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How Debt Relief Works

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In a Nutshell

If you're struggling to keep up with the minimum payments or paying everything you can and not making a dent in the balances that you owe, there are several debt relief options available to help you eliminate your debt and move forward with your life. Read this article to learn the different types of debt relief available and how they work, the benefits and risks associated with each option, and which debt relief solution(s), if any, may be a good fit for your situation.

Written by Attorney Paige Hooper
Updated July 28, 2023

Carrying a large amount of debt can become a serious financial and mental burden. You may be paying all you can afford and realize that you’re still not making a dent in your overall balance owed. You may be struggling to keep up with the minimum payments or may not be able to pay at all. Thankfully, if you feel like you’re drowning in debt, there are several debt relief options available to help you eliminate your debt and move forward with your life.

This article discusses the different types of debt relief available and how they work. It examines the benefits and risks associated with each option and can help you decide which debt relief solution(s), if any, may be a good fit for your situation.

Debt Relief Options

The process of relieving and/or better managing one’s debt burden goes by many names. You’ve probably heard or seen at least one advertisement for debt relief, debt consolidation, debt management, debt resolution, credit repair, debt adjustment, credit counseling, or bankruptcy. Some of these opportunities are legitimate relief options, while some are different labels for the same process, and some are just shady practices.

The primary types of real consumer debt relief methods are debt settlement, debt consolidation, debt management, and bankruptcy. Whether any of these relief options could help you get out of debt will depend upon the details of your financial situation.

Before trying to decide which debt relief process is right for you, you’ll need to have a clear and complete understanding of your total debt picture. Specifically, you’ll need to know all of your debts, the name of the creditor you owe each debt to, and the full amount you owe on each debt, including late fees and interest. It’s also helpful to know the interest rate for each debt, as well as the date of your last payment.

Finally, you’ll need to know whether any of your debts have been turned over to collections or written off. Why will you need all this information? Some debt management solutions apply to different kinds of debt. Additionally, you’ll want to do your best to relieve as much debt as you can, which you can only do if you’re aware of all that you owe.

The best way to gather all this information in a short time is by carefully reviewing your credit reports. You’re entitled to get a free credit report every 12 months from each of the three credit reporting agencies: Equifax, Experian, and TransUnion. (Note, that due to the COVID-19 pandemic, you’re entitled to a free credit report weekly.) Order all three reports, as they may contain different information. Once you have an accurate picture of your full debt situation, you’ll be better equipped to decide how to move forward.

How Debt Settlement Works

Debt settlement is a debt relief method whereby you would try to settle your debts by paying a lump-sum payment that’s less than the full amount you owe. You can attempt to negotiate debt settlements with each of your creditors on your own. There are also debt settlement companies that can negotiate settlement offers on your behalf for a fee.

How To Settle Your Debts

Attempting to settle your debts on your own can save you time and money compared to using a debt settlement company or hiring a debt settlement attorney. The process isn’t usually difficult, but it can be intimidating, and there’s no guarantee that you’ll be successful.

Sometimes, the creditor will start the settlement process. If you haven’t made any payments on your account in five months or longer, a creditor might send you a settlement offer. Around the five-month mark is when many creditors will consider turning your debt over to a collection company. Before this happens, some creditors may offer you the opportunity to settle your debt at a discount to prevent the account from going to collections. 

Most of the time, it’s up to you to suggest a settlement offer to your creditor. Figure out how much you can reasonably afford to pay to eliminate the debt. Be sure to evaluate this amount both as a number and as a percentage of your full balance — this will give you a sense of your chances of a successful settlement. Most settlements involve paying between 30% and 60% of the total balance owed. 

In addition to negotiating a payment amount, try to get the creditor to agree to report your account as “paid in full” or “paid and closed” to the credit bureaus. This is much better for your credit score than an account marked “settled” would be.

Be aware that debt settlement could result in higher taxes. In many cases, the IRS considers any amount forgiven (above a certain threshold) to be taxable income.

What Debt Settlement Companies Do

A debt settlement company will contact your creditors on your behalf to try to settle your debt for less than you owe. The company charges a fee for this service, typically 20%-25% of the total debt balance. 

Before a debt settlement company makes a settlement offer, you must give the company enough money to cover a reasonable lump-sum settlement payment. If you don’t already have this money on hand, the settlement company can set up a payment plan. You’ll deposit money with the settlement company each month until you have enough to cover a lump-sum settlement. Depending on the amount of your debt and how much you can pay in, this process can take months.

You must stop making payments on the debt during this time. Creditors aren’t likely to agree to a settlement if they’re still getting paid, especially if it seems like you can afford to pay the debt without settling. Most debt settlement companies require you to have missed at least four payments before making an offer. 

Using a debt settlement company lets you avoid the daunting process of contacting and negotiating with your creditors on your own. Another benefit is that these companies may have the experience to predict which creditors will settle and how much money they must be offered before they’ll agree to settle your debt. But there are some drawbacks to working with a debt settlement company. When you stop paying your debts for an extended time, your credit score will drop dramatically. At the same time, late fees and interest will pile up and collection efforts will continue. 

For example, assume it will take you six months to pay in enough money for the debt settlement company to make a settlement offer on your behalf. During that time, your credit score will fall, you will receive collection calls and letters (or may even get sued), and your debt balance will increase substantially because of the added penalties and interest. By the time the debt settlement company makes a settlement offer, the discounted balance may not be much less than the balance you started with. After all of this, there is still no guarantee that the creditor will accept the settlement offer.

Working with a debt settlement company can be risky, but if you have cash on hand to offer as a settlement, you may be able to eliminate your debt for much less than what you owe. If you choose this route, take the time to research any particular debt settlement program thoroughly. The Federal Trade Commission (FTC) has reported numerous instances of financial scam artists claiming to be debt settlement services. Watch for red flags, such as making specific promises or guarantees or requiring upfront fees.

