Debt Relief- Make An Educated Decision


There are several types of debt relief programs offered by professional companies. It can be very confusing to readily understand the differences between the various options because they all seem quite similar to the casual observer. In this post, the top five debt relief options are addressed, including how they work and how they affect your credit:

  • Debt Consolidation
  • Credit Counseling (AKA: Debt Management Plan)
  • Debt Settlement
  • Debt Negotiation
  • Bankruptcy

Here’s the low down on each of those five options.

Option 1 – Debt Consolidation

Debt Consolidation is taking out a loan to pay off other debt that is usually credit card debt.

Debt Consolidation is a good option for those who are financially stable, have good credit, and good credit management skills. However, it is not an option that will improve a bad financial situation because all you are doing is moving your debt around. Before you undertake a debt consolidation plan, be very clear about your objectives and whether they can be realistically met through debt consolidation.

It is often done:

  • To save money that would normally be paid for high interest rates on credit cards;
  • To eliminate paying several bills each month vs. one;
  • Because you cannot afford the high interest rates and will default soon if you don’t lower your payments.

Consumer options for Debt Consolidation are as follows:

  1. Take out a personal loan. If you have good credit, this option is easy and the new credit will only affect your credit scores by a few points for a couple of months as long as you make payments on time.
  2. Apply for a Home Equity Line of Credit. If you are a homeowner, and you have good credit, applying for a HELOC is another way to consolidate debt.
  3. Apply for a credit card with a very high limit and a low, or no interest rate offer. Again, if you have good credit, this is an option for you if the credit card offer is great. Keep in mind, however, if the balance on the new card will be over 50% of the available limit when you transfer all of your other accounts over, your scores will go down.

If the credit card accounts you are paying through debt consolidation have high balances, your credit scores will go up when you pay those balances off.

Option 2 – Credit Counseling     

If any two or three of the following items apply to you, Credit Counseling may be a good option.

  1. You are living paycheck to paycheck and cannot get ahead.
  2. You are still current on accounts, but will become past due very soon.
  3. You are over the limit on your credit card accounts.
  4. You have no, or very few late payments.
  5. You have high interest rates that keep going up.
  6. You are starting to receive collection calls from creditors or collection notices from collection agencies.
  7. You do not have the time or skills to create a budget or money management plan that will work.
  8. You are not comfortable dealing directly with creditors to find a solution to your current financial situation.

Credit Counseling is a service provided by organizations to help consumers find ways to repay their debts through careful budgeting and management of money. Credit counseling is an industry that is under severe scrutiny and should be entered into with caution.  

If you feel that your credit counseling challenges are too much to handle on your own, here are two great resources to help you reach your financial goals:

ConsolidatedLogo

Consolidated Credit Counseling Services, Inc., founded in the early 1990s, is an industry leader in providing credit counseling throughout the United States.

Consolidated Credit is a member of the Better Business Bureau, the United States Chamber of Commerce, the Greater Fort Lauderdale Chamber of Commerce, the Association of Independent Consumer Credit Counseling Agencies, and the American Collection Association.

CreditGuardLogo

CreditGUARD of America, Inc. is an independent, non-profit credit counseling agency that provides debt counseling to consumers throughout the United States. Our non-profit credit counseling agency also works with corporate and community leaders to provide quality financial education. Using state-of-the-art technology and superior customer service, CreditGUARD continues to innovate the credit counseling and debt management industries.

Here are some great resources to help you get to know the ins and outs of the industry:

Only unsecured lines of credit are eligible for credit counseling plans. This includes credit cards, personal loans, medical bills, collection accounts, unpaid utilities, auto loans that have gone to repossession, and payday loans.

How Does Credit Counseling Work?

  • First, if you decide not to do it on your own, then you will need to select a credit counseling company to work with. Per The Federal Trade Commission, reputable credit counseling organizations advise you on managing your money and debts, help you develop a budget, and usually offer free educational materials and workshops. Their counselors are certified and trained in the areas of consumer credit, money and debt management, and budgeting. Counselors discuss your entire financial situation with you, and help you develop a personalized plan to solve your money problems. An initial counseling session typically lasts an hour, with an offer of follow-up sessions.

A reputable credit counseling agency should send you free information about the services it provides without requiring you to provide any details about your situation. If a firm doesn’t do that, consider it a red flag and go elsewhere for help.

