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Debt Relief Programs

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In a Nutshell

There are many potential debt management solutions, including credit counseling, debt management plans, debt consolidations, debt settlements, and bankruptcy. Read more to learn about these various debt management solutions, how to avoid debt relief scams, and how your credit report will be impacted by various debt relief options.

Written by Lawyer John Coble
Updated August 10, 2023

You can't afford to pay your debts. What are you going to do? You can begin finding answers to that question below. This article discusses many potential debt management solutions, including credit counseling, debt management plans, debt consolidations, debt settlements, and bankruptcy. The article also provides guidance about how to avoid debt relief scams and how your credit report will be impacted by various debt relief options.

Debt Relief Options

It's easy to become overwhelmed by all of the debt relief options you have available. Simply watching television on a weekday afternoon can result in being bombarded by advertisements from debt solution firms and bankruptcy attorney commercials. Which approach is best? How do these programs work? There's a lot to consider when evaluating your options.

Credit Counseling Is a Good Place To Start

Scheduling a free consultation with a credit counselor employed by an accredited, nonprofit credit counseling agency is a great way to get information custom-tailored to your situation. A trained credit counselor will look over your debts, monthly income, and monthly expenses before recommending any particular course of action. They will also take time to explain why they believe that certain opportunities may suit your unique financial situation better than others would.

Credit counselors will recommend a debt management plan (DMP) if you need it. Debt management programs allow you to make one monthly payment for your unsecured debts. They may also recommend various budgeting strategies, negotiating a modified payment plan with one or more of your creditors, or debt consolidation. 

The credit counselor may also recommend that you file for bankruptcy. In this case, if the credit counselor is approved by the local bankruptcy court for pre-filing counseling, they can issue you the certificate you'll need if you file for bankruptcy. Note that these certificates expire within 180 days. If you file for bankruptcy 181 days after your credit counseling, you'll have to do the credit counseling over again.

Debt Management Plan

A debt management plan is a repayment plan wherein you make one monthly payment to a credit counseling agency. Then, funds from this payment will be distributed to your various creditors The credit counseling agency will charge a modest monthly fee for this service. This can be an excellent approach for those who are juggling payments to numerous creditors each month and are struggling to keep up. 

Even though the credit counseling agency is paying your creditors and taking a fee for themselves, you should end up paying less per month than you were when you were making payments on multiple accounts pre-DMP. This is possible because your credit counselor will negotiate more favorable repayment terms with your creditors than you were bound to before. The credit counselor may also negotiate a longer-term to pay off your debts completely.

DMPs usually last three to five years. Although it will have an impact on your credit score when you first enter the plan, your credit score will improve as regular payments decrease your account balances.

Debt Consolidation Loan

A DMP is a form of debt consolidation. The other major kind of debt consolidation involves taking out a new line of credit or loan. The primary difference between this approach and a DMP is that, instead of a credit counselor consolidating your debt by negotiation, you’ll take out a debt consolidation loan to pay your unsecured debts. For a debt consolidation loan approach to be a good idea, you'll need a credit score high enough to obtain a loan with a favorable interest rate. That interest rate will need to be low enough to make your debt consolidation payment less than the combined payments you were making before you took out the debt consolidation loan.

A key pitfall to avoid with debt consolidations is using a home equity line to consolidate your credit card, personal loans, and other unsecured debts. When you do this, you're turning unsecured debt into secured debt. To make matters worse, if you fail to pay off the home equity line, you could lose your home to foreclosure. While you could probably eliminate your unsecured debts if you choose to file a Chapter 7 bankruptcy, the same is not true for a home equity line. This secured debt will survive a Chapter 7 bankruptcy unless you choose to give up your home. 

Another pitfall to avoid with debt consolidation is using any credit cards that you opt to pay off after taking out a debt consolidation loan. If you do this, you’ll increase your credit utilization ratio. The credit utilization ratio is the portion of your available credit that you are currently using. 

Because you’re seeing a debt management solution, you’re probably using most of your available credit. If you consolidate your debts and pay off your cards, you’ll have much more available credit. Having available credit that you aren't using decreases your credit utilization ratio. The lower the credit utilization ratio, the higher the credit score. For this reason, it's best to keep your old credit card accounts open without using them. Set aside one card for use in emergencies. One card may also be used sparingly, provided that you pay off the balance each month.

