Debt relief: Pros and cons

Debt relief describes the process of reorganizing your debt to make the monthly payments more manageable. There are multiple relief options to choose from, including consolidation, settlement, bankruptcy and even debt forgiveness.

Debt relief can be done by yourself or with the help of an outside agency. While working with an agency can help you make the best decision for your finances, each debt relief method is best for different circumstances and comes with unique drawbacks and advantages.

Much like the debt itself, the relief option you choose will impact your finances down the road. Read through each method and carefully consider the pros and cons to minimize further credit damage or debt accrual.

Debt consolidation

Debt consolidation takes place when you move two or more of your existing debts into one new debt, typically with the help of a product like a debt consolidation loan or a balance transfer credit card. This means that you’ll still owe the amount you started with, but instead of making multiple payments, you’ll only need to make one fixed monthly payment.

Consolidation is a common route for most borrowers, as there are numerous benefits and minimal risks, regardless of whether you choose to take out a new loan or opt for a 0 percent APR credit card.

Debt settlement

Debt settlement is a process that lets you settle large amounts of debt for less than you owe, and it is offered through for-profit debt settlement companies. Typically, these programs ask you to stop paying your creditors as they negotiate your debt with them.

Debt settlement is inherently risky. Creditor’s aren’t required to work with debt settlement agencies and could deny the negotiations altogether. If this happens, your credit will have taken a massive hit (as you stopped making payments), and you’ll be left with the same amount of debt.

If the creditor agrees to the settlement company’s negotiation, you’ll make the payments to the debt company directly in a specified account rather than paying the creditor. While the companies take much of the heavy lifting off your shoulders, the services come at a price.

Settlement fees differ depending on the company but will typically range around 15 percent to 25 percent of the settled debt amount. Keep in mind that settlement companies can also charge you for the amount settled and will never ask you for an upfront fee.

Debt forgiveness

There are some scenarios where a creditor will ultimately forgive the debts you owe, although these instances are increasingly rare. This process will look differently for every debt owed but will almost always start with a debt settlement or credit counseling agency.

For example, if you’re looking to get your credit card debt forgiven, you’ll need to connect with a third-party agency. However, if you’re just looking to have a few medical bills forgiven, you may be able to bypass working with an agency by contacting the hospital’s financial department.

Many hospitals offer medical debt forgiveness programs to individuals who have a lower income. This is often called charity care, and while there’s a limited amount of funding available per institution, charity care funding has been increasing across the nation. According to the American Hospital Association, all hospitals’ median charity care spending rose by 13 percent from 2021 to 2022.

Credit counseling

Credit counseling agencies are organizations that help make your monthly debt expenses more manageable. There are both for-profit and nonprofit agencies across the nation, but you’ll want to go with a nonprofit.

Nonprofit counseling agencies are known to charge lower fees than for-profit agencies, with some offering the services for free. For-profit counseling is offered by debt relief companies and may charge higher rates.

These companies — especially nonprofit — will work with you to help get your finances in order. You’ll be assigned a counselor to look at your current debts and income to curate debt management plans tailored to your monthly budget. Since the counselors are professionals in debt management, they can also offer up suggestions on various debt relief strategies and programs that best fit your needs.

Some agencies also offer long-term financial health assistance and immediate debt management services, like free training and workshops that can help you improve your relationship with money.

Debt management plan

In some cases, credit counseling companies also recommend and oversee debt management plans. These plans have you make a single payment to an account in your name each month, and the credit counseling agency uses this money to pay bills on your behalf. With debt management plans, the company will also work with your creditors to negotiate lower interest rates and more preferential terms.

Like working with any third-party relief company, creating a management plan could devastate your credit score, and creditors aren’t required to work with your counselor.

Bankruptcy

Bankruptcy should be considered as a last resort when other debt relief options won’t work. It’s a long process, isn’t guaranteed and has long-term negative impacts on your credit score. However, bankruptcy can be helpful as it provides a break from creditors and may result in forgiven debt.

There are two main types of bankruptcy — Chapter 7 and Chapter 13. Both types of bankruptcy can help you discharge certain types of debts so you can get a fresh start.

Chapter 13 bankruptcy lets people with stable incomes keep property like a home or car while repaying some other debts over three to five years. Meanwhile, Chapter 7 bankruptcy provides a single discharge of all debts and the liquidation of most property.