A seemingly inescapable part of adult life in today’s world is the overwhelming debt that most of us find ourselves dealing with at some point. It could be thanks to factors beyond our control such as losing a job or having to deal with medical emergencies, or it could be due to something as simple but damaging as overspending. Unfortunately, debt relief doesn't come easy.
Total household debt saw an increase of a staggering $.6 trillion in the third quarter of 2020 alone, according to the Center for Microeconomic Data.
What’s even more astonishing is that total household debt has been steadily increasing nonstop since the second quarter of 2013. Regardless of the cause, the result is a crushing amount of financial stress that begins to impact our everyday lives, change our lifestyles, and even affect our mental and emotional health.
Thankfully, there are always steps that we can take to improve our financial situation, whether it’s a dedicated shift in personal finances, a debt relief program, debt consolidation, debt settlements, or (as a last resort) bankruptcy.
What Is Debt Relief?
Debt relief refers to the process by which an individual or company works with debtors to reduce or even eliminate debt. The core of debt relief is negotiating for debt forgiveness. It can be done by the person who’s actually in debt if they know how to communicate with their debtors in a productive manner, but the process is much more easily done through a professional third-party debt relief company.
How Do Debt Relief Companies Work?
Debt relief companies will typically charge you a fee for their services and attempt to help you manage your debt until it is either paid off or forgiven. More often than not, the debt relief company will either consolidate your debt or settle it for you, and each option has its pros and cons.
In debt consolidation, you essentially take out a larger loan and use that money to pay off your balances. This method is preferable to many people because it doesn’t force you to damage your payment history and it makes it so that you only have to plan for one monthly payment. For those who have a handful of credit cards and personal loans, each of which with their own separate monthly payment, this can minimize stress in a big way.
Not to mention, the new monthly payment you’d be making is often significantly lower than how much you were paying when each individual account had its own amount due. What’s more, debt consolidation programs often have much lower APRs than any of your credit cards will (usually in the single digits), so you’re paying less in interest and subsequently cutting your payment timeline much shorter.
One downside to this method, though, is that most debt consolidation companies will require you to close down any credit cards that are paid off as part of the program. Doing this means that the “Credit Age” factor of your credit score will likely go down considerably, along with the total number of open accounts you have. Neither of these are “high impact” factors, but they do affect your credit score.
Additionally, some services performed by debt consolidation companies could actually be handled by the individual on her own. It’s important to get in writing exactly what the company’s process is before you agree to pay any fees.
Before actually deciding to go through an official debt consolidation program, you may see if you would qualify for a personal credit line large enough to pay off your other, smaller debts first. If so, you can essentially do the entire process on your own without paying a separate company to do it for you.
You would also be able to decide whether or not you want to keep your credit cards open and locked away so that your newly available credit has the chance to benefit your score. Credit card usage has a much higher impact on your score, so you’ll see an immediate increase if you’re able to free up some (or all) of those cards.
This method does more damage to your credit report, but it may be the better option for those who have been unable to keep up with even their minimum payments. It’s important to note that it is illegal for a debt settlement company to ask for a fee before they begin. They must negotiate with each of your debtors (primarily credit cards) to lower or abolish the debt itself before collecting a fee.
Now, this works only if the debtors have reason to believe they’re not going to get any money from you at all. This means that before the debt relief company can start negotiating, your account has to be past due, usually by more than 90 days.
During the time it takes for your account to become past due, it’s recommended that you be funneling those monthly payments into a savings account. This way, once the debt settlement company has done its work, you can make lump-sum payments, thereby holding up your end of the agreement and knocking out those debts for good.
Is Debt Relief Legitimate?
The concept of debt relief is absolutely legitimate and there are numerous legitimate debt relief companies out there. However, there are also plenty of scam companies around that will promise to help you, accept whatever fee you pay them, but leave you saddled with the debt and doing none of the work that was promised.
Again, remember it is illegal for them to ask for a fee upfront. Check The Better Business Bureau’s Scam Tracker for scams if you’re looking into any kind of debt relief company.
How Can I Tell the Difference Between a Legitimate Company or a Scam?
Before you actually sign up with any of these companies, it may help to make sure they aren’t listed as a company currently under investigation with the Federal Trade Commission (FTC). The FTC has a list of debt relief companies who have actual cases against them, so if the one you’re considering is on that list, do NOT give them any money and report them immediately. You can check the FTC’s list and also see any news regarding these cases.
