Is Debt Relief a Good Idea? What To Know Before You Decide

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While credit cards and other forms of debt can play a legitimate role in helping you manage your cash, they can also get you in over your head. When that happens, debt relief is one way to ease the burden. But whether debt relief is a good idea depends on the type of program you use.

The two major types of debt relief are debt management and debt settlement. This article will focus primarily on debt settlement.

How Does Debt Relief Work?

Debt settlement programs try to settle your debt for less than you owe. The programs are offered by for-profit companies that charge fees — often totaling 15% to 25% of your debt amount, according to InCharge Debt Solutions — for their services.

Here’s how it works:

1. Once you enter the program, you typically stop paying your creditors and instead send payments to the debt settlement company.
2. The company deposits your funds into an escrow account. The money is yours, and you can withdraw it whenever you want should you decide to leave the program.
3. After the escrow balance reaches a certain amount, the debt settlement company starts contacting your creditors to try to negotiate a settlement. This step can last up to several years.
4. If the company is successful in settling at least one debt, it’ll collect its fees from the escrow account and pay the rest of the money to the participating creditors.

Keep in Mind

Debt settlement differs from debt consolidation. With debt consolidation, you take out a personal loan and use the proceeds to pay off debt. You then make monthly payments on the personal loan. No negotiation needed, and every payment you make goes directly to your principal and interest.

Is It Worth Doing a Debt Relief Program? Benefits vs. Drawbacks

Generally speaking, debt relief can help you regain control over your finances. However, when debt relief means debt settlement, the drawbacks often outweigh the advantages.

Pros:

• Might eliminate at least some of your debt: The debt settlement company will try to negotiate settlements for less than you owe.
• Simplifies payments: You typically stop paying your creditors while you’re in the debt settlement program. Instead, you make just one payment per month into the escrow account.
• Might avoid bankruptcy: If settlement is successful, it might help you become debt-free without having to go through a court process.
• Can improve long-term financial health: The program could provide a fresh start.

Cons:

• Negative impact on your credit report: You’ll likely accumulate many months of missed payments as well as charge-offs. The impact on your credit score could be more severe than the impact of bankruptcy, according to the National Consumer Law Center.
• It takes time: Debt settlement companies typically need two to four years to attempt to settle your debt.
• No guarantee creditors will settle: Many creditors won’t work with debt settlement companies, according to the Consumer Financial Protection Bureau (CFPB), so it’s unlikely that you’ll be able to settle all of your debt. However, you’ll pay the fee even if only one creditor settles.
• Potential negative consequences beyond credit impact: If the debt settlement company is unsuccessful in settling enough accounts, you could wind up with more debt than you started with due to interest that accumulates after you stop making debt payments. It’s also possible that the creditors will sue you for the amount you owe.
• Possible tax liability: The IRS treats settled debt of more than $600 as taxable income.

Debt Settlement vs. Other Options: A Detailed Comparison

When deciding how to get out of debt, consider the alternatives before you commit to debt settlement.

Debt Settlement

Might be appropriate for high levels of credit card debt when you’re facing serious financial hardship.

Debt Management Plan (DMP)

A nonprofit credit counseling agency can negotiate with your creditors to reduce your payment amounts, then devise a plan allowing you to make one payment each month to the credit counseling agency. The agency then distributes the payment to your creditors. This is a good option if the payments can be reduced enough to make them affordable for you.

Credit Counseling

Credit counseling teaches you how to budget your income more efficiently, and it can help you set financial goals, including accelerating debt repayment. If you’re dissatisfied with the amount of debt you have but aren’t in danger of missing payments, counseling could be all you need to get your finances on track.

Debt Consolidation Loan

A debt consolidation loan is a personal loan you take out to pay off other debts. If you have good credit and steady income, you might qualify for a much lower interest rate than you’re paying on your credit cards, which lets you pay down your debt faster.

Balance Transfer Credit Card

Transferring your debts to a card with a 0% promotional rate can help you pay off smaller amounts of debt. You’ll need a good credit score to qualify. Just be aware that any balance that remains after the promotional period ends is subject to the standard interest rate.

Bankruptcy — Chapter 7 or Chapter 13

Chapter 7 bankruptcy eliminates your debt, while Chapter 13 reorganizes it to make it easier to pay off. Both types protect you against collection activities, including lawsuits. Although bankruptcy is often considered the option of last resort, it sometimes has less impact on credit than debt settlement.

Here’s a summary of ways to get out of debt.

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