Debt settlement is almost always the worst option for people facing collections and creditors. It pays to know the facts.
Let's get started.
Debt settlement, debt consolidation and debt management: Know the difference
- Debt settlement is where you pay less than what you owe. It's a risky path and one often paved with excessive fees and scams. Debt settlement companies actually encourage consumers to stop paying their debts, which causes penalties and fees to build up. This can also lead to wage garnishment and even prompt lawsuits. The Consumer Finance Protection Board describes debt settlement as "risky" and currently lists more than 100 consumer complaints regarding debt settlement in its public database. The Federal Trade Commission warns consumers that debt settlement companies engage in deceptive practices and illegal conduct, such as charging fees before securing any settlements.
- Debt consolidation involves borrowing money to pay off your secured or unsecured debt. This can be in the form of a personal loan, a balance transfer credit card or a loan against an asset you own, such as your home or car. The goal is to erase your unpaid debt and to do so ideally at a lower -- or at least fixed -- interest rate. Personal loans for debt consolidation are an increasingly attractive option for people eager to get out of debt quickly and safely.
- Debt management, or a debt management plan, typically begins with credit counseling. The aim of counseling is to build up budgeting and money management skills and avoid taking on more debt while dealing with creditors. This should only be done with a reputable non-profit credit counseling agency.
Avoiding debt settlement scams
- Anything or anyone that describes a "new government program" to bail you out of credit card debt, according to the CFPB. These programs do not exist.
- Promises that your credit won't be negatively affected. Any collections report or unpaid debt will impact your credit no matter what. [If you haven't done so already, check your credit score with our free tool.]
- Statements that debt settlement won't have tax consequences. It absolutely can. The part of a debt that is forgiven can be considered taxable income and you would have to pay taxes on that amount.
- Implications you will be shielded from creditors. Debt settlement companies can't promise this. If anything, pressure from your creditors are likely to increase.
Alternatives to debt settlement
While only a lawyer can give legal advice, here are five alternatives that can be a better choice than debt settlement:
Non-profit credit counseling
This option can be a good one if you are overwhelmed by debt, but it's important to know that scammers operate in this space too so the same warnings apply -- be wary of excessive fees, reject any advice to stop paying your debt, and run when you hear "too-good-to-be-true" promises. Also, be sure to get a list of all fees in writing before signing onto any debt management plan. The Federal Trade Commission advises consumers to fully vet potential companies with your state Attorney General and local consumer protection agency, even if they say they are non-profit.
In contrast to the credit crunch of the Great Recession, lenders are now willing to offer personal loans large enough to tackle major debt and work with consumers across a range of credit situations, making this an option worth exploring. There are several advantages to consolidating debt with a personal loan, the most attractive of which is a fixed interest rate for the life of the loan. This is in contrast to credit cards, even balance transfer credit cards. These cards often feature limited-time "teaser" rates only to jump to interest rates as high as 20% or more after 18 months. Personal loan rates start as low at 5%, depending on credit profile. Added benefits: You can check your rate without impacting your credit score and apply for a loan free of charge. You can also get a personal loan without putting up your home or car as collateral. Further, in some cases, taking out a personal loan to eliminate credit card debt can improve your credit score because personal loans are considered installment debt versus revolving debt like credit cards.
Home equity loans and home equity lines of credit
If you have untapped equity in your home, you could consider a home equity loan or a HELOC, a home equity line of credit, to pay off your debt. This option should be approached cautiously. Here's why: First, if you cannot meet the terms of either loan, your home is at risk. Second, if you don't have the financial discipline to stop adding to your debt, you will end up in a worse spot. This will also require more planning and paperwork than other options, including a home appraisal. You will also need to thoroughly investigate the differences between a home equity loan and a HELOC -- they are different. A HELOC is more like a credit card and will most likely have an adjustable rate of interest. Interest rates are only expected to go higher, so be careful.
Working with creditors yourself
While it is absolutely do-able to negotiate debt relief and secure repayment plans yourself, success with this option depends on your ability to stay on top of the situation and keep a patient, level-head. It pays to know your rights as a consumer against debt collectors and be willing to document every step on the process, from phone calls to written correspondence. It's not for everyone but the CPFB provides sample letters for communicating with debt collectors. Best of all, it's completely free.
In some cases bankruptcy can be the best option, but it's important to get advice from a credible, experienced attorney first. Be aware: your credit will take a major hit and it can be expensive. The average cost of a bankruptcy varies state by state and lawyer by lawyer, but expect to pay between $1,500 to $3,000.
No matter who you are or your unique situation, facing a large amount of debt can be incredibly stressful, so knowing your options is the best first step.
Have you gone through a tough time with debt and come out stronger on the other side? Let us know what worked for you in our WisePiggy Facebook community.