How Do Debt Relief Programs Work?

There are a lot of ways to pay off debt, but which is the right solution for you? Find out how different types of debt relief programs work, and discover which suites your situation best.

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Debt-relief programs offer consumers a pathway to financial freedom. These programs can help consumers deal with overwhelming debt in a number of ways, with each one offering a slightly different solution.

Sometimes the solution includes asking lenders for lower interest rates.

Sometimes it involves negotiating with lenders to reduce the total amount owed.

Sometimes the solution is asking the lender to extend repayment terms by another year or two.

Whatever form it takes, the goal of a debt-relief program is to alleviate the financial burden, and even the emotional effects of debt. Sorting through the options to find the most suitable program can be the first step to regaining control of your finances.

Do Debt-Relief Programs Work?

It takes a combination of several factors for a debt-relief program to be successful.

If you’re working with a professional agency, or any third party other than your lender, you’ll need to choose a reputable service. The debt-relief landscape is filled with scams and un-backed guarantees, so it’s important to choose well-reviewed, well-established programs.

You’ll also need commitment. No debt-relief option provides immediate or total debt forgiveness, and many of them take a few years to complete. If you abandon your debt-relief payment plan mid-way through, you may face even bigger penalties than you did at the start. Alternatively, sticking to the program could mean paying off your debt sooner, and for less money.

Seven Types of Debt Relief

There are a handful of ways to get relief from debt. Though the methods and timeframe for each one vary, the solution often takes time. Debtors who commit to a structured program can typically expect a timeline of 3-5 years to become debt free.

Here are the seven debt relief options:

  1. Credit counseling – Sometimes debt relief can come from examining your budget and making adjustments. Only 40% of consumers use a budget, but a counselor from a nonprofit agency can offer free expertise and guidance in using this powerful financial tool.
  2. Debt consolidation – Those who qualify can use a loan to combine credit card bills and some other debt payments into one consolidated monthly payment. Consolidation may lead to a more manageable monthly debt bill or lower interest rates.
  3. Debt management – A nonprofit credit counseling agency can work with lenders to make payments more manageable and  affordable, or even forgive certain fees. Credit scores are not a factor for joining a debt management program (DMP), but there may be fees, and if you miss payments, any concessions you received could be terminated.
  4. Debt settlement – You pay a company to negotiate with your lenders and settle debt for less than what is owed, which sounds too good to be true … and usually is. Lenders are not obligated to settle and some won’t. Also, your credit report will negatively reflect any settlements for seven to 10 years. A potentially lower-risk option is nonprofit debt settlement, which does not involve negotiations. Instead, some lenders may agree to accept 50% to 60% of what is owed, when spread out over a three year payment plan.
  5. Bankruptcy – This legal solution is extremely damaging for your credit, and you’ll have to cover legal fees, but it can give a fresh start to borrowers who have no other means to become debt-free. Bankruptcy can include having most of your unsecured debt forgiven, or setting up an affordable repayment plan.
  6. Balance transfer credit cards – Some credit cards offer promotional interest rates — even as low as zero percent — for a set period of time. For those with great credit, taking out one of these cards to pay off high interest debt could help you pay down your balances. Just beware of high balance transfer fees and the promotion time expiring before you pay off the balance.
  7. Debt forgiveness – Full-blown debt forgiveness is almost never legitimate, but some lenders may work with you to set up partial loan forgiveness. Your best shot at having some of your debt forgiven is by qualifying for lender-sponsored assistance, like the Department of Education’s student loan forgiveness programs or specific mortgage relief directly through your mortgage lender.

It should be noted that not all debt-relief programs work for every consumer. The success of each program often reflects the resources, goals and commitment of the consumer. Before starting any program or applying for new financing, do your research and be sure you’re comfortable with the requirements and responsibilities involved.

When You Should and Shouldn’t Use Debt Relief

Many Americans carry debt, but owing money doesn’t have to be a fact of life. If any of the following describes your current situation, consider looking into a debt-relief solution ASAP:

  • You have no means to pay your unsecured debts — which includes credit cards, medical debt or other debts that have no property as collateral — within the next five years.
  • You’re making monthly payments but, due to high interest rates, your balances aren’t decreasing.
  • You’re behind, or about to fall behind, on bill payments.
  • You’re facing serious consequences for overdue debt, such as home foreclosure or vehicle repossession.
  • You struggle to choose between covering monthly debt payments and necessities.
  • You avoid answering calls or opening mail for fear of being contacted by debt collectors.

Keep in mind that some debt-relief options have costs. Consider the fees and the impact to your credit before signing up for any program or new financing. If you can manage the debt yourself, at a lower cost or less credit risk, it might be worth doing on your own.

Alternatively, some borrowers may be exempt from legal action by debt collectors and might not have any real benefit to paying old debts, or seeking relief. If you have a collection debt, but the statute of limitations has passed, you may no longer be legally required to pay. If you live on fixed government benefits or minimal income, you may be judgment proof, meaning that collectors are not allowed to take legal action to collect certain debts from you.

What Debt-Relief Program is Best?

The best solution is based on the severity of your situation. For someone who simply wants to reduce their debt expenses, and who has relatively good credit, a consolidation loan or balance transfer card could offer relief in the form of lower interest charges.

But if you’re in danger of falling behind on debt payments, or if you’re already behind, it’s worth seeking professional intervention. A nonprofit credit counselor can help you determine if a more structured solution, like a debt management program or even bankruptcy, is the best next step toward getting relief.