A sure-fire way is if they ask for up-front fees without doing any of the work.
What Do Debt Settlement and Debt Consolidation Companies Charge?
This answer varies depending on which company you decide to go through, but the fee for debt settlement and debt consolidation companies generally hovers between 15 and 25 percent. Similarly, some companies will require that the fee be paid upfront before they begin actually working on your debt. Others will collect that fee only after your debts have been settled.
So, say you have a total accumulated debt of $10,000. Once the company has done its part in relieving you of that debt, they’ll charge you between $1,500 and $2,500.
Now, your original $10,000 debt was split between three cards with varying APRs between 16.49 percent and 22.49 percent (a common range for those with lower credit scores) and a combined minimum payment due of $514 (since most minimum payments are between 2 and 5 percent of the total balance). As things stand, you’d be able to pay off that balance in two years if you stick to the monthly minimums.
So, to reiterate, your original debt plan is to pay off $10,000 over two years with monthly payments of $514.
After a consolidation, with a projected 5 percent interest rate, your monthly payments are lowered to about $439 while still meeting that two-year payoff date. This saves you a total of around $1,800 in interest payments while putting $75 back in your pocket every month. Not to mention, you can sometimes opt for a longer payback period to lower your minimum payments even further if immediate relief is more of a focus for you.
Something else you should calculate before signing any paperwork is whether the program you’re considering will save you more money than the quoted fee. Also weigh whether the time your program saves you is worth the fee, since debt consolidation can cut years off your payback timeline. If not, the debt relief program may not be your best option and it would be worth pursuing other possibilities.
Do These Companies Actually Work?
Debt relief programs can work, the operative word being can. In order for them to successfully relieve you of your debt, you have to do your part. If you’ve chosen debt settlement, you must actually set aside whatever amount has been agreed upon in a savings account.
That way, once the debtor has agreed to a settlement amount, you’re ready to pay it outright or at least set an agreed-upon payment plan for the lesser amount. Failure to do this will result in you being unable to complete the program, and can even lead to defaulted payments, a large number of collections accounts being added to your report, and (obviously) the full unpaid balances still reflecting as being due.
If you decide to use debt consolidation, you should need to worry about making only that one monthly payment. However, it’s recommended that you pay more than the minimum amount due if you’re able to, if only to pay off the debt faster. Also, before you agree to the terms of the debt consolidation, be sure to actually calculate whether your new monthly payment amount would actually be less than the current total of all of your minimum payments combined.
Does Debt Settlement or Consolidation Ruin Your Credit?
Both options can negatively impact your credit. There are numerous factors that impact your credit score, some of which are payment history, number of accounts, age of credit accounts, and derogatory marks. All of these are likely to be affected by debt relief programs, though some will have more impact than others.
Debt settlement companies will require you to let your accounts get severely past due, which will drastically lower the payment history part of your score. This is one of the factors with the highest impact on your credit score, so this should be a last resort (before bankruptcy).
Additionally, it’s possible that choosing this route may lead to accounts going into collection, which count as derogatory remarks. Now, a successful debt settlement will reflect that those accounts were settled (i.e., you paid a portion of the total debt and the debtor agreed to forgive the rest), but the mark will remain on your account for up to seven years.
Debt consolidation companies often require you to close the credit cards that you pay off using the consolidation loan. It makes sense, given that the idea is to free you of credit card debt permanently, but closing down your cards can damage your credit score in a couple of different ways.
One, doing so reduces the number of accounts you have open. Two, it lowers your median credit age, as however long your credit cards had been open will no longer be relevant. Granted, these two factors affect your credit score less than your payment history and derogatory marks do, so this is still a preferable option to debt settlement in terms of credit damage.
How Long Does It Take to Recover Financially from Debt Settlement or Debt Consolidation?
Any effects from your debt settlement or consolidation can remain on your credit report for a maximum of seven years, but some of these effects won’t even last that long if you’re taking care of your credit health. For example, if you elect to go with debt consolidation and close your credit cards upon payoff, then continue to make your monthly payments without fail, your payment history will stay steady and you’ll have the chance to open and build new accounts over the years.
Granted, you don’t want to just immediately open new credit cards and build up more debt, but it wouldn’t hurt to get a gas card or a store card here and there for the sake of credit history.
