How Do Debt Relief Programs Work?
If you’ve been struggling with debt and are looking for an alternative to help repay it, it might be time to start looking into debt relief programs. Debt relief programs can help you reduce your debt burden by creating a comprehensive payment plan that fits your budget. However, it’s important to note that debt relief is a long-term commitment that is not always the most optimal path to become debt free.
Read on to understand how debt relief programs work and if what they offer is the best solution for you and your financial situation.
What is debt relief?
The term “debt relief” usually refers to a process known as debt settlement, in which you or a third party in your name negotiates with creditors to reduce the amount of debt that you owe. This differs from other solutions to reduce your debt such as debt consolidation —which combines multiple debts into a single monthly payment— and debt management plans —which are structured repayment plans offered by nonprofit credit counseling agencies.
With debt settlement, which is also sometimes known as “debt resolution” or “debt negotiation”, the goal is to make a deal with creditors to accept a payment that is less than the full amount you owe. Many creditors will be willing to accept a lower payment rather than have you default on your loan. You can negotiate with creditors directly but it tends to be a long and tedious process, as you have to make yourself familiar with your finances and the creditor’s terms.
People who don’t want to or can’t apply for debt relief on their own have the option to enroll in a debt relief program. A debt relief program is run by a debt relief company, who serves as an intermediary between you and your creditors when negotiating the terms of your debt settlement.
How do debt relief programs work?
Debt relief programs work by negotiating with your creditors to have you pay an amount less than you owe, usually 30% to 80% of your outstanding debt. Debtors make monthly deposits into a savings account that they control, which are ultimately used to pay the negotiated balance to creditors. In most cases, debt relief companies charge between 15% and 25% of either the original amount owed or the amount that gets settled, depending on the company.
Debt relief companies can’t legally charge you fees until the company has negotiated a settlement with your creditors, you have approved said settlement and a first payment has been made to the creditor. Debt relief programs can take from 2 to 4 years to complete and it is common for your credit score to suffer as you negotiate your debt. Once your debt is settled, your credit score should recover.
Who should consider applying for a debt relief program
Debt relief programs are usually only available to debtors that owe at least $7,500 and have a significant amount of unsecured debt. Debtors who owe more than half of their gross income or have gone through a recent financial crisis should consider applying. If you cannot even meet your debt’s minimum payments and your credit score is dropping as a result of it, you may want to consider debt relief.
What to do before applying for debt relief
Determine what type of debt you have
Only debtors with unsecured debt can apply for debt relief. Unsecured debt is debt that is not backed by collateral, such as a car or a house. This means most auto and home loans are secured debt and cannot be negotiated via debt relief. Common types of unsecured debt are debt from credit cards, personal loans or unpaid medical bills. If your debt applies to one or more of these types, a debt relief program could help you.
Consider alternative options
As stated before, debt relief or debt settlement is not the only option when it comes to facilitating you to get out of debt. Other alternatives include:
Debt consolidation: If reducing the amount of different payments is what’s most important to you, you can take out a debt consolidation loan to help you reduce multiple payments into a single monthly bill. This could also help lower your interest rate, although you need to be in good financial standing to qualify.
Home equity loans or a home equity line of credit (HELOC): These loans can help you access your home’s equity to get some cash, which can then be used to pay off your outstanding debt. If you own a home and have a good amount of equity on it, this could help you avoid having to take out a personal loan to pay for it. Your home will be used as collateral, though, so make sure not to miss payments.
Balance transfer credit cards: This is a way to consolidate your credit card debt under a new credit card that offers lower interest rates or a promotional 0% APR for an introductory period. You can then pay off the card before the period ends, significantly reducing your interest costs.
Choose your debt relief company wisely
Choose a debt relief company that has a reliable reputation and a long track record. It’s important to remember that debt relief companies cannot charge you fees before they help you reach a deal with your creditors. If a company you’re considering working with wants to charge you upfront fees, makes unbelievable promises to settle all your debts or contact you first offering to eliminate your debts, it might be best to avoid them. Choose a company accredited by the American Association for Debt Resolution and check online reviews from the Better Business Bureau and the Consumer Financial Protection Bureau.
How do debt relief programs work summed up
Debt relief programs work by helping you lower your overall unsecured debt, negotiating with creditors to have you pay less than what you owe. Debt relief companies facilitate this process, although you can engage in the process by yourself. Debt relief companies will charge you a fraction of your overall debt, although legally they cannot charge you before you approve a deal with your creditors.