What sort of credit card debt help is best for you?
Our columnists are constantly fielding questions from our readers about credit issues. However, over the years, we've seen certain issues pop up more often than others. All this week, we're having each of our columnists field one of the most frequently asked questions for our users. Opening Credits' Erica Sandberg is today's columnist.
Question: I'm in debt up to my eyeballs! What should I do next: bankruptcy, debt settlement, credit counseling, credit repair or debt consolidation?
Out of the steady stream of e-mails I receive from readers, by far the most common question involves how to deal with debt. Specifically, would it be better to contact a debt settlement company, use a credit counseling agency's plan, bundle it all up with a consolidation loan or just give up and file for bankruptcy?
To cut through the confusion, here's an overview of how they all work, and when you might want to consider each.
Debt settlement company
Owe money, but can't or don't want to pay the full balance? You're probably wondering if bargaining the balance down makes sense. A debt settlement is when a creditor agrees to accept less than what you really owe. While not easy to get with an account in good standing, some collection agencies will settle for pennies on the dollar, especially if the statute of limitations for lawsuits has passed or if evidence of it is about to fall off your credit report. Among the downsides: Settled accounts don't look great on your credit report, and the IRS considers forgiven debt over $600 as taxable income.
While you can negotiate your own for free, there are fee-based companies that will arrange them for you. The problem, however, is that most are notoriously bad. Not all are, but a recent study from the federal Government Accountability Office (GAO) found that an alarming percentage of debt settlement companies did not help consumers pay less and were extremely expensive and damaging to the consumer's credit. They typically work this way:
- You stop paying your creditors, instead depositing those funds into an escrow account.
- When the creditors are about to charge the accounts off, the debt settlement company steps in and settles.
- Many creditors quickly understand what's happening, though, and some will sue you for the debt when they find out.
When to consider: Never. If you really want to settle, do it yourself. But your bills should also already be late or in a collection agency before you even try.
Credit counseling agency
I'm a veteran of the nonprofit credit counseling world, and I must say that most of these agencies and their employees are excellent. If you're lucky enough to be assigned a quality counselor -- caring, knowledgeable, passionate; just like I was, of course -- you will emerge from your free appointment with a refined budget and plenty of practical, arrearage-reducing suggestions. Among them may be a debt management plan (DMP). These arrangements allow you to make one monthly payment to the agency for all of your credit accounts. The agency will then distribute that money to those you owe. In return, you receive reduced interest rates, support and education on money and credit management, and you will be in the black in fewer than five years.
Of course, there are some downsides to DMPs. You must close your credit cards and not open any new ones while you're on the plan. (Actually, not such a bad thing, really.) And while a DMP has no impact on a credit score, some lenders balk when they see it on a credit report.
When to consider: When most of your debts are with credit cards, the interest rates will be better than the ones you have right now, and you want the structure of an organization that compels you to live a cash-free lifestyle.
Debt consolidation works by you taking out a personal loan from a bank or credit union and paying off existing debts with it. If the new interest rate is less than the average of the rates you're being charged on your existing accounts, repackaging them in this way can save you a bundle in finance charges. Also, because a loan has a definite payment payoff time, you'll know exactly when you'll be out of the hole.
Some drawbacks: Another obligation can hurt a credit score, and they're hard to get if you're behind or overextended. Oh, and if you don't close your open-but-empty credit lines, you can charge on them again and get into even more debt.
When to consider: When you can get a
lower interest rate and are certain that you will not use your old accounts.
Finally, there's bankruptcy. A few different types are available to consumers, with the most popular being Chapters 7 and 13.
Chapter 7 is what most people think of when the word "bankrupt" comes up. If you qualify, you get to walk away from unsecured balances, such as those from credit and charge cards, collection accounts and medical bills. You'll need proof that you can't pay your debts, and non-exempt assets will likely be liquidated. Though Chapter 7s can offer relief, they also come with profound consequences, including serious credit damage. The notation will remain on your report for 10 long years and loans and lines of credit with decent terms can be mighty hard to get. Plus, people who see the bankruptcy -- from employers to landlords -- are free to make rather harsh judgments about your character.
When to consider: When the bulk of your debts are dischargeable, you don't have any income or assets to pay for what you owe and no other good options are available.
The other main variety is Chapter 13, which is a court-supervised repayment program. With it, you may pay a whole host of liabilities -- from the unsecured variety to mortgage, tax and legal bills through the courts for up to five years. A portion of some balances may be forgiven while others must be paid in full.
What's nice: Interest and fees stop accruing, and your property won't have to be sold. What's not so nice: You have to pay a trustee to manage the bankruptcy, and if you get a raise or a higher paying job, the extra monies will be rerouted to your creditors.
Evidence of the Chapter 13 will remain on your report for seven years, and though it's usually perceived as less horrible than a Chapter 7, many still frown upon it.
When to consider: You have several kinds of difficult and expensive debts, an income to pay for at least a portion of it and valuable assets you want to keep.
What should be clear by now is that there is no single right answer for every stressed-out borrower, and that even positive methods possess some negative qualities. Decide carefully. As famed NBA coach Pat Riley once said, "Look for your choices, pick the best one, then go with it." I'm no basketball aficionado, but that I like.
See related: State statute of limitations for credit card debt, Forgiven debt resurfaces at tax time, The basics of debt settlement, How to pick a nonprofit credit counselor, 9 things you must know about debt consolidation, What you must know about credit reports and scores, 7-point checklist to determine if bankruptcy is right for you
Erica Sandberg is a nationally renowned personal finance authority. She’s host of several financial web shows, and a frequent guest for media outlets such as Fox, Forbes, Nightly Business Report and NPR. Erica previously was affiliated with Consumer Credit Counseling Service and was KRON-TV’s on-air credit expert. Her book, "Expecting Money: The Essential Financial Plan for New and Growing Families," was published in 2008 by Kaplan Press.
Send your question to Erica.
Published: August 25, 2010
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