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Debt Settlement

A debt settlement works just the way it sounds. You negotiate a settlement with one or more of your lenders for less than the full amount due. This approach usually requires a lump-sum payment, or it may be broken down into two or three payments over a short time period. Creditors won't agree to long repayment periods because that's what they had at the start of the negotiations. 

If you have a large lump sum that can be used to facilitate debt settlement, be aware that there are several potential problems with this approach:

  • Not all lenders are willing to settle

  • You’ll likely need to stop making payments on an account for a few months before your creditor will be interested in a settlement. This approach can be extremely harmful to your credit history (and your credit score, by extension)

  • Usually, if someone has large enough amounts of money to make the lump sum payments necessary for debt settlements, they wouldn't have debt problems in the first place

Even when it seems that a debt settlement program is your best option, there's still another downside. When you settle a debt for less than the total amount owed, the IRS usually considers that forgiven debt to be taxable income. It will be as if you had earned that amount at your job. You'll have to pay taxes on this debt cancellation income unless it falls below a certain threshold.

Debt Settlement Companies

Debt settlement companies handle the negotiation of debt settlements for you. These companies are for-profit organizations aiming to make money for themselves. They will charge you fees for settling your debts. These fees can be expensive. In addition to fees, the company will likely require you to make monthly payments for a while as you “save up” for a lump sum settlement offer. 

Some lenders may not agree to any settlement with a debt settlement company. They may not even talk to them. Because of unhappy customers and the prevalence of debt settlement scams, the federal government has placed certain requirements on these companies. If you choose to work with a debt settlement company, which is usually not a good idea because you can always negotiate debt settlement terms directly with your creditors, make sure to do your research before signing anything or investing any of your money in debt settlement. 

Watch Out For Debt Relief Scams

Any type of debt relief program can be a scam. Thankfully, there are certain things you can do to protect yourself. You can check a debt relief company’s rating with the Better Business Bureau. You can check with your state's attorney general's office to see if there have been complaints about the company.

For credit counseling agencies, it's best to make sure they're a nonprofit credit counseling operation. It's ideal if the credit counseling agency is a member of the National Foundation for Credit Counseling (NFCC). The NFCC has strict requirements for its members.

Debt settlement companies are the most common debt relief programs found to be scams. For this reason, the Federal Trade Commission (FTC) has issued certain requirements for how these debt settlement companies must conduct their businesses. The FTC also requires several disclosures to be made to their clients.

It's important to know that debt settlement companies can't charge you any upfront fees. They can only take fees from you when they successfully settle a debt for you. Any payments that you make to build up your account for debt settlement services must be paid into an escrow savings account administered by a third party that is in no way connected with the debt settlement company.

The FTC requires a debt settlement company to:

  • Explain its fees and any conditions of its services.

  • The company must tell you how long it's going to take to get results from the settlement process.

  • The company must tell you how much money you're going to have to put into your escrow account before they'll make a settlement offer. 

  • If the company asks you to stop making payments to your creditors, it must also explain how this could damage your credit score; how it could cause you to be sued or your wages to be garnished; and that it may cause interest and late fees to be added to your debt. If the creditor doesn't accept your offer, you could end up owing more than you did before you hired the debt settlement company.

  • The company must tell you that any money you pay into your escrow account is yours until a settlement is made on your behalf.  You are also entitled to any interest earned on this money. 

  • The company must tell you that the administrator of your escrow account is not affiliated with the debt relief company and that it's not paying a referral fee to the administrator.

  • You have the right to withdraw your money from the escrow account at any time without any penalty.

These regulations are designed to reduce the chances of you being scammed by a debt settlement company. It doesn't always work, since the Consumer Financial Protection Bureau is continuously forcing debt settlement companies to return fees to their customers. So, be careful. Take it as a warning sign if a debt settlement company doesn't go over all these disclosures with you. Protect yourself by using the common-sense measures of checking with the Better Business Bureau and the attorney general's office to learn about a company’s reputation before opting to work with them.

