How Does Debt Relief Work?

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Flip through the channels on your TV, and you’re bound to see an ad offering debt relief.

Why? American families in debt have a lot of it … and many of them need help repaying it.

Consumer debt topped $14 trillion in 2019, a record high and $2.3 trillion more than a decade earlier. Mortgage debt was at an all-time high of $9.5 trillion with an average balance of $202,284. Student loan debt rose 116% from 2009 and 2019, when it reached a record $1.4 trillion with an average debt per borrower of $35,359. American households carried a credit card balance of $6,194 in 2019, with overall U.S. credit card debt reaching a record $830 billion, up 6% from 2018.

Increased joblessness and widespread economic dislocation connected to the coronavirus pandemic could result in many more people struggling with debts in 2020.  If you’re one of them, you need to evaluate your options and decide what form of debt relief you need and who will provide that relief.

How Do Debt Relief Companies Work?

Debt relief companies, often called debt settlors, are for-profit businesses that promise to resolve clients’ financial woes through negotiations with creditors. They usually try to get lenders to accept less than what they are owed, arguing that without a settlement the borrower might be unable to repay anything.

Since these companies are profit driven, they often charge hefty fees. If they successfully settle your debt, expect to pay 20% to 25% of what you owed as well as side fees for their services. When you enter a plan, they usually tell you to stop paying your debts and instead make monthly payments to accounts they manage. When your accounts grow large enough to make your creditors a settlement offer, they handle the negotiations.

Though the strategy might work, it comes with unsavory caveats. Creditors often refuse to settle. Though the settlement company won’t charge you a fee if creditors refuse to settle, you will have fallen farther behind in your payments, resulting in increased late fees, interest charges and more damage to your credit score.

At this point, the creditors file debt collections lawsuits or sell your accounts to collection agencies. If they do, your credit report will suffer and your problems will grow.

If the settlement offers are accepted and your creditors accept partial payments, you might have tax problems. The IRS considers settled debt income – whatever amount the creditor forgives — as a payment to you and you have to pay tax on it.

Finally, the process can damage your credit and lower your all-important score. Any payments you missed during the settlement process are reported to the credit-rating bureaus. Since your payment history is the biggest factor in setting your credit score, it will almost certainly go down.

Nonprofit credit counselors such as InCharge Debt Solutions are alternatives to the for-profit companies, especially for consumers with manageable debt issues. Instead of pressuring creditors to accept a settlement, they review your debts and recommend steps you can take to rehabilitate you finances. They might suggest you contact your lenders and explain why you’re having trouble paying on time. Sometimes creditors will reduce interest rates and revise payment schedules. Nonprofit counselors will often tailor a debt-management plan for you. You make monthly payments to the agency, which will pay off your debts over three to five years. During that time, you’ll probably live without credit cards.

When to Consider Debt Relief

Debtors often turn to for-profit debt relief programs if other options haven’t worked. The strategy can damage your credit rating and might not work. If you think you can repay your unsecured debt within five years, consider contacting your creditors to propose a repayment plan. The plan might include consolidating debts with a lower interest credit card and following a strict budget until your debts are repaid.

Keep in mind that the for-profit debt relief industry is known for shady operators. They often demand large fees and deliver unsatisfactory results, so beware. The strategy works for some, but make sure you understand all the costs and the consequences.

Before contacting a debt relief company, consider an appointment with a nonprofit credit counselor who can review your options. In some instances, a low-cost debt management plan might achieve your goals; in others, bankruptcy might be the best alternative. Before moving forward, you should review all alternatives.

Debt Relief Options

Generally, there are four types of debt relief:

  1. Debt management programs
  2. Debt consolidation loans
  3. Debt settlement
  4. Bankruptcy

Your circumstances will dictate which one is right for you.

You could choose on your own, of course, and you may make a perfectly acceptable decision. But even athletes at the most elite ranks of sports lean on coaches. If they need coaches to help them achieve a result, chances are you need one, too.

In the world of debt relief, nonprofit credit counselors, like those at InCharge Debt Solutions, are the go-to professional coaches. A certified credit counselor will provide financial advice — including how to create a budget and options for systematically paying down debt — as well as help keep you on track.

