How to decide if debt relief makes sense for you

Whether debt relief is the right choice depends on your personal finances and whether any available option matches your budget and long-term goals. If you’re having trouble keeping up with debt payments, learning about debt relief and debt management can be an important first step toward regaining control. OneMain Financial explains how different debt relief approaches work and how each one may affect your credit score.

What debt relief means

Debt relief is an umbrella term for several strategies people use to make debt easier to handle. Depending on the method, the aim may be to:

• Set up a repayment plan

• Reduce your interest rate, which is the cost of borrowing money

• Cut fees

• Reach a lower payoff amount through negotiation

Different debt relief approaches can affect your credit score and overall finances in different ways. Before choosing one, it’s important to understand what each option involves and what it could mean for you.

Debt relief options and programs

Debt relief options differ in how they operate and how they may affect your credit.

Credit counseling is a service in which you meet with a counselor, ideally from a nonprofit agency, who reviews your finances, explains possible options and helps you build a personalized debt plan.

Credit counseling is designed to help you organize a plan to address debt, but it does not erase what you owe. You still have to follow the plan and repay the balances. According to the Consumer Financial Protection Bureau, a legitimate credit counselor typically will not try to reduce your balance and will never tell you to stop paying your debts.

With a debt management plan, or DMP, the counselor usually works with your creditors to lower your monthly payment, extend your repayment timeline or reduce your interest rate. They may also seek to pause collection activity and waive late fees while the plan is active. Once the plan begins, you make one monthly payment to the counseling agency instead of paying creditors separately. A DMP may help you pay off unsecured debt within 3 to 5 years.

Credit counseling agencies may charge a fee to establish a DMP, along with a monthly fee of $25-$50 while you are enrolled. In general, DMPs do not affect your taxes. It’s also worth noting that counselors often advise closing credit card accounts, which can lower your credit score at first. Over time, though, your score may improve if you make payments on schedule.

Most credit counseling agencies explain fees upfront and do not bill you before services are provided. To help ensure you are working with a reputable counselor, look for nonprofit agencies certified by the National Foundation for Credit Counseling or the Financial Counseling Association of America.

If you are struggling to make payments, contact your lender or credit card issuer as soon as possible to ask about available options. Lenders may be willing to make payments more manageable by lowering your interest rate or temporarily waiving fees.

Some lenders offer hardship programs designed to help keep accounts in good standing during difficult times, such as after a job loss or a medical emergency. Under a hardship program, a lender may change the terms of your debt to make it easier to handle, possibly by pausing or reducing payments, waiving fees or temporarily lowering the interest rate. Be ready to provide proof of hardship and review your budget in advance so you know what terms you can afford.

Debt settlement involves negotiating with creditors in hopes they will accept less than the full amount you owe. You can try to negotiate on your own or hire a for-profit debt settlement company, also called a debt settlement agency, to do it for you. But creditors are not required to agree, and there is no guarantee that your debt will be settled.

Before hiring a debt settlement agency, consider speaking with your lenders directly to explain your situation and ask whether any adjustments are possible. Even if they cannot reduce or pause your payments, it usually does not hurt to ask.

If you choose paid help with debt, it is important to understand how a debt settlement agency differs from a credit counselor. Unlike a counselor, a debt settlement agency may tell you to stop paying creditors and instead send money into a savings account held by the agency, often called a trust account. If the agency reaches an agreement with your creditors, it uses those funds to pay them. However, being in negotiations does not mean payments are no longer due. Missing or stopping payments can lead to delinquency, collections or legal action, even while settlement talks continue. The longer a debt goes unpaid, the more it can damage your credit score.

Before working with a debt settlement agency, make sure you understand the financial risks. The service can be costly even if it does not succeed. Along with the consequences of missed payments, you may owe income taxes on forgiven debt. And even settled debts on your credit report can make it harder to qualify for mortgages, credit cards, auto loans and other forms of credit later. If you do get approved for new credit, the interest rate may be higher.

Visit Consumerfinance.gov to learn more about debt settlement companies.

Bankruptcy

Bankruptcy is a legal process that may allow you to discharge, or legally eliminate or reorganize, certain debts. Depending on the bankruptcy chapter you file, the process may erase some debts entirely or create a court-approved repayment plan with legal protection.

The kinds of debt that may be discharged vary depending on the type of bankruptcy filed. Not every debt can be wiped out, and some may still need to be repaid through a court-approved plan.

Bankruptcy can have serious long-term negative effects on your credit score. Although rebuilding credit after bankruptcy is possible, it is not a fast process. Before considering this option, it is wise to get advice from both a bankruptcy attorney and a certified credit counselor.

