How to determine if debt relief makes sense for you

Whether debt relief is the right move for you depends on your personal finances, your budget, and the goals you want to reach. If you’re having trouble keeping up with debt payments, however, learning about debt relief and debt management choices can be an important first step toward regaining control. OneMain Financial explains how the main options work and how each one may affect your credit score.

What debt relief means

Debt relief is an umbrella term for a range of strategies that can make debt easier to handle. Depending on the method, the aim may be to:

• Create a repayment plan
• Reduce your interest rate, which is the cost of borrowing
• Cut down on fees
• Negotiate a smaller payoff amount

Different debt relief approaches can affect your finances and credit score in different ways, so it’s important to understand the trade-offs before deciding.

Main debt relief options and programs

Each debt relief option works differently and may affect your credit in a different way.

Credit counseling

Credit counseling is a service in which you meet with a counselor, ideally from a nonprofit agency, to review your finances, discuss possible solutions, and build a personalized debt plan.

This approach is designed to help you manage debt, not erase it. You still need to follow the plan and pay down what you owe. According to the Consumer Financial Protection Bureau, a legitimate credit counselor usually will not try to reduce the amount you owe and will not tell you to stop paying your debts.

A credit counselor may help with:

• Budgeting strategies: You may learn how to budget in a way that leaves more money available for debt repayment.
• DIY debt payoff strategies: A counselor can explain do-it-yourself methods such as the snowball or avalanche approach.
• Debt management plan (DMP): A counselor may recommend a structured repayment plan called a debt management plan.

With a DMP, the counselor typically works with your creditors to lower your monthly payment, extend the repayment period, or reduce your interest rate. They may also arrange for collection efforts to pause and late fees to be waived while the plan is active. Once the plan is in place, you make one monthly payment to the counseling agency instead of paying each creditor separately. A DMP may help you pay off unsecured debt within 3 to 5 years.

Credit counseling agencies may charge a setup fee for a DMP and a monthly fee of $25 to $50 while you are enrolled. In general, DMPs do not affect your taxes. It is also worth noting that counselors often tell you to close credit card accounts, which can hurt your score at first. Over time, though, your score may improve as you make on-time payments under the plan.

Most counseling agencies explain their fees up front and do not bill you before services are provided. To find a reputable counselor, look for nonprofit agencies certified by the National Foundation for Credit Counseling (NFCC) or the Financial Counseling Association of America (FCAA).

Working directly with creditors

If you are struggling to make payments, it can help to contact your lender or credit card company as soon as possible to see what options you have. Some lenders may be willing to make payments more manageable by lowering your interest rate or pausing fees.

Some creditors also offer hardship programs meant to keep your account in good standing during difficult times, such as after a job loss or medical emergency. Under such a program, the lender may change your loan terms to make repayment easier by reducing or pausing payments, waiving fees, or temporarily lowering the interest rate. Be ready to show proof of hardship and review your budget first so you know what terms you can realistically afford.

Debt settlement

Debt settlement involves negotiating with creditors in the hope that they will accept less than the full amount owed. You can try to do this yourself or hire a for-profit debt settlement company, also called a debt settlement agency (DSA), to negotiate for you. But creditors are not required to agree, and there is no guarantee that the debt will be settled, whether or not you use a DSA.

Before hiring a DSA, consider contacting your lenders directly to explain your situation and ask whether they can adjust your loan. Even if they cannot lower or pause your payments, it usually does no harm to ask.

If you choose paid help, it is important to understand how a DSA differs from a credit counselor. Unlike a counselor, a DSA may tell you to stop paying creditors and instead deposit money into a savings account controlled by the DSA, often called a trust account. If an agreement is reached, the DSA uses the money in that account to pay creditors. But negotiations do not stop the debt from being due. Missing payments or stopping them can lead to delinquency, collection activity, or even legal action, even while settlement talks are underway. The longer the debt goes unpaid, the more damage it can do to your credit score.

Before working with a DSA, make sure you understand the risks. The service can be costly even if it is unsuccessful. In addition to the consequences of missed payments, you may owe income taxes on any forgiven debt. And even settled debts on your credit report can make it harder to qualify for mortgages, credit cards, auto loans, and other borrowing in the future. If you are approved for new credit, the lender may charge a higher interest rate.

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 type you file, it may wipe out some debts entirely or create a court-approved repayment plan under legal protection.

The types of debt that can be discharged depend on the bankruptcy chapter you file. Not every debt can be eliminated, and some may still need to be repaid through a court-approved plan.

Bankruptcy can have serious and long-lasting negative effects on your credit score. While rebuilding credit afterward is possible, it is not quick. Before considering this path, it is important to seek guidance from both a bankruptcy attorney and a certified credit counselor.

Other debt relief alternatives

There are other ways to get a handle on debt besides credit counseling, debt settlement, and bankruptcy. These options may also be worth exploring.

