Consumer debt…how would I love to pay thee off! Let me count the ways…
We live in a culture where the burden of consumer debt has not only become acceptable but even expected. Since the average household in America carries nearly $17,000 of credit card debt, a large percentage of American households are looking for the best way to pay off their debt. Here are descriptions of some of the most popular options:
Debt Settlement Companies (or “Negotiators”)
When credit card debt becomes overwhelming, too many individuals trust emails and ads that claim to help out by negotiating down the total balance of money owed-also known as debt settlement.
As in most cases in life, if it sounds too good to be true, it probably is. Past governmental investigations of widely known debt settlement companies concluded that “fraudulent, abusive and deceptive practices” were occurring within the industry.
While the government attempts to reign in such harmful behavior, it is impossible to keep up with the rapid emergence of these companies. To ensure you don’t fall victim, here are a few common myths promoted by the debt settlement industry, followed by their corresponding realities:
1. MYTH: “Your credit score will only drop a few points while on the program.”
REALITY: FICO (the pioneering credit score company) has indicated that scores typically fall 65 to 125 points when a consumer stops making payments to their creditors.
2. MYTH: “Creditors generally report settled debts as ‘paid in full’ or ‘paid as agreed.’”
REALITY: Again, according to FICO, creditors typically report such accounts as “settlement accepted on the account” or “settled for less than full balance.”
3. MYTH: “Some settlement companies are associated with federal aid initiatives.”
REALITY: Such claims are not just deceptive but fraudulent. The government does not provide for any such consumer debt relief, nor is there a government office or agency set up to manage such a program.
4. MYTH: “Anyone can get their credit card debts settled for half of what they owe.”
REALITY: Credit card companies enact settlements with consumers experiencing true financial hardship. Creditors are unlikely to forgive any portion of a debt’s principle without good reason to believe the consumer is otherwise unable to meet their obligations.
Even when a company is legitimate, this method isn’t guaranteed to be effective. True settlement companies do try to work with creditors to lower the amount you owe, but charge you a monthly fee to do so and additionally as much as 25% of whatever settlement they might reach in your behalf. Even when successful, you’re likely to pay about 80% of the original debt due to these fees and other taxes. In the end, is there any real relief to be had?
It is also critically important to note that as part of the settlement, credit companies “charge off” forgiven debt which will negatively affect your credit score for up to 7 years.
Generally considered the last of all debt-relief options, bankruptcy can protect your assets from creditors and may remove your obligations to pay your debts at all. You will still be required to pay certain types of debt, such as government student loans, fines and child support. This debt solution is often sought because it can be completed in a matter of months, however bankruptcies stay on credit reports and negatively impact credit scores for 7-10 years.
This may make it difficult to secure a loan with a reasonable amount of interest, if you can be approved at all. Bankruptcy may also limit one’s ability to get jobs (e.g. law enforcement, finance, government), affect one’s military security clearance, and even increase the premiums you pay for car insurance.
This method also fails to teach clients important lessons of personal finance and how to make improvements in order to avoid debt in the future. Statistics show that 16% of all bankruptcy cases are repeat filers. Debt like a flesh wound can require a more permanent fix such as proper cleaning and stitches. Bankruptcy only offers a band aid. If clients do not take the steps to increase income, secure medical insurance, or curb spending habits, they will likely find themselves in a similar situation down the road. It would be wise to realize that bankruptcy can only be pursued every 2-8 eight years depending on type of filing and debt. If it is resorted to now, it may not be an option later on.
Lastly, many filers find bankruptcy too complicated to complete on their own. While an attorney comes with a cost, it is sometimes the better option than going it alone.
Debt Consolidation Program
This type of program is offered through credit counseling agencies, such as Debt Reduction Services, and helps you pay off dollar-for-dollar what you owe, but generally at better interest rates and monthly payments. A notation on your credit report that you are participating in Debt Consolidation (which usually prohibits you from getting a new credit card) is typically removed upon completion of the program. Debt Consolidation Programs generally take 3-5 years to complete, depending on the amount of accumulated debt. There is no direct impact on your credit report.
When considering ways to address your debt, most independent, financial specialists would suggest that you first contact a reputable credit counselor for a few good reasons.
First, besides providing you with strategies for eliminating your debt, credit counselors will also help you address the root cause of your financial challenges: personal budgeting, spending controls and learning how to use credit wisely.
Second, even including monthly account maintenance fees, the client pays a fraction of what they would if they were to attempt to pay their debt on their own because of lowered interest rates and fees waived as negotiated by the agency.
Third, a debt consolidation program impacts a consumer’s credit the least. A temporary note on one’s report is far better than destroying your credit history for the next 7 years or more. Additionally, documents issued by a credit counseling agency such as letters of recommendation, educational certificates, and verification of program completion can aid clients in the future when seeking loans or proceeding to rebuild credit.
The best repayment option for your debt should be affordable, effective, and will give you the best opportunity to make long-term improvements to your personal finances.
Related article: Debt Repayment Options
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