Help Getting Out of Debt – Using Credit Counseling

There is Help Available, but be Careful to Avoid Scams

Have you tried to get a handle on your debt yourself but still can’t seem to make any headway? First of all, it’s OK and there’s nothing to be ashamed about. If you find that you just can’t get back on track yourself, there are people out there who can help. At the same time, you must be careful when selecting your help because there are those who prey on people in debt and seeking help. Some programs may end up costing you a lot of money to simply do what you’ve already been doing, and others are downright scams targeted at taking advantage of you.

To help you understand what type of help is out there, we’re going to talk about the different assistance programs typically offered, what kind of services they provide, and what you can expect from them. There are four basic types of resources to help you get a handle on your debt:

1. Debt Settlement Companies

Debt settlement companies negotiate with lenders to accept only a portion of the amount owed and forgive the remaining debt. They often charge a considerable fee and claim to be able to obtain an immediate reduction in monthly payments. The reality of debt settlement is that the consumer is told to stop paying bills and make payments for a few months while they negotiate with the creditors. The debt settlement company then tries to negotiate a payoff amount with each creditor and uses the threat that you’re heading into bankruptcy as a negotiating tool. This often appears legitimate since you’ve been missing more payments, so it can help reach a settlement with the creditors for an amount much lower than what you owe. Then you use the money that you hopefully saved over the past few months to pay off the negotiated payoff amount.

For example, let’s say you owe $10,000. Instead of making your regular monthly payments on this debt, you stop and put that money aside and find you’re able to save up $2,500 over the course of four months. The debt settlement company charges you a $500 fee to negotiate this debt on your behalf and is able to get the creditors to agree to settling the debt for $2,500. That’s great, right? You were able to get out of paying most of your debt! Not so fast. Remember how you were told to stop making payments on the debt? Those negative marks usually aren’t going away and have now caused significant damage to your credit history and will be there for seven years. And the fact that you settled the debt doesn’t make it appear as if you paid off your debt. That alone will show up on your credit report as “settled” and is also a significant negative mark on your history that will be with you for years. Unless your credit score is already at rock bottom, you’re already months behind on your payments, and you’re staring bankruptcy in the face, this is usually not a good option.

2. Bankruptcy

That brings us to the next ugly alternative — bankruptcy. Under bankruptcy, all or a portion of your debt can be absolved by the courts. Bankruptcy is typically held as the last resort since a bankruptcy will stay on your credit history for ten years and make it quite difficult to obtain lending for a while. In addition, the legal fees associated with filing bankruptcy can be fairly steep. You’ll often hear stories about people who are too broke to even afford to file bankruptcy because the attorney fees alone can run into the thousands of dollars.

Things can get complicated depending on whether you have secured or unsecured debt, own property, have equity, and what type of investment accounts you have, and what chapter bankruptcy you file. The potential complications and legal issues surrounding bankruptcy go far beyond this article, so it’s certainly worth your while to consult legal assistance if you feel that bankruptcy is your only option.

3. Debt Consolidation

So, we’ve talked about two of the least attractive options, but now it’s time to focus on the two potentially better options. First, you may be considering debt consolidation. Here, you’re not negotiating out of any debts, settling for a smaller amount, or absolving yourself of any debts through legal proceedings. Instead, you’re simply consolidating all of your debts into one or two more manageable payments.

We’re not magically fixing any debt problems, but just making it easier to make payments and hopefully reduce the amount of interest paid. For example, if you have six outstanding credit cards with interest rates from 20-30%, consolidating these into a single loan or credit card that has a 12% interest rate can not only reduce the number of payments each month, but it could potentially save thousands in interest.

A few words of caution. Be careful when seeking out a debt consolidation company. Some will advertise debt consolidation only to pressure you into some sort of debt settlement program after meeting with you. Others will offer a consolidation loan that doesn’t have a very good interest rate and may be lined with fees that make it so you aren’t actually saving any money. And finally, the biggest problem when consolidating debt is that people don’t change their behaviors and end up right back where they started and in even more debt a few years later. Remember, debt consolidation doesn’t pay off your debt, it simply shuffles it around. If you consolidate your debt and now have all of this available credit on your credit cards, you have to make sure you don’t start using that credit or you’ll find that you’re going to be in even more trouble.

4. Credit Counseling Services

This brings us to credit counseling services. There are two different ways that a credit counseling service can help you if you are burdened with debt. First, a good credit counseling service works closely with you to help provide financial education and tools that can help you get your finances under control. They may work with you to create a budget and assist in helping with the emotional baggage that comes with excess debt.