Debt-Relief Qualifications

Each debt-relief option has unique requirements. In order to enroll or qualify you may have to meet one or all of the following requirements:

  • Credit: Opening a new consolidation loan or credit card requires a review of your credit reports and scores. The higher your scores, the more likely you are to qualify for a low-APR consolidation loan or card.
  • Income: Some debt-relief programs are income-based, and income is also reviewed to determine if you’re eligible to file for bankruptcy.
  • Total amounts owed: Smaller debt amounts may be deemed ineligible for certain relief programs. For example, the debt settlement program from National Debt Relief requires consumers to have at least $7,500 in unsecured debt.

What Types of Debt Are Eligible for Debt Relief?

Certain types of debt are eligible for more relief options than others. Generally, most debt-relief programs work best for unsecured debt, meaning debt that is not backed by any collateral. This includes credit cards, medical debt, personal loans and collections debt.

There are far fewer options to get relief from secured debts, such as mortgages and auto loans. These debts are generally excluded from DMPs and debt settlement negotiations. Filing for bankruptcy can be one option for preventing lenders from seizing secured debt.

Some types of debt can never be forgiven, including taxes, child support, alimony and certain federal student loans, however there may be government programs available to help reduce the amount owed, like California’s Child Support Debt Reduction Program or the IRS’s Offer in Compromise.

How Does Debt Relief Impact Your Credit Score?

There are many ways that debt relief can impact your credit. In fact, some debt-relief options can affect your scores both negatively and positively. Overall, paying debts on time and reducing the balances on your open debt accounts will always improve your scores.

But each of the following activities may be initiated by debt relief, and can cause drops in your scores. We’ve listed them in order, starting from least severe:

  • Applications for new credit cards and loans: You’ll lose roughly one to five points per application, but the points are gained back over the course of a year.
  • Missing a debt payment: Someone with great credit could lose as many as or more for just one missed payment, while a borrower with lower scores may lose fewer points. The missed payment stays on your credit reports for seven to 10 years.
  • New collections accounts: You may see a major drop to your scores, and FICO says you’ll have a limited ability to improve your scores in the near future.
  • Filing bankruptcy: The higher your scores, the bigger the impact, and FICO says someone with stellar credit will see a huge drop. The record of bankruptcy will stay on the reports for seven to 10 years.

How to Find a Legitimate Debt-Relief Company

To find the best debt-relief companies, you’ll want to go through the National Foundation for Credit Counseling (NFCC) or the Financial Counseling Association of America (FCAA). Each organization has member agencies that serve consumers all over the country.

Their professional counselors must maintain certifications and participate in ongoing training. They can provide budget and credit report reviews, as well as debt management and bankruptcy counseling. If a credit counseling agency can’t prove their counselors are trained and certified, don’t work with them.

Additionally, you may want to ask for recommendations from family or friends. You could even ask your bank or credit union for a referral, since they may partner with one of the certified nonprofit credit counseling agencies.

Fraudulent Claims

Some debt-relief claims are a dead giveaway for fraud.

Beware of any company that claims to settle debt for pennies-on-the-dollar, or completely eliminate your debt. These kinds of guarantees are major red flags.

Lenders aren’t obligated to accept settlement offers, and some won’t even work with debt settlement companies, so there is no such thing as a guarantee that your debt will be reduced or eliminated.

This is especially true when it comes to secured debt, since the lender can seize and sell the property to get their money back, instead of accepting a settlement. If you hear a “guarantee” that secured debt or other debt will be settled, move on to another company.

Another warning sign is being asked for money up-front. If a company wants payment before they eliminate your debt, they’re likely in violation of federal law, and you can report them to the state attorney in your area or file a complaint with the Consumer Financial Protection Bureau (CFPB).

You can also ask for documented proof of the company’s claims. If they’re honest, providing proof won’t be a problem.

Whatever you do, don’t dig yourself into a deeper financial hole by trusting a company who makes false guarantees. Always verify information before you agree to do business with any third-party.

Illegal Business Practices

The debt-relief industry underwent some serious changes in the early 2000s. The Telemarketing Sales Rule (TSR) of 2003 was passed after several debt-relief companies were caught committing scams, and eventually the Dodd-Frank Consumer Protection Act followed in 2010.

Anyone who uses debt-relief services should be aware of how they’re protected under the TSR:

  • It prohibits debt-relief providers from charging upfront fees before reducing or settling a customer’s unsecured debt.
  • It forbids companies from misleading customers on the services provided, specifically, how long the program lasts and what the fees are.
  • It grants customers access to the “dedicated accounts” used to build funding for attempts at settling a debt. The money in those accounts belongs to the customer and is now available for withdrawal at any time, without penalty.

Counseling/Advising Services

Choosing between all of the options for debt-relief can feel almost as stressful as thinking about your debt. There are many options to choose from, risks to watch out for and fees to consider.

If you’re feeling confused, or just want objective advice, nonprofit credit counseling agencies can help. When you set an appointment with one of their certified credit counselors, you’ll get free guidance from a financial professional who can help you by reviewing your budget and showing you how to pay off debt in the way that works best for you.

About The Author

Bill Fay

Bill “No Pay” Fay has lived a meager financial existence his entire life. He started writing/bragging about it in 2012, helping birth into existence as the site’s original “Frugal Man.” Prior to that, he spent more than 30 years covering the high finance world of college and professional sports for major publications, including the Associated Press, New York Times and Sports Illustrated. His interest in sports has waned some, but he is as passionate as ever about not reaching for his wallet. Bill can be reached at [email protected].


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