Be sure to check out your prospective credit counselor with your state Attorney General, local consumer protection agency, and Better Business Bureau. They can tell you if consumers have filed complaints about them.

  • Once you have selected a credit counseling company that you trust, you will then work with the credit counselor to create a workable payment plan with all of your existing unsecured debt that fits within your budget. The overall budget and analysis process will also take into consideration your income and expenses. 
  • When the plan is on paper, the credit counselor will work with you to negotiate reduced interest rates and payments with your creditors. They may even be able to remove late fees and penalties if you are already in default.
  • Once the new payment schedule is in place with the original creditors, you, the consumer, are responsible for making the agreed-to monthly payments to each creditor on time every month. 
  • If your debt is overwhelming or burdensome, the credit counseling agency may speak to you about entering into a Debt Management Plan (DMP) with them. Instead of paying the creditors directly as outlined above, this plan would allow you to make a lump sum monthly payment to the credit counseling agency, and they would pay your creditors according to the agreed-upon payment schedule.  

In most instances, if you default on the payment schedule that was implemented by a credit counseling company, you stand to lose all negotiated reductions and your interest rates, payments and fees will all reset to where they were when you first worked with the counseling agency.  So if you do not have time to set aside each month to make your payments directly, this would be the best option for you.

How Does Credit Counseling Affect Your Credit?

Credit counseling agencies are not creditors and they do not report to the credit bureaus. So it is a myth that just by contacting a credit counseling agency, your scores will go down.  However, once you enter into a credit counseling program, a comment indicator is entered into your credit profile.  Although the note should not affect your credit, it will be evident to lenders and creditors that you are a part of a program.

However, if you are past due on your bills at the time you start a credit counseling plan, then your scores have already been affected negatively.  But once you start making payments under the newly negotiated payment schedule, your scores will start to improve. Bottom line is that if you are current, and have not incurred any late pays, then credit counseling and debt management plans should not affect your credit scores, provided that you remain current.  

One item to note is that once you enter into a negotiated payment schedule, all of the accounts included in the credit counseling program will be closed.  Since approximately 30% of your credit scores are made up of open-active accounts, you will most likely lose points for not having any open accounts.

WORD OF CAUTION:  If you enter into a debt management program with a credit counseling service, and you hire them to pay your creditors in a workout plan, if they pay that creditor late the creditors will report a late pay and your scores can drop instantly by as much as 100 points. There is nothing you can do about it short of suing the credit counseling company. This is why it is so important that you conduct a thorough background search, work with the most reputable firm you can find, and be very deliberate and cautious before you turn your financial well being over to anyone.

When it comes to how Credit Counseling and DMP’s are reflected in your credit reports, you can expect that debt management plans will show up as “Account handled by CCCS” or “Account on DMP,” as a note or comment added by the creditor. This note intends to discourage lenders from enabling the individual to add additional lines of unsecured credit. However, it should not affect a borrower’s ability to obtain a secured loan, such as a mortgage or car loan, and this note will not affect your credit scores. Once the plan is completed, the note will be removed. If you enter into such a plan, make sure that you request copies of your reports once you have paid balances in full in order to make sure the note has been removed.

Pros of Credit Counseling

  1. You will have a repayment plan that you can live with, that will give you instant relief from your burdensome debt; one that would be very time consuming and difficult for you to negotiate on your own because creditors very rarely work with consumers directly to renegotiate interest rates and payments when consumers are in trouble. 
  2. You will be free of the stress of not being able to make your payments. You will be able to focus on the important things in life such as your family and your work without worrying about paying that stack of bills.
  3. If you have not fallen behind on your accounts before entering into credit counseling, then your scores will only be affected very little due to the closing of your accounts. However, if you are in default, creditors will stop reporting you as payment late, once you start making payment on the newly agreed to schedule. This way your negative history can start aging out.
  4. Because of your efforts, you will stay in the good graces of your creditors and they will most likely be willing to do business with you again.

Option 3 – Debt Settlement

Unlike credit counseling, which involves an immediate plan to pay the total amount due over time and with reduced interest rates, Debt Settlement companies will negotiate with the creditors to reach a reduced payoff balance once you have saved enough money to negotiate down your debts. An efficient debt settlement company can reduce the payable amount to 40-60% of your original amount, and so can you!

You are a candidate for Debt Settlement if:

  • You are already delinquent on accounts by a few months.
  • You have accounts that have already been charged off or sent to collections.
  • You are being threatened by lawsuit or judgment.
  • You do not have the funds to pay the delinquent items in full.

