Debt relief can help lower the amount you owe, but it’s important to understand how it works so you can choose a solution that fits your needs. The best debt relief options may include credit counseling, a debt management plan or debt settlement. Other options, such as filing for bankruptcy, may be less attractive for people who want to keep their credit scores high.
A number of factors can cause you to take on more debt than you can manage, including job loss or health issues. Regardless of the reason, high balances on credit cards and other forms of unsecured debt can be hard to pay down without some form of debt relief. Investopedia spoke with consumer finance expert Erica Sandberg about her take on this topic and some of the top debt relief options for consumers.
Investopedia: What is debt relief, and how does it work?
Sandberg: In general, debt relief is the decrease or cancellation of a consumer’s legitimate financial obligations. It can come from a variety of sources, such as the creditor forgiving a portion of the debt, agreeing to a lower interest rate or converging multiple accounts into one. The goal of debt relief is to make it easier for the consumer to repay their debts, rather than allowing them to go into collections or worsening their credit score by defaulting on payments.
Debt relief companies typically charge a fee to negotiate with creditors on the consumer’s behalf. This is generally 15% to 25% of the total enrolled debt, as well as monthly maintenance fees for an account in which the company will deposit a portion of each month’s owed money. This savings is used to pay off your outstanding debts, with the remaining balance then showing as “zero” on your credit report.
The most common form of debt relief is a debt management program. With this type of debt relief, a certified credit counselor will review your budget and spending habits to determine how much you can afford to pay on a monthly basis towards all your debts. The credit counselor will then create a customized plan in which you consolidate all your debt into one monthly payment that will be paid to all your creditors, and each month the credit counselor will work with your creditors to reduce your interest rates or other fees on outstanding balances.
There are some drawbacks to debt relief, and it’s important to weigh the pros and cons with a financial professional before you decide on a specific option. For example, most debt relief programs will require that you stop paying your creditors for a period of time while they’re working on negotiating with them on your behalf. This can have a negative impact on your credit, so it’s a good idea to speak with a certified credit counselor before you begin. Additionally, you should check the CFPB’s database of consumer complaints about debt relief companies and the Better Business Bureau to ensure you’re working with a reputable company.