Ever since the housing market came to a crash in 2007 there emerged a flood of companies promising to help financially strapped consumers get out of debt. It’s not so much the case any more but I used to hear commercials non-stop about how all these companies can get me out of debt in 2-3 years and only pay pennies on the dollar back to the banks. In some cases they made it sound like President Barack Obama approved these programs as part of the stimulus package. There’s got to be catch to these programs right? Of course, no matter what you purchase or do in life it always comes with a trade off. You name it and I can write 10 things that can be taken as a trade off.
Before this wave of debt relief programs came about the only options I had heard of while working in the mortgage lending industry was bankruptcy and consumer credit counseling.
Everyone who is an adult in the U.S. knows what bankruptcy is. It’s that forbidden option that only the truly most desperate should use as a last resort. When this option is used it comes with dire consequences. Your credit rating takes a severe hit for about 10 years. The ability to qualify for a loan will be severely hindered, and it’s highly unlikely you will qualify without a co-signer. Potential employers tend to frown upon a bankruptcy, especially if you’re trying to apply for a job in the financial services industry or work in retail.
There are two types of bankruptcy that exist for individuals. The first is a Chapter 7 bankruptcy. In a Chapter 7 bankruptcy what normally happens is the individual’s assets are liquidated, and whatever cash is generated gets distributed to the creditors. This is typically what most people think of when it comes to bankruptcy. You file bankruptcy and then somehow your debts are gone and you’re left with a negative mark on your credit report, and/or public records.
Then there is Chapter 13 bankruptcy. Simply put this is a repayment plan. Unlike a Chapter 7 this typically does not require a liquidation of your assets. It usually takes 5 years to repay the debt, and impacts your credit for about 10 years as well.
Simply put these are the two traditional forms of debt relief programs most people know about. Now for the juicy stuff those debt relief companies.
Debt Relief Programs
Aside from bankruptcy as a way out of debt there is also consumer credit counseling, also known as a Debt Management Plan (DMP), and debt settlement (also known as debt negotiation, or debt relief).
Credit counseling, or a DMP, is a program where you make one monthly payment to a company that in turn distributes those payments to your creditors. The credit counseling company negotiates lower interest rates with your creditors which therefore typically offers a lower monthly payment. If you think about it this sounds very similar to a Chapter 13 bankruptcy except you don’t have to file with the court. This type of program also takes about 5 years to complete. In many cases your credit report will show that the accounts were enrolled in a debt management program. Many lenders tend to look at this negatively so this will impact your ability to qualify for loans. However, your credit scores usually don’t see much of an impact.
Debt settlement is a much different approach than the other debt relief programs. This program is typically considered a last resort before bankruptcy and can be argued that it’s better than a credit counseling program. In this type of program, this can also be done without hiring a company to do it for you, what ultimately happens is a company negotiates with your creditors to settle your unsecured debt at a reduced amount. The only way a creditor will be willing to negotiate a settlement is if your accounts are past due. Generally speaking, your accounts need to be past due at least 6 months so that they can be charged off. This will obviously negatively affect your credit, but it’s not typically treated like a bankruptcy. The good news is that it typically takes 2-3 years to get out of all the debt, and you pay back about half of what you owe. I don’t think this program makes sense for someone who can afford to make more than the minimum payments. Debt settlement seems to make sense for those that can no longer afford the minimum payments. In other words if you are falling behind with your payments you might as well try to settle your debts. The good news with a debt settlement plan is that there are FTC regulations controlling how these companies charge consumers, so they can only charge you once an account gets settled, in other words no upfront fees.
There are companies out there that can help you recover from financial problems, especially with credit card debt. You should be aware that this normally costs money. You will also have a negative impact on your credit score, and this won’t be resolved immediately. If you’re looking for some sort of help with your debt then you should probably assume that there’s going to be a trade off. If you’re not struggling financially then there is no reason to be looking into these options. Debt Relief programs are for people who are in serious financial hardships.