Bankruptcy Relief

Bankruptcy is the ultimate solution to your debt problems. A Chapter 7 bankruptcy may eliminate all of your unsecured debts. A Chapter 7 bankruptcy will usually eliminate these debts without you losing anything as a result of the process. But, a bankruptcy trustee may sell your assets when those "things" are classified as partially or totally nonexempt. The good news is, few people who file for Chapter 7 bankruptcies have sufficient non-exempt equity in their assets for the trustee to be interested in selling anything.

There are certain types of debt that are nondischargeable in bankruptcy. These include some tax debts, all child support debts, and (in some cases) student loans. In a Chapter 7 bankruptcy, assuming that you're not too far behind on a secured debt, you'll reaffirm those debts. It will be as if you never filed bankruptcy with regards to your secured collateral. On the other hand, if you're behind on payments, a secured creditor may not be willing to reaffirm the affected debt. They may want the collateral back.

In cases wherein you may have too much non-exempt equity, you have nondischargeable debts, or you're behind on your secured debts, a Chapter 13 bankruptcy may be your best choice. A Chapter 13 bankruptcy involves a manageable repayment plan that lasts from 36 to 60 months.

A Chapter 13 bankruptcy can do many things that a Chapter 7 bankruptcy can't. It can be used to pay off nondischargeable debts. It can be used to pay short-term secured debts or catch up on arrearages on long-term secured debts. If you have too much nonexempt equity to file a Chapter 7 bankruptcy without losing assets to a trustee, you can use a Chapter 13 bankruptcy and keep those assets.

You may decide that filing for bankruptcy is your best option. If so, Upsolve can help you. If you have a straightforward Chapter 7 case, you may qualify to use Upsolve's free bankruptcy tool. It can save you a lot of money since it can help you file for bankruptcy without an attorney. For more complicated bankruptcy cases, Upsolve can help you find an attorney in your area.

How Your Credit Report And Credit Score Are Impacted

Each of the different debt relief programs will affect your credit report.

  • Debt management plans cause a drop in your credit score at first. As your account balances drop, your credit score improves over the term of the plan.

  • Debt consolidation loans usually have the least impact on one’s credit score. Taking out a new loan causes a credit score to drop initially, but consistent repayment of this loan can increase your credit score quickly if you also reduce your credit utilization ratio. Leaving credit cards open, with zero balances will favorably decrease this ratio. If you use your credit cards without paying off the balance each month, you'll be increasing your credit utilization ratio. The credit bureaus frown on high credit utilization ratios.

  • Bankruptcy will harm your credit score. It will stay on your credit for up to 10 years. But, bankruptcies can greatly improve your financial situation. With a better financial situation, your credit score can improve quickly over time.

  • Debt settlements can significantly harm your credit score, depending on how much debt you settle. Though the negative impact of settled debt will show in your credit history for only seven years, you likely won’t greatly improve your financial situation by settling a few debts. How much your financial situation will improve with a debt settlement is unpredictable. On the other hand, the outcome of bankruptcy is extremely predictable, which is why filing for bankruptcy can actually serve as a “plus” on your credit history overall, provided that you don’t slide back into a challenging financial situation after your case is closed.

Let’s Summarize…

If you're having debt problems, you have a lot of options available. The best thing to do is gather all the information you can before deciding which choice is best for you.

Some of your options are riskier than others. For example, there's a much greater risk of a scam with debt settlement companies as opposed to a nonprofit credit counseling agency. Each of the options impact your credit report and credit score in different ways. The quicker you get started with whatever debt relief option is best for your situation, the sooner your debt problems will be behind you.

Written By:

Lawyer John Coble


John Coble has practiced as both a CPA and an attorney. John's legal specialties were tax law and bankruptcy law. Before starting his own firm, John worked for law offices, accounting firms, and one of America's largest banks. John handled almost 1,500 bankruptcy cases in the eig... read more about Lawyer John Coble

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Upsolve is a 501(c)(3) nonprofit that started in 2016. Our mission is to help low-income families who cannot afford lawyers file bankruptcy for free, using an online web app. Our team includes lawyers, engineers, and judges. We have world-class funders that include the U.S. government, former Google CEO Eric Schmidt, and leading foundations. It's one of the greatest civil rights injustices of our time that low-income families can't access their basic rights when they can't afford to pay for help. Combining direct services and advocacy, we're fighting this injustice.

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