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How Debt Consolidation Works

Debt consolidation is another possible debt relief option that involves combining several debts into a single debt. Most of the time, debt consolidation involves taking out a new loan and using the credit from the new loan to pay off your old debts. A balance transfer is a type of debt consolidation. Unlike debt settlement, debt consolidation doesn’t reduce the amount of debt you owe. Instead, it makes your debt easier to pay off. 

A debt consolidation loan is most effective when the terms of the new loan are significantly better than the terms of the previous debts. This includes a lower interest rate, plus either a lower monthly payment or a shorter repayment term, depending on your situation and goals. Even if the terms of the new loan aren’t dramatically better, consolidation still offers some benefits.

If you use the consolidation loan money to pay off credit card debt, for example, your credit score is likely to improve. Your paid-off credit card accounts remain in good standing, and the percentage of available credit that you’re using (also known as your credit utilization rate) decreases, provided that you keep your accounts paid-in-full “open” instead of closing them once your balances have been reduced to zero. This approach improves your debt-to-income ratio (the percentage of your monthly income that goes to debt payments). 

Also, after consolidation, you’ll only have one monthly payment to make. If you’re struggling to keep track of multiple due dates and often end up paying any of your accounts late, debt consolidation could make your life easier, reduce late fees, and help improve your credit score by eliminating the risk of late payments on multiple accounts.

Debt consolidation isn’t right for everyone. If you have bad credit, you may not qualify for a new loan with favorable terms or any new loan at all. Or, if your current monthly debt payments are completely unaffordable, combining them into one larger payment isn’t likely to help your situation. Remember, debt consolidation doesn’t reduce your debt balance, it just makes that balance easier to tackle.

How A Debt Management Plan Works

A debt management plan (DMP) is a debt relief option wherein you work with an approved consumer credit counseling agency to pay off your debts, usually on better repayment terms than you could negotiate on your own.

The National Foundation for Credit Counseling (NFCC) is a nonprofit organization that offers free credit counseling sessions to people struggling with debt. If you schedule a free credit counseling session, a certified credit counselor will review your financial situation, including your debts, income, and expenses. The counselor may offer budgeting advice and may also help you find other free financial education resources. The credit counselor will also discuss your debt relief options and help you decide if one of these options is a good choice for you. For example, the counselor might suggest debt consolidation, bankruptcy, or a debt management plan.

A DMP is an option administered by the credit counseling agency. If you opt for a DMP, the counseling agency will contact your creditors on your behalf to try to negotiate lower interest rates, late fee waivers, and other benefits. This is similar to the actions that a debt settlement company takes, but an accredited nonprofit credit counseling agency is likely to be more effective and won’t scam you.

Additionally, NFCC-approved credit counseling agencies are funded almost entirely by credit card companies. Those creditors have already agreed to reduced rates and other benefits for people who enroll in DMPs through these agencies. Some lenders reserve these advantages exclusively for NFCC-managed DMPs, meaning that they won’t offer the same benefits to debt settlement companies. Like other forms of debt consolidation, a DMP does not reduce the amount of debt you owe.

A DMP also offers many of the same benefits that debt consolidation loans do. Through a DMP, you’ll only pay one monthly payment to the counseling agency. The agency will then distribute the money to your creditors. DMPs typically last from 2-4 years. While your initial credit counseling session is free, the counseling agency usually charges a monthly fee for administering a DMP.

How Bankruptcy Works

Bankruptcy is a powerful debt elimination tool, but it also has strict rules and important consequences. There are different types of bankruptcy, often called chapters. Each kind of bankruptcy is uniquely tailored to help with a different kind of debt-related problem. The most common types of personal (non-business) bankruptcy are Chapter 7 and Chapter 13.

Chapter 7 is designed to help people who find themselves overloaded with debt, particularly unsecured debt. A Chapter 7 bankruptcy usually takes about 3-6 months from start to finish. At the conclusion of a successful Chapter 7 case, you can eliminate most unsecured debt, such as credit card debt and medical bills. There are exceptions for certain kinds of unsecured debts, including government-backed student loans, domestic support obligations, and some tax debts. Upsolve can help you file for Chapter 7 yourself.

Unlike Chapter 7, Chapter 13 is primarily designed to help people who have fallen behind on paying their secured debts, like a mortgage or car note, get caught up again. Additionally, those filers who earn too much money to file under Chapter 7 can benefit from Chapter 13 relief. Chapter 13 uses a reorganization plan, somewhat like a DMP. A Chapter 13 bankruptcy usually takes about 3-5 years to complete.

Let’s Summarize...

Debt continues to be a significant problem for many Americans. Some possible debt relief solutions include attempting to settle your debts for less than you owe, consolidating your debts into a manageable monthly payment, working with an approved counseling agency to negotiate an affordable repayment plan, or filing for bankruptcy.

A free 45–60-minute session with a certified, nonprofit credit counselor is a no-risk way to learn more about the various debt relief options available to you and how they may apply to your unique situation. (Note: This type of credit counseling is not the same as the pre-bankruptcy credit counseling course that’s required for filing bankruptcy.) Alternatively, if you’re being sued by your creditors, or if you think bankruptcy might be a good fit, you may want to speak to an attorney to learn more about your rights.

Written By:

Attorney Paige Hooper


Paige Hooper is a seasoned consumer bankruptcy attorney with 15 years of experience successfully representing debtors in Chapter 7, Chapter 11 and Chapter 13 cases. Paige began practicing bankruptcy law in 2006 and started her own solo, multi-state bankruptcy practice in 2012. Gi... read more about Attorney Paige Hooper

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