What is debt relief?

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• Debt relief is a general term for programs that give you more favorable terms on your outstanding debt.
• Debt consolidation and debt management programs offer lighter forms of debt relief for people with some debt troubles.
• Bankruptcy and debt settlements offer significant relief at the cost of your credit score. 

The average American accrued over $101,000 in debt by the end of 2022, almost a 6% increase from the previous year, according to data from Experian.

Excessive debt can result in a high credit utilization ratio and missed payments, which hurt your credit score. A poor credit score can prevent you from qualifying for financial products such as a mortgage or a business loan. Additionally, debt can hold you back from building wealth, as you spend your dollar on past purchases rather than your future self. 

Fortunately, if you're swimming in unpaid bills, debt relief programs utilize various strategies to help reduce your overall debt.

How does debt relief work?

Debt relief is a general term for programs that help consumers deal with outstanding debt and eventually pay that debt off completely. Various debt relief options can lower your monthly payments, reduce your overall debt, or eradicate your debt entirely. 

While these relief services can be helpful, each program has perks and drawbacks. Assessing your situation is essential to determine if a program is right for you.

Types of debt relief programs

When picking a debt relief solution, consider how much you owe and the type of interest rates you're paying before jumping into a program.

Debt consolidation

Debt consolidation merges your debts into a single consolidation loan, allowing you to make a single payment each month. The best debt consolidation loans will have a high enough credit limit to let you consolidate all your debts at a lower interest rate.

To qualify for a debt consolidation loan, you must meet the lender's required credit score, which may be difficult with a poor credit score. 

If you're considering this debt relief option, consider applying for a balance transfer credit card. Like a consolidation loan, a balance transfer card can help you streamline and simplify your debt into a single monthly payment. Additionally, the best balance transfer cards offer an introductory 0% APR rate for a limited time, which can help you save money on interest payments.

Debt management plan

Credit counseling agencies offer debt management plans to help manage your debt. A credit counseling agency will pair you with a credit counselor who'll negotiate with your creditors for lower monthly payments, reduced interest rates, or waived fees. These negotiations typically don't affect the amount you owe, just how you'll pay it back.

A credit counselor can do more than help you tackle your debt. "Credit counselors can work with you to develop a budget, establish affordable repayment plans with your creditors, and provide education on managing your finances," says Bruce McClary, senior vice president of membership and communications of the National Foundation for Credit Counseling (NFCC). 

Debt settlement

While debt management plans negotiate the terms of your debt payment, debt settlement services negotiate the actual amount you owe your creditors. While it's possible to settle debt yourself, debt settlement companies can negotiate on your behalf and lower your overall debt.

Debt settlement companies usually ask you to stop paying your credit cards while negotiating with creditors. Instead, your debt settlement company will ask you to place your payments into a savings account which you will use to pay off your debt later. 

Debt settlement services can be tricky and may leave you in a worse situation than you originally were. Missed payments may result in a drop in your credit score. In the worst-case scenario, your creditors may come after you in court. Additionally, your creditors will charge you late fees and interest on your outstanding balance while you sidestep your payments.

Debt forgiveness

Debt forgiveness refers to lenders releasing you from some or all of your debt obligations. Unfortunately, debt forgiveness programs are challenging to find. Debt forgiveness is often associated with federal student loan forgiveness, which requires applying for a special program to qualify.

However, you may also find debt forgiveness programs for your medical debt under a hospital's charity care or financial assistance policy. Nonprofit hospitals are compelled by the Affordable Care Act to offer financial assistance. 

Bankruptcy

Bankruptcy gives those in financial distress a chance to start over by liquidating their assets to clear their debt.

While this option lets you clear debt immediately and gets debt collectors off your back, declaring bankruptcy should be the last resort. Bankruptcy can stay on your credit history for up to 10 years, harming your credit score and making it difficult to access credit.