The second method of assistance is through a debt management program, or DMP. Through a DMP, the credit counseling organization works with you and with your lenders to find a way to manage the debt and pay it off. Unlike a typical debt settlement, a DMP will usually focus on working with the creditors to reduce interest rates, waive late fees, and establish a more affordable monthly payment before trying to negotiate the amount of the debt entirely. Because of this, being on a DMP generally won’t hurt your credit score. Even so, there may be a note on your credit history indicating that you used a DMP to assist in paying off the debt, and future lenders could use this to decide whether or not to extend credit to you. At any rate, this is still better than having months of late payments and a debt being shown as settled on your credit history. After all, in the end it’s all about lowering your overall debt and utilized credit ratio that will ultimately help you improve your credit.

The problem is that not all credit counseling services are created equal. First, there are two primary types: for-profit and non-profit debt counseling services. For-profit services are almost always a bad idea, and in some states for-profit credit counseling companies are illegal. So, your first step should be to determine whether or not you’re looking into a non-profit agency or not. Unfortunately, just finding a non-profit counseling agency is not enough. Every organization is different and there will be different fees and services associated with each. In some cases you may be able to have the fees waived, but you certainly want to make sure you understand what you’re getting for your money if it does cost anything. Be wary of any company that promises a lot but charges a high monthly fee.

More about Debt Management Plans

As I mentioned above, many credit counseling services will offer a debt management plan (DMP) to help you in getting out of debt. One thing you need to understand is that these plans aren’t typically like debt settlement companies and won’t cancel out existing debt, nor is it a consolidation loan. It’s actually a plan put together that helps the creditors get their money while allowing you to make payments on time.You’ll also want to note that most DMPs will only address unsecured credit, so if your primary concern is a home or auto loan, there won’t be much a credit counselor can do other than help you budget those payments.

With a DMP your credit counselor will work directly with each of your lenders to see if they accept a DMP and if they can work with you to make sure that you stay current on your payments and possibly even reduce the interest rate. In some cases a credit card company will temporarily reduce the interest rate while on a DMP. I’ve seen people get their rates reduced all the way down to about 6% in the past.

The other benefit of a DMP is that it can often simplify your monthly payments. Most credit counseling services will take over sending monthly payments to each individual lender so you’re left with only making one single payment to the credit counseling agency. They usually schedule these for monthly or bi-weekly through automatic debit with your bank account so it can ensure you don’t miss a payment. As you probably know, it’s a lot easier to make and keep track of one or two fixed payments a month rather than a bunch.

A Few Final Thoughts

As you can see, there are options out there to help you manage your debt problems if you find you can’t handle it yourself. Aside from bankruptcy, you can accomplish most of the tasks that these services provide on your own for little or no extra cost. Understandably, not everyone has the time or resources available to follow through with their plans and this is when seeking assistance from a third-party can be beneficial.

While you explore your options, be sure to look at all the alternatives and make sure you’re dealing with a reputable company. There are people out there who realize the amount of stress someone with debt problems is under and they will sometimes try to take advantage of this situation. If anyone is promising seemingly incredible results, know that there is no magic bullet for getting out of debt. Each avenue has its own pros and cons, and some may have a lingering impact on your credit history that will be with you for years, so don’t take the decision lightly.

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About the Author: Jeremy Vohwinkle is a Chartered Retirement Planning CounselorĀ® and spent a few years working as a financial planner. Today, he helps people make the most of their money by writing about personal finance here and elsewhere on the web. Jeremy is also Coach at Adaptu and a regular contributor for other publications such as Intuit, and American Express. Be sure to follow Jeremy on Twitter or Google+.

3 comments
ctreit
ctreit

Good list but I think the most important thing to consider is your first statement, "be careful to avoid scams". It is amazing to me how many people try to take advantage of others who are already in severe financial troubles due to high debt.

Wealth Pilgrim
Wealth Pilgrim

This is really helpful. I have to admit that I know nothing about this. Many people in this industry ask to link to my site...now I know why. THANKS!

MoneyEnergy
MoneyEnergy

I haven't used any of these services, but as I move closer to paying off some small debts, I might think about consolidating my student loans, just for convenience of payment - right now they're spread out over four accounts.

I've seen some relatives go through bankruptcy, and now they seem to be doing ok, but that's just on the surface. Could be a case of keeping up with the Joneses. I'd make it my last option.

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