Debt consolidation loan

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 each creditor in full. In some cases, the lender may pay your creditors for you. You then repay the new loan over a set term through predictable monthly installments. These loans usually have a fixed interest rate, so if you pay on time, you will know exactly how much you owe each month and when the debt will be paid off.

A debt consolidation loan can be secured or unsecured. A secured loan is backed by collateral, such as a vehicle you own. Secured loans may offer better terms, including a lower interest rate, smaller monthly payments, or a larger borrowing amount. But if you fail to repay, the lender can take the collateral.

An unsecured loan does not require collateral. Without that security, however, lenders rely more heavily on your credit history and overall financial situation when deciding whether to approve you.

Whether you choose a secured or unsecured debt consolidation loan, this strategy usually works best if you avoid taking on new debt while paying off the old balances.

Credit card balance transfer offer

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

This approach works best if you have a clear plan to pay off the transferred balance before the promotional period ends. If you do not pay it off in full, the remaining balance starts accruing interest at the regular APR, which is often much higher. If the card uses deferred interest, you could even be charged interest on the full transferred amount.

Depending on the issuer, you may also have to pay a balance transfer fee, which can be up to 3% to 5% of the amount transferred. And the credit limit offered may not be enough to cover all of your balances.

It is also important to remember that a balance transfer may only lower your interest rate temporarily; it does not reduce the amount you owe. If you do not pay it off before the promotional period ends, or if you use the card for new purchases, you could end up owing more than when you started.

Do-it-yourself debt management methods

You can also handle debt on your own without working with a third party. Two of the most common DIY approaches are the debt snowball and debt avalanche methods.

Debt snowball method

With the debt snowball method, you list your debts from smallest to largest and put 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.

This method can provide quick wins that help keep you motivated, but it may cost more in interest because it does not focus first on the highest-interest debt.

Debt avalanche method

The debt avalanche method focuses on APR rather than balance size. You rank debts from the highest APR to the lowest, then direct extra money toward the debt with the highest rate first. Once that is paid off, you move to the next highest APR and continue until all debt is gone.

Depending on your balances and rates, the avalanche method may save more money on interest, but it can take longer to feel like you are making progress 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 all debts to avoid late fees and protect your credit score.

How debt relief may affect your credit score

The impact on your credit score depends on the method you choose and which scoring factors it affects. Some strategies may help if used carefully, while others can cause serious harm. Here are some of the main ways debt relief can affect your credit:

Payment history

Payment history is one of the most important parts of your credit score. If a DMP or debt consolidation helps you make regular on-time payments, your score may improve over time. But solutions that cause you to miss or delay payments, such as debt settlement, can lower your score and remain on your credit report for seven years.

Credit utilization

Credit utilization is the percentage of available credit you are using. In general, lower utilization is better for your score. For example, using a debt consolidation loan to pay off credit card balances usually lowers utilization, as long as you keep the cards open.

New credit

Applying for a debt consolidation loan or a balance transfer card usually involves a hard credit inquiry, which may temporarily lower your score by a few points. Several hard inquiries in a short period can have a bigger effect, so it is wise to limit how many applications you submit at once.

If you want to compare offers, you may want to prequalify first. Prequalification only creates a soft inquiry, which does not affect your credit score, and it is an easy way to narrow your choices. If prequalification is not available, some scoring models count hard inquiries made within 14 days as a single inquiry.

Negative events

Debt settlement and bankruptcy can lead to negative marks on your credit report:

• Settlement: Debt settlement can reduce your credit score by 100 points or more, and a settled debt can remain on your credit report for seven years.
• Default: A DSA may tell you to stop making monthly payments while it negotiates on your behalf. If you default on the debt during this time, the default can stay on your credit report for seven years.
• Bankruptcy: A bankruptcy record can lower your score by up to 200 points and may remain on your credit report for up to 10 years. The exact impact depends on your prior score and the type of bankruptcy filed.

Things to consider before choosing a debt relief strategy

Debt relief choices do not all offer the same benefits or risks. As you review your options, keep these points in mind:

• Fees and costs: Some solutions involve fees that add to the total cost of resolving your debt. For example, a balance transfer card may charge a transfer fee, and a debt consolidation loan may include an origination fee.
• Not all debts qualify: Make sure the debts you want to address are eligible for the option you are considering. For example, student loans and secured debts such as mortgages generally do not qualify for a DMP.
• Some methods can make matters worse: Pausing payments, as with debt settlement, can trigger late fees, collections, or legal action.
• Time and commitment: Most debt relief strategies require months or even years of consistent effort. There is no quick fix for debt.
• Risk of scams: Scammers can show up in any industry, but they are especially common in debt settlement. Watch out for anyone who asks for upfront fees, promises guaranteed results, or tells you to stop talking to your creditors.

Debt relief is not one-size-fits-all

Debt relief is not a single solution. Some approaches, like debt consolidation or a debt management plan, can simplify repayment or reduce the interest you pay over time. Others, such as debt settlement or bankruptcy, may lower the total amount you repay but come with serious drawbacks, especially for your credit score.

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