A credit counselor also will explain, in detail, the various types of debt relief programs, why one or the other might be right  (or disastrous)  for you, and, using his/her expertise, fit you with the best relief plan for your situation.

So, gather your financial information — income, recent pay stubs, assets, liabilities — and contact a certified nonprofit credit counseling agency online, or by phone. You will get help.

Types of Debt Eligible for Debt Relief

Before tackling a debt problem, be clear on what sort of trouble you have. Debt comes in two flavors: secured and unsecured. Most debt relief programs focus on resolving unsecured debt problems, the kind usually associated with credit card balances.

Unsecured loans don’t rely on guarantees or collateral to protect against default, but failing to pay them has consequences. If you default, your wages could be garnished, or you could be forced into bankruptcy. Your credit score would be damaged, making it difficult to borrow at affordable rates in the near future.

Some common unsecured debts are:

  • Credit card balances
  • Some private student loans
  • Medical debts
  • Personal loans
  • Utility bills

On the other hand, a secured debt relies on whatever was purchased with the borrowed money as collateral. Mortgages are secured debts since lenders can foreclose if you don’t make timely payments. Car loans are also secured because if you miss loan payments, your vehicle can be repossessed. Any time you borrow money and pledge something of value or have someone co-sign the loan, the debt is secured. The U.S. government backs federally guaranteed student loans, promising repayment to the lender if the borrower defaults.

Here are some examples of secured debt:

Types of Debt Relief

Ideally, debt-relief plans should guide you toward becoming debt free in three to five years. Each has benefits; each has drawbacks. That’s why choosing the right plan for you is crucial, as well as why professional guidance is pivotal.

Let’s consider each so you’re familiar with your options when you contact a certified credit counselor.

Debt Management Program

Debt management programs involve third parties acting as liaisons between you and your creditors, but with a key difference: They won’t wreck your credit long term.

Reputable debt management companies arrange lower interest rates and lighter monthly payments with an eye to making debt payments affordable, but also payable in full.

Debt Management Program Pros:

  • A single, affordable monthly payment sent to your debt-management company for distribution among your creditors.
  • Minimal, short-term impact on your credit rating.
  • A date-certain when you will become debt-free (usually 36 to 60 months).
  • You won’t go it alone. You will have a dedicated debt counselor to oversee your program, and to coach you through the tough spots.
  • Your interest rates will fall, and your fees likely will be waived.
  • You avoid bankruptcy but retain it as an option.
  • Creditors and collectors end their harassment.

Debt Management Program Cons:

  • You will be obliged to cancel credit cards.
  • Because the Big Three credit-tracking agencies weigh access to credit in their ratings, canceling credit cards while you still have debt will lower your credit score for the first few months you’re in the program.
  • Much of what debt-management companies do — contacting creditors, negotiating better terms, setting a new payment schedule — can be achieved on your own.

Debt Consolidation Loans

Alone among the Big Four, traditional debt consolidation is a do-it-yourself enterprise. The process involves lumping some or all of your credit card debt into a single new loan: a personal loan, a low- or zero-interest credit card, or a cash-out refinance of your home.

If you have good credit, sufficient income, and the discipline to see it through, a debt consolidation loan could be your ticket out.

Debt Consolidation Loan Pros:

  • Single monthly payment. You won’t have to keep track of multiple closing and due dates.
  • Lower interest rate. Average credit card rates are in the high teens; miss a payment, even by a few days, and you can wind up paying rates in the high 20s, or even low 30s. Depending on your credit score, interest on most personal loans usually is a fraction of those rates, allowing you to take a bigger monthly chunk out of your debt.
  • Making minimum payments? You may never climb out. Debt consolidation can put you on a glide path to debt freedom in 36 to 60 months.
  • You can keep your credit card accounts open.

Debt Consolidation Loan Cons:

  • You’re taking on another loan to pay back the loan you got from the credit card company.
  • Depending on the length of the loan, you could end up paying more in interest, despite the lower rate.
  • Going it alone means it’s up to you to stick to a budget and avoid temptation. Otherwise, you could end up more deeply in debt.

Debt Settlement

While it’s possible to achieve debt settlement — also known as debt arbitration, debt negotiation, or credit settlement — on your own, most often you contract with a third party to intervene on your behalf, attempting to settle your liabilities in a lump sum payment for some fraction of what you owe.

