

If you're experiencing overwhelming debt, rest assured that you have options and it's possible to get back on the right path. There's no one-size-fits-all debt relief plan. The right choice for you will depend on the amount of debt you have, what kind of debt you have, how much time you can commit to addressing it, and what your other financial goals are. A nonprofit credit counseling agency can help point you in the right direction about whether a debt management plan, debt consolidation, debt settlement, or bankruptcy is the best path for you.