In the case of debt settlements, however, there are a couple of options available if you’re willing to put in a little extra work. Because those late payments and collections accounts are “high impact” factors and can stay on your credit report for the full seven years, you may want to consider contacting the debtors involved once your accounts have been settled.
Sometimes, a debtor may be willing to remove themselves from your credit report if they see that the account has been paid or forgiven. They have the power to do so, and it’s worth having that conversation with them. Even having one or two collection accounts removed from your credit report can drastically improve your score. You can do the same with the late payments showing on your report.
There will always be ways to rebuild your credit after damage is done. If taking a hit to your credit score now will dramatically improve your current financial wellbeing and give you a fresh start being debt-free, it may be worth investing in the debt relief option and building from there. You can use secured credit cards, make your payments on time every month, and keep your balances low (below 33 percent of your total credit limit) to improve your score over time.
Can the Government Help with Debt Relief?
The short answer is no, not directly. To date, the government does not sponsor any debt relief programs of its own. It does, however, monitor any and all reports sent in about debt relief companies suspected to be a scam.
If a company is found to have been scamming its customers, the government will actively punish said company and often offer compensation or refunds to its victims. This is a big part of the FTC’s duties, and you can track active cases here.
How Do I Know If Debt Settlement Is Right for My Situation?
Ultimately, debt settlement ought to be your last option. When you’re unable to pay your monthly minimums, have no options available for refinancing or consolidating your debt through a personal loan, and don’t have a way to catch up on your payments, debt settlement can keep you from having to file for bankruptcy.
If you’re able to utilize a different method to pay down your debts, you should try to do so before attempting to work with a debt settlement company.
Debt settlement can seem like an easier way out than other options. After all, you don’t pay your monthly minimums and your debt is cut into a fraction of its original amount. However, as explained above, opting for debt settlement can negatively impact your credit score in several ways.
Those “missed” minimum payments are recorded in your payment history and remain there for up to seven years, damaging your percentage of on-time payments. Paying less than you owe on a balance will damage your credit score quite a bit as well. If you can lower your debts in ways that won’t negatively impact your credit score, doing so will help you in the long-term.
That isn’t possible for everyone, though, and that’s precisely why debt settlement companies exist. Bankruptcy stays on your credit report for a maximum of seven years, and that’s a horrible mark against you in the eyes of lenders.
It can even affect housing opportunities and job offers. Debt settlement programs, on the other hand, give you the opportunity to pay back a portion of your debt and still wipe the slate clean.
Yes, your credit score will take a hit, but not nearly as bad of a hit as it would with a bankruptcy. Plus, you can improve your score much more quickly once you’re not having to shell out hundreds of dollars in minimum payments every month.
The Bottom Line on Debt Relief Companies
Debt relief companies can be helpful if you’ve run out of options for handling your debt on your own. There’s nothing wrong with needing assistance, and most of us know how it feels to be overburdened with debt, regardless of what got us there. If you’ve found yourself in that position, here are our recommendations:
- First, make sure you have a clear budget that represents all of your incoming and outgoing cash flow. Budget for groceries and gas, Starbucks runs, and anything else you regularly indulge in that you don’t want to cut out. Calculate how much money you’re left with after all of your expenses are taken out of your monthly income. If that amount is in the negatives or is too low to reasonably sustain you, proceed to the next step.
- Do your research. Consider all your options and decide whether debt consolidation might work (i.e., if you’re up to date on all your payments, but a lower monthly payment would go a long way toward improving your financial stability) or debt settlement is more appropriate (i.e., if you’re behind on your payments and truly won’t be able to afford your balances anytime soon, but might be able to set money aside for settlement offers).
- Select a reputable debt relief company after making sure that it isn’t on any watch lists and hasn’t been reported as a scam. Look for ones that don’t require an upfront fee from you and have good reviews.
- Follow through with your plan of action. If the program you’ve chosen requires you to set money aside, make sure you do so and don’t treat that money as actual savings. When the time comes for you to pay off the debt, you need to be able to pay it, or you’ll wind up right back where you started.
- Once you’ve seen your program through to the end and your balances are paid or settled, enjoy your freedom from the crushing weight of your debt and rebuild!
It all comes down to making sure that debt relief is your best option, choosing a company that will genuinely work to free you from your debts, and sticking to the program until you’re free. Once you’ve made it to the end, you’ll undoubtedly find yourself in a better financial state than you were in before and be able to rebuild your credit while breathing a bit easier.