In debt settlement, you stop making payments to your creditors. Instead, you make payments to a savings account you control that builds over time. Meanwhile, the debt settlement company attempts to negotiate payment plans, interest rates, or a lump sum payoff your creditor(s) will stamp as “settled.”

However — and this is important — your account will not be stamped “paid in full.”

You should know this about the process going in: No matter what you heard on the radio, you don’t have a “right” to settle unsecured debt for pennies on the dollar. Debt settlement is risky at best.

Debt Settlement Pros:

  • You may lower your debt amount.
  • You possibly avoid bankruptcy.
  • Creditor and collections harassment ceases.

Debt Settlement Cons:

  • Creditors are not obligated to negotiate, and some refuse to negotiate with debt settlement companies at all. Your credit counselor will help you sort out which is which.
  • You could wind up deeper in the hole. When you stop making payments, you could trigger late fees or higher interest, or both. There’s no guarantee these will be waived.
  • If your debt is successfully settled, the IRS will consider the forgiven portion of your debt as regular income, taxable in the settlement year.
  • Your credit rating will take a dive, both because you stopped making payments and, if you settle successfully, because you walked away from paying your debt in full.
  • Even if you have several accounts that remain in debt-settlement limbo, you’re obligated to start paying fees the moment the company has settled that first account.


Bankruptcy means either discharging certain qualifying debts (Chapter 7, straight bankruptcy), or reorganizing them (Chapter 13, reorganization) so they can be paid in full over a specified timeframe.

Bankruptcy isn’t for everyone. Falling behind in your payments and finding it hard to make ends meet does not a bankruptcy make. Instead, you must be truly insolvent, with no obvious way to recover.

Bankruptcy Pros:

  • Your eligible debts are erased or reorganized in a way that makes them easier to pay back.
  • Bill collectors stop calling.
  • You get a clean slate to start rebuilding your credit.
  • You eliminate credit cards, giving you the chance to develop healthier spending/budgeting habits.

Bankruptcy Cons:

  • You’ll have trouble getting a new loan — even a mortgage — for at least two years.
  • You may be targeted by lenders on the prowl for recent bankruptcy filers, offering credit opportunities with sky-high interest rates.
  • Your filing will be a matter of public record. Anyone can ask to inspect it.
  • You have to qualify. You may have too much in the way of assets or income to clear the bankruptcy hurdle.
  • Your assets will be liquidated to help pay back your creditors.
  • You’ll be on the hook for a filing fee, and most likely attorney’s fees; bankruptcy is not a proceeding lay folk should tackle on their own.

How to Choose the Best Debt Relief Program

If getting out of debt is your goal, choosing the right plan is crucial, and that hinges on your circumstances.

If your debt is more of an annoyance than a crisis, your credit and income are in good shape, and you simply want to streamline, a consolidation loan or credit card transfer might be right for you — as long as you have the discipline not to charge your cards back up while you’re whittling away at your new loan.

However, if the mere-annoyance bird has flown, you’ve fallen behind, and things are on the brink of spinning out of control, you probably need more serious intervention. You’ve seen in the table above the benefits and drawbacks of various strategies. From these, you can decipher the beginnings of a reasonable evaluation of your options.

Then again, a second set of eyes — trained, expert, certified eyes — wouldn’t hurt. Before you commit to a course of action, do that nonprofit credit counseling thing. Call or go online to reach experts at deft-relief options.

At worst, you’ll discover you were on the right track.

At best, you’ll wind up on an unexpected path that gets you where you want to go with the least amount of pain.

About The Author

Tom Jackson

Tom Jackson focuses on writing about debt solutions for consumers struggling to make ends meet. His background includes time as a columnist for newspapers in Washington D.C., Tampa and Sacramento, Calif., where he reported and commented on everything from city and state budgets to the marketing of local businesses and how the business of professional sports impacts a city. Along the way, he has racked up state and national awards for writing, editing and design. Tom’s blogging on the 2016 election won a pair of top honors from the Florida Press Club. A University of Florida alumnus, St. Louis Cardinals fan and eager-if-haphazard golfer, Tom splits time between Tampa and Cashiers, N.C., with his wife of 40 years, college-age son, and Spencer, a yappy Shetland sheepdog.


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