4 Ways to Pay-Off Your Debt
One of our DC-based Financial Trainer, Mike, explains why you may not want to consider debt settlement right away, even though it may seem like a tempting offer to alleviate some of the stress of paying back your debt.
Loss of income, unexpected expenses, and depleted savings. All of that comes with increased debt-- which is reality for a lot of Americans this year. If it feels like your debt has gotten out of control, you might be wondering, “Hey, is debt settlement right for me?” I’m here to tell you, “No, probably not.” and here’s why!
Here at The Financial Gym we rarely recommend a client to go the debt settlement route. When you’re paying back debt, you have a few options, I’ve listed them best to worst:
Honor your credit contract and pay in full (and on time)
Debt management (you pay back 100%)
File bankruptcy (pay back 0%-a percentage based off your income)
Debt settlement (usually pay back around 60%)
You might be thinking, “So Mike, why don’t you recommend debt settlement? It looks like I save money going that route!” While you may save money from your original contract, there are a lot of implications and effects that happen from debt settlement route, versus any of the others.
Let’s start with the difference between debt management and debt settlement. These options sometimes can be confused for the same thing, but they are very, very different. With debt management you pay back 100% of your debt and you work with a not-for-profit debt management program. They work with your creditors on your behalf to help lower interest rates, lower fees, and sometimes monthly payments. They help you keep your credit from suffering if you’re struggling with your monthly payments. They will even work with you to create better cash management habits (very similar to what we do with our clients here at The Financial Gym all the time!!)
Did you get all that? Okay...
With debt settlement, you pay 60% of your original debt, and you are working with for-profit settlement companies. Typically what happens if you work with a settlement company is they take all your information, and mail cease-and-desist letters to your creditors and the debt settlement company tells you to pay them instead of your creditors. By doing this, your accounts go into arrears (or past due) and it negatively impacts your score. Because the settlement company already sent a cease and desist letter your creditor can’t contact you let you know your account is past due! Once they’re in collections, the settlement company will reach out to your creditors and try and “settle” the debt for you. You continue to pay the settlement company and they get a percentage of the monthly payments you pay them. This not only destroys your credit but you have no legal protections for “breaking” your original debt contract. Creditors can flat out refuse to work with a settlement company, they can put a lien on your property, garnish your wages, or sue you for not honoring your original contract. If you do decide to go this route you should re-read your lending agreement you signed when you originally took out the loan or credit card. One final part with debt settlement you may not know about until the following year - the creditor can issue a 1099-C for any forgiven debt as income - so while you paid 60% of your original debt, you’re paying income tax on the forgiven amount!
“Wow Mike, I had NO idea all that was possible with debt settlement!”
“Yeah if you have heard any debt settlement company’s advertisements recently (which are on the rise) you probably didn’t hear about any of those realities, because it would be bad for business…”
“So….if I’m having trouble paying my debt back and having a hard time making ends meet, should I just file for bankruptcy??”
You’re catching on! With bankruptcy you get legal protections for breaking your initial credit contract. Your creditors cannot contact you, sue you, put liens on your property or garnish your wages. You can also sometimes be protected from any income tax penalties for the forgiven debt. With Chapter 7 Bankruptcy you can have ALL of your unsecured debt wiped away. While it will affect your credit - typically those that file bankruptcy see their score bounce back much quicker because all of the bad debt is closed and cancelled and can not be “reopened” on your credit report vs debt settlement. Debt settlement is a lot like Chapter 13 Bankruptcy without all the legal protections. With Chapter 13 the court decides how much you pay back (based on your current financial situation) and they tell your creditors how much they’re getting and they have to be okay with it.
One note I want to mention; bankruptcy tends to have a lot of negative feelings around it, but it is DESIGNED for consumers to get a “fresh start” especially if you’ve had a catastrophic life event (or even if you’ve just had a bunch of small setbacks and you’re trying to get ahead). There is absolutely no shame in realizing bankruptcy is your best option for you.
So here’s what you need to know:
If you’re able to pay all of your bills, but it just feels like you can’t see to get ahead, you should probably schedule a free consultation here at the Gym, and work with a Certified Financial Trainer to keep you on track with your goals. The nice thing about working with a Financial Trainer is we can take a look at your situation and we will, without judgement, suggest bankruptcy if we think it can improve your overall financial health.
If you are behind on your bills and are having trouble paying your bills and managing your money you should seek a debt management program (with a not-for-profit organization) or consult a bankruptcy lawyer if you think declaring bankruptcy is your best option.
Finally, if you have exhausted all your options, and you find out you do not qualify for bankruptcy, I would then recommend a debt settlement company. Be sure to read their terms and conditions, look at google reviews, and ask questions before signing any contract. As I stated prior I would look at all your lending agreements from your current debts to make sure you won’t have action taken against you for settling your debt (breaching your contract!).
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