How Does Debt Settlement Work?

  • To analyze your current situation, the debt settlement company will conduct the same process as that of a Credit Counseling company. They estimate how much they think they can reduce your debt through negotiation. From there, they consider that reduced rate in relation to your income and expenses so as to design an affordable monthly “savings plan” stretched over a period of 12-36 months. 
  • If you decide to hire them, most debt settlement companies require that you make an agreement to deposit that amount into a trust account for the 12-36 month time period. 
  • While you are in the program, you cannot make payments to your creditors. If you do, you stand to lose a good percentage of the monies you have deposited into the trust account. 
  • Realizing that if you just stop paying your creditors they will start calling and harassing you for money, most debt settlement companies offer to educate you on how to handle creditor calls and communications. They will not speak to your creditors until you have enough money in the trust account to pay the debt, and they are the ones who make that decision, not you. 
  • Once there is enough money in the account, the debt settlement company will start negotiations with your creditors and will pay off your debts one by one as the monies are available; usually 12-36 months, depending on which plan you are in.

How Does Debt Settlement Affect Your Credit?

To put it succinctly, debt settlement trashes your credit.

When you enter into a debt settlement program, the plan is to immediately stop paying your creditors. As such, you will continue to be reported late, accounts will go to charge-off and collections, judgments could be filed against you, and yes, you might be sued. Most likely, this is why debt settlement companies have you deposit your money into a trust account. This way, the monies cannot be garnished or confiscated.

Option 4 – Debt Negotiation

Debt Negotiation occurs when you make an agreement with a creditor to pay less for a debt than the amount you actually owe. In my professional experience, I have found that debts can be negotiated for between 20-60% of the original debt.

The current account status determines with whom you will negotiate and how you will negotiate. If the account has not been sent off to collection or charge-off yet, then you will negotiate with the original creditor. If the account is in collections or has been charged off, then you will be negotiating with a collection agency or collection attorney.

You can always get a better deal once an account has been charged off or sent to collections, however, if there is any chance that you can save your credit by making an arrangement before it goes to collection, you should try that avenue.

You are a candidate for Debt negotiation if:

  • You are still current on accounts, but are just about to go into default for a long period of time due to financial hardship (loss of job, medical crisis, divorce).  It is true that most creditors make it very difficult to negotiate debts that are still open active accounts, but I have seen many clients successfully negotiate with their credit card companies to pay off accounts for less, and before they have actually defaulted on accounts. This is especially doable if they are upside down in their mortgage payments.
  • You are already delinquent on accounts by a few months and do not foresee being able to catch up any time soon. 
  • You have accounts that have already been charged-off or sent to collections. 
  • You are being threatened by lawsuit or judgment.

How Does Debt Negotiation Work?

First, decide whether you will do the negotiating on your own or hire someone to do it for you. Debt negotiation is a strategic and a time-consuming process, and is easier to accomplish with limited emotional attachment involved. Collection agencies are ruthless, and will go to any extent to scare you into thinking that they will take away everything from you if you don’t pay your debt in full today. If you find a reputable company, hiring a professional debt negotiator who is thoroughly trained to effectively and strategically work with creditors to reduce your debt is a benefit. 

Here is the process:

  • The debt negotiation company will work with you to create a list of the debts they will negotiate for you. Most debt negotiation companies will charge for their services at the rate of 15-18% of your total debt. You will sign a contract that gives them power of attorney to negotiate on your behalf. This contract will set forth stipulations as to your actions during the process. 

It is much better for you to work with a debt negotiator who charges a percentage of the amount they save you. By charging a percentage of total debt, they may lack the motivation to settle for less in a shorter period of time. In contrast, when a negotiator gets paid on how much they save you, they will work hard to save you more.

  • You will be required to deposit an established amount of money (usually 50-60% of the total debt) into a bank or escrow account to which they have access. Doing so ensures that the money is easily available when negotiation is complete.
  • Most often, the fee to get started is substantial. This is because debt negotiators will start working with all of your creditors immediately, and if you change your mind at the last minute they need to be paid for the time they spent negotiating on your behalf. For this reason, it is important that you conduct intense research on the person you intend to hire before you send them that fee.
  • When an agreement has been struck with one of your creditors, the debt negotiator should request a letter from the creditor confirming the agreement. Once this confirmation letter is received, funds will need to be available immediately via transfer, automatic withdraw, credit card, or overnight cashier’s check.
  • The debt negotiator will receive a payoff letter and you will send that letter to the credit bureaus that are reporting the item asking that they update your credit report with the new information.

