How to get out of credit card debt
The 5 main techniques for becoming debt free and their pros and cons By Sarah Stevens of Loan Amnesty
Being in Credit Card debt is horrible. As a trained and certified debt arbitrator I know very well how these debts effect people. I’ve seen how monthly payments swell and although, for a while, most people are able to avoid missing payments by swapping debts from one card to another, eventually all the debts catch up with them, they start missing monthly payments and what I call the bad debt whirlwind begins. The whirlwind usually involves the credit card companies raising interest rates and charging penalty fees so that the customer finds it even harder to pay their monthlies, and the collection agencies then stepping in to harass their victims into paying the fees that they no longer have any chance of paying whatsoever. I know that once you are in the whirlwind it consumes your every moment and creates an immense amount of anxiety and uncertainty in your life. However, it doesn’t have to be like this! As a consumer advocate who works for a debt resolution company that is trying to change the debt industry for the better, I want to show you the 5 main techniques for avoiding bankruptcy and dealing with your credit card debts. None are a completely easy road but they have all worked in the past for many, many people in a situation like yours. 1. Debt Settlement
We have all heard the radio commercials and seen the ads on TV claiming that they can eliminate your debts for a fraction of what you owe etc. These days it seems like they are the most dominant ads out there, sadly. Often these commercials will refer to their services as debt consolidation or debt management but almost all of them are for what the industry calls “debt settlement”. How does it work? The first thing to know is that a debt settlement plan involves stopping payment of any of your credit card debts immediately. Instead of making these payments to the credit card company, you make monthly payments to a “trust account” that the debt settlement company sets up for you. Then as the funds build up in the trust account the debt settlement company starts to negotiate with your credit card companies, offering to pay off your debt, usually for a lump sum that is now in your trust account. Since you have not being paying your credit card company anything at all for several months, at this point the credit card companies do regularly accept less (sometimes a lot less) than what you owe them. The industry average reduction seems to currently however at around the 40-50% mark. The other beneficial thing that debt settlement companies are able to do is contact your credit companies as soon as you enter the plan. After that most credit card companies will back down and call off their collection agencies because they know they will get paid something, eventually. However, they will contact the credit bureaus to tell them that you are in a default status and that often has a quite negative impact on customers’ credit ratings. The higher your credit rating going into the plan, the more points you will lose on your credit rating. The cost of these plans varies, but the most common arrangement is that a debt settlement company will take 15% of your total debt as compensation, which is pretty expensive. And because they know that people tend to drop out of debt settlement plans, they also usually ask for the bulk of these fees as the first three monthly payments. That means that for the first three months of the plan you will not be
paying any of your debt off at all. That being said there is a reason that debt settlement is so popular, and it is not just because companies are getting rich from it. At the end of the day debt settlement is the most effective technique that currently exists to have a significant amount of debt forgiven and that aspect appeals to many people. Summary of Debt Settlement Benefits You can reduce your debts by as much as 70% You’ll no longer be paying any interest Collection agencies will probably stop calling you Your monthly payments will be less than before the plan Because your debts are lowered and you no longer effectively pay interest you will pay off your debt much sooner The bigger your debts the more effective debt settlement has the potential of being
Summary of Debt Settlement Negatives Your credit score will take a negative hit Fees are fairly high with the reputable debt settlement companies Some credit card companies don’t like debt settlement and tend to sue anyone who enters into a debt settlement plan if they think that they can in fact afford to pay their minimum monthlies. An example of a company that has at times had this policy is Chase. Debt Settlement is not available in all states. These are Arizona, Georgia, Hawaii, Louisiana, Maine, Mississippi, New Jersey, New Mexico, New York, North Dakota, West Virginia and Wyoming. Generally these states have banned debt settlement because they either believe that it is not in consumers’ interests or they do not know how to regulate the industry so that they can support the good companies and close down the bad ones. Some argue that it is cheaper to just negotiate your debts yourself. In practice this is actually fairly difficult to pull off.
2.