"Bankruptcy could offer debt relief in the most severe circumstances, but it should be a last resort after other options are considered," says McClary. Not only will bankruptcy harm your credit profile, but filing for bankruptcy is a long, complicated, and expensive process. You'll need to hire a bankruptcy attorney, costing thousands of dollars throughout months of bankruptcy proceedings.

What to know before you apply for debt relief

It's important to assess all your options and weigh the pros and cons of each debt relief program before jumping into it. Ignorance may cost you.

Debt relief scams

Debt relief service scams claim to help consumers in financial distress by promising to settle their debt with creditors or lower their monthly payments but never delivering. 

Keep your eyes peeled for red flags indicating a debt relief company is committing fraud. Companies that offer debt relief must charge for services after they're done, not upfront. So any company that requires upfront payment before completing debt relief services or any service that promises to remove harmful data from your credit report is likely a scam. 

Before working with a debt settlement company, ensure that the organization you're working with is legitimate. You can contact your state Attorney General and local consumer protection agency to view past complaints about the organization and if it's licensed to work in your state.

Interest rates

If you're consolidating your debt, be mindful of interest rates. The average interest rate for personal loans was 11.41% in the fourth quarter of 2022, significantly lower than the average credit card interest rate of 20.40%. However, you may see higher rates than you currently pay if you have poor credit. Therefore, it wouldn't make financial sense to consolidate your debt. 

Another excellent way to consolidate debt is using a balance transfer credit card. Many balance transfer credit cards offer an introductory 0% APR lasting 12-18 months. If you choose this route, commit to paying off your debt before the end of the promotional period. Doing so is essential, especially if the variable APR on the balance transfer is higher than the interest rates on your debt.

Fees

Debt relief programs charge fees for their services, including up-front fees, monthly payments, or a percentage of the amount managed, says McClary.

Does debt relief affect your credit score?

While some debt relief options can improve your credit scores, others may negatively impact your score.  

• Debt consolidation: This debt relief option can result in a small ding in your credit score as creditors perform a hard inquiry on your account before loaning you funds. 
• Debt settlement: This debt relief option can significantly impact your credit. Debt settlement companies typically ask you to stop paying your credit card bills as they negotiate with creditors to lower your debt. Missed payments can cause a plunge in your credit score. 
• Debt management plan: This debt relief program can increase your credit score if you make regular payments. If you miss a payment, your creditors may pull out of the deal, leaving you back at square one.
• Bankruptcy: This debt relief option will significantly lower your credit score and chances of getting approved for a loan, as creditors will be hesitant to lend money to someone who has filed for bankruptcy. This will continue to lower your credit score until the bankruptcy falls off your credit history, which takes 1o years.

Is debt relief right for you?

Debt relief programs can be your saving grace when eliminating large amounts of debt. McClary recommends different strategies for various circumstances. 

Balance transfers and debt consolidation may be an adequate solution if lower monthly payments and interest rates are all you need to pay off your debts. Balance transfers work best if you're confident you can get your bets settled by the end of the introductory APR period.

If you're struggling to manage your financial situation on your own, you may benefit from a consultation with a nonprofit credit counselor and if your credit counselor recommends it, a debt management plan. 

Those with more severe circumstances may settle their debt or file for bankruptcy. These options are reserved for situations where paying off your debt isn't a realistic resolution. Remember, these programs may provide debt relief immediately, but your credit score will take a significant hit. 

Debt relief frequently asked questions (FAQ)

What is debt relief, and how does it work?

Debt relief refers to the various strategies aimed at lowering or eliminating debt. The debt relief industry helps consumers eradicate debt by reducing interest rates, waiving fees, or lowering the overall amount owed, making debt repayment manageable.

What is the disadvantage of debt relief?

Some debt relief options, like debt settlement and filing for bankruptcy, can result in considerable credit score decreases. Additionally, most debt relief programs require you to pay a fixed fee or a percentage of the debt you owe.

Can I do debt relief myself?

Yes, settling your debt or creating a debt management plan is possible by directly negotiating with creditors. You can also use debt management apps like Tally to automatically distribute your monthly payment across your various accounts.