How Does Debt Negotiation Affect Your Credit?

Most likely, if you have entered debt negotiations you are over-extended and even in default. How all of this affects your credit depends on the outcome of the negotiations, which can range as follows:

  • If you negotiate with original creditors on accounts still in good standing, they will not negotiate a deletion letter in exchange for payment. This is considered a “fresh” account, removal of which is not part of their policies or procedures. Successful negotiations with them may lead to a reduction in your total amount due by 40-60%, with one of the following credit reporting options: 

1.  Paid For Less Than Total Amount Due;

2.  Settlement Accepted On This Account; or

3.  Paid Settlement

Each of the above ratings can instantly drop your credit scores by 100 points, depending on how many points you have to lose. If you have several accounts to negotiate, you will suffer a severe hit for the first account, but the drops for subsequent accounts settled will be less severe. Eventually, you will max out in your penalty for the Payment History Factor which is 297.5 points. 

The good news for your Payment History Factor is that once the negative reporting hits your credit reports, the 7-Year Reporting Period will commence, and the account will start aging out within 6 months. Also, if you handle your negotiations at this level, you will avoid additional negative activity spun off from the original account, such as collection or judgment.

If you have a great relationship with your creditor, and you point out to them that by law they are not obligated to report negative information about you to the credit bureaus, you may be able to negotiate a Paid As Agreed reporting. If you succeed, and have not had any late pays on the account, your credit scores will only receive a small penalty for closing the account. 

  • If you are negotiating with a collection agency, or collection attorney, it means that the accounts have already been reported on your credit reports and your scores have already taken the initial hit of up to 100 points.  

The good news about negotiation on a collection, especially one that is a couple of years old, is that you can negotiate payment in exchange for a deletion letter, which is the ultimate goal. If you are successful, your scores will go back up as soon as the credit bureaus delete the account from your credit file.

Pros of Debt Negotiation

  • You pay less―in some cases far less― than what you owe.
  • Paying off the negotiated debt immediately puts you in a position to leverage a letter for full deletion so the negative record can be completely stricken from your credit reports. This is much more difficult after you enter into a payment plan.
  • You get rid of the debt immediately.
  • You can start rebuilding your credit immediately.
  • You can seek removal immediately.

IRS Form 1099-C: Cancellation of Debt

When it comes to negotiating debt, it’s important to realize that when a creditor charges off debt, it can write-off all or part of the debt it claims you owe, and report it as a tax loss to the IRS using a 1099-C: Cancellation of Debt Form. The IRS can treat a cancellation of a debt as income you have received even

The best thing that you can do about this issue is to ask. If you accept a settlement offer, or negotiate with a creditor to pay less for a debt, ask the creditor if they intend to file a 1099-C Form. Remind them that by law, they MUST send a copy of that form to you, and that they MUST report the loss at its true and accurate amount.

In addition, if you are in a position of having to settle a debt for less with a creditor, you can negotiate with them to NOT send the remainder as a loss to the IRS. They are not legally obligated to do so.

Option 5 – Bankruptcy

Plain and simple, bankruptcy is the most difficult option to choose; one you should avoid at all costs unless you are upside down on everything. This public record will wreak havoc on credit scores and can prevent people from being hired or being able to rent a place to live.

Sad but very true, bankruptcy has always been the most popular debt relief program. I am certain that this is the case because so many people either receive bad advice or just simply do not understand the other options available to them. When faced with this type of struggle, people become confused and frightened. They become so desperate to make the pain go away that they make bad choices, sometimes exacerbating the problem.

There are plenty of steps you can take to correct your situation before it results in bankruptcy. Bankruptcy should always be your last option.   

In Conclusion

The moment you sense a problem with your credit card debt, consider your options. If you feel that you would benefit from professional help, seek assistance from a reputable credit counseling agency as early as possible. This is the best way to avoid long-lasting problems.

There are many opportunities to correct your problems before you reach the dead end of bankruptcy. If you need help, I strongly advise you to act quickly, decisively, and intelligently so as to avoid more painful avenues that avoidance will force.

Source: Linda Ferrari’s Book: The Big Score – Getting It & Keeping It