Other debt relief alternatives

There may be additional ways to manage debt beyond credit counseling, debt settlement and bankruptcy. Here are a few options to consider.

A debt consolidation loan is a personal loan used to pay off several debts at once. If approved, you receive a lump sum and use it to pay your creditors in full, though in some cases the lender may pay them directly. You then repay the new loan over a set period in predictable monthly installments. These loans usually have a fixed interest rate, so if you make payments on time, you will know exactly how much you owe each month and when the debt will be paid off.

Debt consolidation loans can be secured or unsecured. A secured loan is backed by collateral, such as a vehicle or another asset you own. With a secured loan, you may qualify for better terms, such as a lower interest rate, smaller monthly payments or a larger borrowing limit. But if you fail to repay a secured loan, the lender can take the collateral.

An unsecured loan does not require collateral. Without collateral, however, the lender relies more heavily on your credit history and financial situation when deciding whether to approve you.

Whether you choose a secured or unsecured debt consolidation loan, consolidation usually works best if you avoid taking on new debt while paying down existing balances.

A balance transfer offer is a low introductory or promotional annual percentage rate, or APR, offered by a credit card issuer for moving existing balances to one of its cards. APR is the yearly cost of borrowing, including interest and fees. In some cases, the promotional rate can be as low as 0% during the offer period.

A balance transfer card works best when you have a clear plan to pay off the transferred balance before the promotional period ends. If you do not repay the full amount in time, the remaining balance begins accruing interest at the regular APR, which is often much higher. And if the card uses deferred interest, you could be charged interest on the entire transferred amount.

Depending on the card issuer, you may also have to pay a balance transfer fee, often equal to 3%-5% of the amount transferred. You should also keep in mind that your credit limit may not be high enough to cover all of your balances.

If you use this kind of credit card debt relief, remember that a balance transfer offer may temporarily lower your interest rate, but it does not reduce the total amount you owe. In fact, if you fail to pay off the balance before the promotional period ends or use the card for new purchases, you could end up owing more than when you started.

Do-it-yourself debt management methods

DIY debt management methods let you tackle debt on your own, without a third party. Two common approaches are the debt snowball and debt avalanche methods.

To use the debt snowball method, list your debts from smallest to largest. Then direct as much extra money as possible toward the smallest balance first. Each time you pay off a debt, the money available for the next one “snowballs,” or grows.

The debt snowball method can create quick wins that help keep you motivated, but it may cost more in interest because it does not prioritize higher-interest debt.

With the debt avalanche method, you focus on APR rather than balance size. Start by ranking your debts from highest APR to lowest, then send any extra money you can spare toward the debt with the highest rate first. After that debt is paid off, move to the next highest APR and continue until all debt is gone.

Depending on your debts and their APRs, the debt avalanche method may save you money on interest, although progress may feel slower at first if your highest-interest debt also has a large balance.

Whichever method you choose, be sure to keep making at least the minimum monthly payment on every debt to avoid late fees and protect your credit score.

How debt relief and debt management can affect your credit score

The effect of debt relief on your credit score depends on the option you choose and which scoring factors it touches. Some methods may help your score if used carefully, while others can hurt it significantly. Here are some common ways debt relief can influence credit:

Payment history has a major impact on your credit score. For example, if a DMP or debt consolidation helps you make more consistent on-time payments, your score may improve over time. By contrast, debt relief strategies that cause you to miss or delay payments, such as debt settlement, may lower your score and remain on your credit report for seven years.

Credit utilization is the share of your available credit that you use. In general, the lower your utilization, the better it is for your score. For instance, paying off credit card debt with a debt consolidation loan usually lowers utilization, as long as you keep the credit cards open.

Applying for new credit, such as a debt consolidation loan or a balance transfer card, usually results in a hard inquiry that may temporarily reduce your score by a few points. Several hard inquiries in a short period can lower your score even more, so it is wise to be cautious about how many loans or credit cards you apply for at once.

If you want to compare offers, prequalifying may be a good first step. Prequalification only triggers a soft inquiry, which does not affect your score, and can help narrow your choices. If prequalification is not available, some scoring models treat hard inquiries made within 14 days as a single inquiry.

What to consider before choosing debt relief or a debt management strategy

Debt relief is not one-size-fits-all

Debt relief does not refer to just one solution. Some options, such as debt consolidation or a debt management plan, may simplify repayment or lower the interest you pay over time. Others, such as debt settlement or bankruptcy, may reduce the amount you ultimately repay, but they also have drawbacks, especially for your credit.

The best option for you depends on your short-term and long-term financial goals, your cash flow and how comfortable you are with each approach.