3 Alternatives for Debt Relief
Let’s say you want to eliminate some bad debts, what’s the best way to do that? I’m sure you’ve seen or heard debt-settlement commercials claiming that they possess a secret ability to negotiate large discounts with your creditors. You’ve probably also seen news reports about debt-settlement scams that collect large fees while providing no real benefits – or even making things worse. With all of the big promises and horror stories out there, trying to determine the best option can seem overwhelming.
Well good news: figuring out the best way to get out of debt doesn’t have to be so daunting. With the right information, you can determine the best plan of attack. To begin, you need to know the different options available for resolving debt. Below we give you the options available to you and the framework for deciding how to choose. Let’s dive in.
The 3 General Options for Resolving Debts.
1. Pay them Off.
The most obvious option is to simply pay off the debt. Since most credit cards are set up to be paid over 20-30 years, and the interest rates are astronomical, paying a credit card debt back by making minimum monthly payments is rarely, if ever, the best option for repayment. If paying the amounts back is realistic for you, consider paying much more than the minimum monthly payment towards the debt each month. But be extremely careful and realistic with yourself. I’ve helped many people who had attempted this option when they shouldn’t have, only coming to this realization too late, after having paid large sums of money to creditors that they otherwise could have protected for their own or their family’s wellbeing.
i. Pay Them Over Time.
Most people who find themselves in financial trouble or who see trouble coming simply want more time. If only they had more time they could get things back on track. Creditors are rarely willing to wait for you to find more income. To determine your ability to pay off the debts over time, create a budget for your realistic monthly living expenditures. Include your mortgage and car payments, but exclude all other debt-service payments. Make sure you have included ALL of your living expenses. Budgets that are not realistic will never stand the test of time. Now, with the money you have available each month (after paying your living expenses, including mortgage and car payments), can you pay off your debts in 3-5 years at the current interest rates? If not, you may want to consider one of the other options below.
What about the Dave Ramsey debt snowball? I think it’s great. I love Dave Ramsey and I think his advice is sound.
ii. Lump Sum Settlement.
Most people considering the best option to pay off debts are not sitting on a pile of cash, so this option is rarely a realistic option. And if you have the ability to obtain a lump sum of money, paying off your debts may not be the best use of it. However, in order to negotiate a discounted settlement with creditors, they will usually require a lump-sum payment.
(** ALWAYS talk to a bankruptcy lawyer or other financial professional before cashing out retirement savings to pay creditors – THIS IS ALMOST NEVER A GOOD IDEA** Retirement savings are generally protected from creditors, so using them to pay off debt is one of the worst mistakes you can make.) This can also have drastic tax consequences, where you essentially trade credit card debt (dischargeable in bankruptcy) for tax debt (not dischargeable in bankruptcy).
There are many downsides to the lump-sum payment option, not the least of which is that to negotiate such a settlement, you generally must be behind on your payments – meaning that if you aren’t now behind, you must voluntarily fall behind, which may trigger severe increases in your interest rates.
Another drawback to any debt settlement plan is that any amount forgiven by a creditor (i.e., the amount by which the debt is discounted) qualifies as taxable income to you, meaning you can have to pay tax on the discounted amount.
2. Settle Them.
If you can’t pay off your debt within 3-5 years, you may consider contacting a debt-settlement company to help you negotiate with your creditors. BE VERY CAREFUL. As you’ve likely heard on the news the last few years, many of these companies charge high fees and provide very little benefit, or worse commit fraud. (See the dangers of Debt Settlement Scams).
When you consider debt settlement plans through the lense of common sense, the dangers seem pretty apparent. But they’re not so obvious when you’re scared and desperate. Ask yourself this: why would a creditor take less on their debt simply because you contacted them through a third-party debt-settlement company? They certainly are not required to do so. It is generally understood that these companies start by accumulating a lump-sum of your money (against which they will deduct hefty fees, regardless of whether the plan is successful). Once they have a lump-sum of cash to dangle in front of a creditor, they will (or are supposed to) attempt to negotiate a discounted settlement with your creditors. This rarely works. Almost inevitably, at least one of your creditors will eventually file a lawsuit against you, causing the whole house-of-cards to collapse. And while the settlement company has already received its fees, you’re now stuck with a mess.
3. Eliminate your debts with Bankruptcy.
The word “bankruptcy” is scary to most people, but it shouldn’t be. If I told you that you could get rid of your unsecured debts (e.g., credit card debts, medical bills, pay day loans, etc.) with the certainty of a Federal Court order for between $1,000-$2,000, and at the same time keep all of your belongings, would you take that deal? Odds are you would. Well that is exactly what bankruptcy offers. In roughly 90% of all bankruptcy cases filed, none of the filer’s assets are liquidated. And of those cases in which an asset is sold, there are very few in which the filer did not know ahead of time that such a liquidation would occur. So the very large majority of bankruptcy filers get rid of their debts and keep everything they own. In addition, the discharge of debts is guaranteed by a federal court order, and creditors cannot choose whether to participate, their debts are discharged whether they like it or not.
What about your credit? This is the most common question I receive, and upon inspection, one of the most irrelevant. First, in almost every case a bankruptcy will allow you to repair your credit more quickly than you otherwise could. The general rule that is often repeated across the internet is that a bankruptcy will stay on your credit report for 7-10 years. But that does not mean you won’t be able to get credit for 7-10 years. The further away from a bankruptcy you are, the better your chances of obtaining credit. And if you are paying on a home or a car that you keep after the bankruptcy, odds are your continuing timely payments will be reported, which will allow you to improve your credit even faster. Second, the people I help often start by making a false comparison between filing bankruptcy on the one hand, and not having a debt problem at all on the other. That’s not an appropriate comparison. The real question is how will your credit look a year and half from now if you file bankruptcy and rid yourself of debts, compared to if you stay on your current path. And third, for most people I speak with, their credit is already dinged up, so it’s not a factor relevant to their decision whether to file bankruptcy, it’s only a question of quickly they can repair their credit, and as I said above, bankruptcy usually helps speed things up.
It takes time to repair credit, but that’s true whether or not you file bankruptcy. Creditors and lenders are very familiar with bankruptcy, it’s been around for hundreds of years. In fact, some lenders may offer you credit right after a bankruptcy, knowing that you can more easily repay them now that you've eliminated your other debts. In fact, I have clients all the time who tell me that right after they file bankruptcy, they receive numerous credit card offers in the mail.
There is no set formula to tell you whether bankruptcy is the best option for you, but an experienced bankruptcy lawyer is a great resource. Talk to one. Many bankruptcy attorneys (if not all of them) offer a free initial consultation. I encourage you to speak with a qualified bankruptcy attorney before you decide on any of the above alternatives.