At a Glance
Debt relief is a tool some people use to avoid bankruptcy, but it isn’t the best option for everyone. By understanding how debt relief works, the pros and cons, and what your other options are, you can make a confident decision about how to deal with your debt.
In this article, you’ll learn:
Debt relief meaning
The term debt relief has a wide-ranging meaning. Some sites use it in the generic sense, like an all-encompassing concept of getting relief from your debt that includes methods like debt consolidation, debt settlement, and even bankruptcy. However, others use debt relief only to refer to methods that help you avoid bankruptcy.
For our purposes, we’re going to say that debt relief is the process of reducing or refinancing your debt to make it easier to repay. So, we will not include bankruptcy, though it may be an alternative option for some borrowers who find themselves stuck on the struggle bus.
Who qualifies for debt relief?
Depending on which method debt relief you choose, you may need to meet specific debt and credit requirements to apply. For a debt consolidation loan, you’ll likely need a good credit score to get approved (sometimes in the mid-600s and above), and the loan amount will depend on your credit history. Balance transfer credit cards can be similar when it comes to credit score requirements. For debt settlement programs, you usually need a minimum amount of debt, typically $7,500 or higher. Many programs may also have a cap on how much debt they’ll deal with, so if you owe more than $100,000 in credit card debt, you might want to consider another payoff method before you engage with a debt relief company.
It’s also important to note that just because you qualify for a debt relief option doesn’t mean it’s the right one for you.
What is a debt relief program?
When you hear the term “debt relief program,” it typically means debt settlement, which is a debt relief option. So, what is debt settlement?
Debt settlement is a way to reduce the amount you owe through a debt relief/settlement company that negotiates with creditors on your behalf. If you’ve missed several payments, your creditors may be open to negotiating settling for a lower amount in a lump sum—because getting back some of that money from you is better than getting none of it.
Debt relief options
You have plenty of options when it comes to debt relief. Here’s a list of the most popular ones:
- Debt consolidation
- Debt management
- Debt settlement
- Credit counseling
- Debt forgiveness
With debt consolidation, you combine multiple high-interest debts (i.e., credit card debt) into a single account. Consolidating your debt can help you simplify your monthly payments, lower your interest rates, and/or get out of debt faster. There are several ways to consolidate your debt, including:
- Debt consolidation loan: Consolidation loans usually have lower interest rates than credit cards and personal loans, so you’re able to dig your way out of debt by putting the loan toward your debt and then repaying the loan every month at a lower interest rate than you previously had. This way, you’ll get out of debt faster because interest isn’t piling up quite as fast.
- Balance transfer: This is a good option if you’re dealing with multiple credit card debts. With a balance transfer, you move all your credit card balances onto a new card with lower or 0% APR. If your credit is good enough, you should qualify for introductory 0% APR offers, which will allot you 12-18 months of repaying your balance with 0% interest. The catch is that you should make sure you pay it all off before that promotional APR period ends, or else you’ll be stuck paying an astronomical APR on the remaining balance.
- Home equity loan or home equity line of credit (HELOC): Home equity loans and HELOCs usually have low interest rates, so if you’re a homeowner, you might be able to save by consolidating your high-interest debts using one of these methods. These methods are good for people who are serious about getting out of debt and have a solid repayment history. After all, you could risk foreclosure on your house if you default on a home equity loan.
- Cash-out refinance: With a cash-out refinance, you replace your mortgage with a new one that’s worth more than you owe on your house. You then get the difference in cash, which you can use for consolidating your debts. You could save on interest, but you risk foreclosure and will probably be responsible for closing costs that range from 2-5%.
Debt management or credit counseling
DIY debt management involves addressing your unsecured debts through budgeting and repayment methods like the debt snowball or debt avalanche. With the debt snowball method, you pay the minimums on all your monthly payments and put extra money toward your debt with the lowest balance. With the debt avalanche method, you pay the minimums and put extra money toward your highest-interest debt.
Another form of debt management is credit counseling, which involves getting help from a professional credit counselor. They can help you build a debt repayment plan, negotiate with creditors on your behalf, and more.
As we mentioned above, debt settlement is when you or a debt settlement company negotiate with creditors so you can pay less than the full amount you owe. Be careful, though, as debt settlement companies might assess late fees and other penalties. It’s also crucial to be wary of debt settlement scams.
If you qualify for a special debt forgiveness program, your creditor may forgive some or all of your debt owed. You will likely be required to report any unpaid debt to the IRS, which could lead to a higher tax bill come tax season.
How does debt relief work?
Using one of the debt relief options we’ve outlined above, you can help make your monthly payments more realistic. If you consolidate with a loan, you’ll likely lower your interest rate. Depending on the method you choose, you’ll face different advantages and disadvantages.
Debt relief pros and cons
The biggest advantages of all debt relief options are:
- If you’re successful, you can save money on interest or end up paying less than you actually owe—especially if you settle your debt or get some forgiven
- Simplifying your monthly payments
- Lower interest rates and/or waived fees
The biggest disadvantages are:
- Potential fees
- You may need good credit to qualify for lower interest rates
- Your credit score might suffer
How debt relief affects your credit
Speaking of your credit, debt relief can affect your credit score in several ways.
For the positives, you can help your credit score by paying off credit card debts and lowering your credit utilization ratio. With a debt management plan, consistent payments can also help strengthen your credit history and raise your score.
For the negatives, opening a new account for a consolidation loan or balance transfer card can cause a slight dip in your score because of the hard inquiry on your report. You should also be aware that through debt settlement or forgiveness, your debts may show up on your report as “settled” or “forgiven” rather than “paid.”
Debt relief alternative: bankruptcy
If all else fails—assuming you’ve already tried DIY repayment methods and different debt relief strategies—bankruptcy might be your only remaining option. Sometimes, if your credit is poor enough or if your income isn’t where it needs to be to mathematically dig yourself out of the hole, bankruptcy can help keep creditors and collections off your back.
Read more: What Is Bankruptcy?
Is debt relief a good idea?
It’s best to consider debt relief when you’ve tried DIY repayment options and haven’t been able to make a dent in your overall debt, or when your debt-to-income ratio exceeds 50%. But if you can become debt-free in the next few years, we recommend trying a DIY plan or consolidating with a loan or balance transfer.