Debt Consolidation
This is one of the most misused phrases in the debt industry. What debt consolidation really means is to take a loan and consolidate all of your debts into that loan. The reason to do this is that you usually take the loan at a lower rate (APR) than you are paying on all of your other debts, especially your credit cards. It’s a great option for people who are eligible for a loan that is big enough to consolidate all your debts into. However, currently because banks are being very picky about whom they lend money to, less and less people can get such a loan. In order to get a consolidation loan you likely fall into one of three criteria; 1) You are rich (and therefore don’t need to worry about debts anyway), 2) you have a home that is worth a lot more than your mortgage (this accounts for fewer and fewer people), or 3) you have an outstanding credit score (750+). If the reason that you qualify for a debt consolidation loan is number 2, essentially you own equity in your home, then be a little careful. What you will usually be doing is taking a loan backed by the equity in your home. If you start to be unable to pay your loan in this scenario, the loan company can take your home off of you! Summary of the Benefits of Debt Consolidation As long as you pay your loan’s minimum payments you’ll retain your credit score
Your interest payments will be lower Your monthly payments will be lower
Summary of the Negatives of Debt Consolidation 3. You don’t reduce the actual debt that you pay off If you use your home to get the loan then you could end up losing it This option is not open to many people
Credit Counseling
Credit Counseling is really about education first and foremost. The idea behind it is that someone who is in debt can best get out of debt by better financial planning and money habits. Usually a credit counselor will work with their clients to figure out a budget that you can afford and then help you to rearrange your finances so that you live comfortably but not excessively and pay off your debts on time. Although they are usually not allowed to recommend aggressive debt resolution techniques like debt settlement, they usually will recommend debt management and will actually administer the debt management plan (DMP) themselves (see explanation of Debt Management below). Credit counseling in itself can often be a fairly cheap option. The better companies will charge a relatively small setup and monthly administration fee which is usually below $100. Indeed, if you may want to think twice about any company that wants to charge you considerably more than $100 a month. This brings us to the next point credit counseling comes in a number of shapes and sizes. It can be a wonderful way to fix your debt issues with some companies and can be a very negative experience with others. Unfortunately it is fairly difficult to tell the two types of company apart. The dominant form of credit counseling is non-profit. That doesn’t mean that it is free, just that the company doesn’t make a profit from you. Sadly however that doesn’t necessarily mean that you are in good hands. A company will sometimes pay its owners huge sums of money as a salary and therefore is able to claim that it didn’t make a profit, even though, in effect, the company’s owners are definitely profiting from your “business”. And some of the for-profit companies can actually be highly professional, largely because they are more motivated to get you a situation that has you recommending their services to others. However, whatever you do you should at least make sure that the credit counseling company is registered with the Better Business Bureau (BBB). Summary of the Positives of Credit Counseling Can be an inexpensive way to deal with your debt issues Educates you in how to make lifelong changes in the way you deal with debt Is often government endorsed Is available in all states
Summary of Negatives of Credit Counseling 4. Doesn’t, in itself, reduce the amount of debt you owe. Cannot recommend some of the more aggressive debt resolution techniques Difficult to tell reputable from disreputable companies
Debt Management
Debt Management, also known as “DMP” is the normal debt resolution technique employed by credit counseling companies. Following an assessment of your finances, your credit counselor will suggest a new, consolidated monthly payment that you make to the credit counselor to pay off all of your debts. The credit counselor then tries to come to an agreement with your credit card companies that your interest rate will be reduced (sometimes to zero) and fees forgiven since you are now less of a risk to the credit company because you are in the hands of a credit counselor. They may also be able to negotiate that your debt is re-aged, what this means is that your credit card company forgives the delinquent period during which you did not pay your credit card, waives the late fees and reports you as current on your payment to your credit card companies. On the whole, debt management plans can be a really great way to get you out of debt while saving you some money. However there are a lot of myths about debt management plans and credit counseling that are untrue. These are usually spread by unscrupulous debt settlement companies who try to convince you that credit counseling is a bad option, when in fact it can be a great option, especially for people with less than $15,000 in credit card debt or in a state that doesn’t allow debt settlement companies to operate. In fact if you see any of the following myths on a debt resolution company’s website, I would recommend that you avoid that particular company. Myths about Debt Management and Credit Counseling a) Credit Counseling Organizations work for your creditors
This is quite a distortion of the truth, in my opinion. The reason that critics of credit counseling say this is that when you are on a debt management plan the company you are dealing with gets paid in two ways 1) from relatively small fees from you and, 2) from what is known in the industry as a “fair-share” payment from the credit card company. This means that the credit card company actually pays your credit counselor a certain amount of the money that you pay to the credit card company. Although this sounds a little shady, if you think about it it is actually pretty fair (excuse the pun). The credit counselor gets to reduce the amount that you pay directly to them because the credit card company is effectively subsidizing the plan. Despite the payment the credit counseling organizations are rarely affiliated in any other way with the credit card companies. b) Debt Management Plans negatively affect your credit score This is largely untrue. The company that administers credit scores claims that they do not reduce credit scores because someone is on a DMP. However, credit counselors do report that you are on a DMP to you’re the credit bureaus. What this means is that your FICO score will not drop, however, any company that pulls your credit will be able to see that you entered into a debt management plan and may therefore consider you a bit more risky. At the end of the day credit counseling is better for your credit score than debt settlement. Summary of Benefits of Debt Management You can significantly reduce the interest that you pay You may eliminate your delinquency history and late fees No negative impact on your credit score Tends to be cheaper than debt settlement Available in all states
Summary of Negatives of Debt Management
It does not involve any debt actually being forgiven It can take longer to pay off debts than with debt settlement
5.
Personal Financial Discipline (DIY plans)
Some commentators will tell you that the best way to get out of debt is to do it yourself. That you need to be more organized, create a budget, cut back on unnecessary expenses and pay off your credit cards oneby-one in a methodical fashion until you are debt-free. This is certainly the approach that many popular celebrity debt advisors like Dave Ramsey suggest in his My Total Money Makeover scheme. The other thing that they suggest is that you pay off your smallest debts first because this keeps your motivation high as you quickly see results. Others argue that you can employ other debt resolution techniques like debt settlement yourself and save a lot of money. DIY debt settlement is certainly an option that is worth thinking about, however it involves real discipline and quite a thorough understanding of your rights. You will need to set aside funds each month, deal with collection agencies and also contact the right people at each credit card company to agree to your debt settlement. On the whole these departments don’t really like dealing with customers so you are probably at a disadvantage going this route. Summary of Benefits of DIY debt resolution It is free If done right it doesn’t negatively affect your credit rating
Summary of Negatives of DIY debt resolution It is really hard to pull off You will not save anything unless you successfully negotiate with your creditors yourself You are unlikely to get an interest rate reduction The majority of people fail to “do it themselves”
As you can see there are certainly pros and cons to each type of debt resolution technique but the key is really to do something. Worrying about your debts doesn’t get you anywhere, weigh up the advantages and disadvantages, use a debt recommendation engine like Loan Amnesty’s if you are still not sure what to do and then get on with paying off your debts and becoming debt free.
Do you have questions about this paper? Feel free to contact the author at asksarah@loanamnesty.com