Let's face a cold, hard truth: Americans today face mountains of debt. Credit cards, college tuition, home mortgages - the list goes on and on. In fact, the average household has an average $18,000 worth of debt to manage, and that figure is only growing higher. Sometimes trying to set a budget and stick to it just isn't enough - and that's when it's time to seek professional assistance.
The good news? There are many different types of debt relief available today - everything from picking up tips from Suze Orman or Clark Howard (nationally-recognized finance experts/talk show hosts), to simple counseling from a credit counselor, to filing for bankruptcy.
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Most individuals who find themselves in need of debt management fall somewhere in the middle - but we'll help you to explore all the options available, and provide you with tips on how to make the right decisions (and avoid some common traps along the way).
Sound good? All right then - let's get started - remember, you've not nothing to lose - except your debt!
What Is Debt Management?
By its standard financial definition, debt management means that either you - or a third party - works to restructure the terms of debts owed to your creditors. Many people opt to work with an experienced debt management agency, in which experienced credit counselors help individuals (or other companies) with heavy debts or damaged credit get back on their financial feet. This process can be entered into voluntarily, but sometimes is the result of a court order (this is more typically the case with companies who owe large amounts of money to various creditors).
It's important to note that debt management differs from debt reduction. Debt reduction's main objective is to eliminate debt as quickly as possible, which almost without fail will leave damaging marks on your credit report. Debt management is subtler, and involves paying back debts on much more favorable terms. The process can take years, and can in some cases still result in damaging your credit score (though usually to a much lesser degree than with rapid debt reduction, as with bankruptcy).
Debt Management Options
In general, there are three different ways you can go about paying off your debts that truly fall under the debt management umbrella: Debt Consolidation Loans, Credit Counseling and Debt Settlement. Let's take a more in-depth look at all three and see what they entail.
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Debt Consolidation Loans
When people hear the term debt consolidation, loans are usually what come to mind first. Simply put, it involves taking out a larger lower interest rate loan to combine the higher interest debts into one the lower interest rate loan. Typically, you end up paying less per month on a minimum payment, and your interest rate will be lower than that of the smaller loans. It does take a fair amount of fiscal responsibility to not get into further debt WHILE paying off the debt consolidation loan, but if that's something you feel you can handle, these loans can work out very well in the long run.
Debt consolidation loans come in two forms: Unsecured and Secured. Unsecured loans are usually smaller than their secured counterparts, and generally don't exceed $8,000. That's because most financial institutions aren't in the habit of loaning out larger sums of money without some type of collateral in return. If, for example, you have less than $6,000 of high-interest credit card debt, an unsecured loan can be a great way to pay off that debt with a lower interest rate - it can even help you increase your credit score (provided you make on-time payments).
Secured loans, on the other hand, require you to put up a large asset (such as your house) as collateral to secure the debt. Secured loans are often used to pay off much higher dollar amounts (including pricey medical bills). And while the benefits are the same with secured loans as they are with unsecured loans, failing to keep up with month-to-month payments could mean losing your house to the bank.
With credit counseling, you don't take out a loan to consolidate your debts under. Rather, credit counselors provide you with assistance, advice and various tools to help you pay back your debts on terms that are more favorable. This can be as simple as helping you to establish a household budget, guiding you through consolidation, or even taking you through a bankruptcy filing - if that is truly your last resort.
One of the measures that credit counselors will sometimes recommend is establishing a Debt Management Plan (or a DMP). In setting up this plan, the credit counseling agency makes proposals to your credit card companies on your behalf to get them to reduce interest rates, potentially waive fees and penalties, and/or extend you more favorable repayment terms. The agency explains your financial situation, and upon understanding what you're able to pay, many credit card companies may agree to the proposed terms. Once proposals have been approved, your credit counselor will consolidate all the high-interest debts into a single lower payment that you pay each month until the process is complete, and he or she then uses that payment to pay off all the creditors individually.
Debt Management Plans often make sense for both parties: Consumers may be able to get on a path to get rid of debt and save money via lower interest rates, and credit card companies may be willing to offer relief in the form of lower rates, waived fees and penalties if they believe they will receive timely monthly payments to service the debt. The credit counselor's role in the process is, in many ways, like acting as the go-between to make proposals on behalf of consumers to the credit card companies.
Regarding the potential benefits of credit counseling or debt management -- via lowered interest rates, and your discipline to make monthly payments and NOT add to your existing debt, debt management plans typically can help consumers break free of the debt cycle in as little as three to five years - much less than the twenty or more it would take you to clear your debt if you only paid monthly minimums on high-interest credit cards.
A word of caution however. While the Fair Isaac Corporation (the company that devised the FICO Credit Score) has asserted that credit counseling and debt management plans themselves don't have a negative impact on your credit score, there are other credit reports on which a debt management plan will have a negative effect. As a result, you may find it more difficult to secure additional loans for a car or home purchase, and you may also have trouble opening up new credit cards. So if you are planning on making any major purchases in the near future, a debt management plan might not be the best avenue to take.
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This third type of debt relief involves negotiating and settling the amount of debt you owe to your creditors. Whereas, debt management involves paying back all that you owe, just via more favorable terms, debt settlement requires the consumer to set aside funds or accumulate funds that can be used to make a lump sum settlement offer to creditors. Partially due to much tougher bankruptcy laws, debt settlement has become a popular alternative for consumers who want to get rid of debt as quickly as possible via negotiated settlements.
It is important to note, however, that debt settlement will typically have a negative impact on credit scores, although not as severe as bankruptcy. And, individuals who work with a settlement company and voluntarily STOP MAKING PAYMENTS to credit card companies may be sued for defaulting on the terms of their credit card agreement. Despite the fact that settlement can hurt credit ratings and bring on legal action, it still has become more and more popular is a preferred form of debt relief to bankruptcy -- which has an even longer lasting and severe impact on personal credit.
As to how debt settlement companies typically work, consumers who enter settlement programs work with a debt relief representative who will have you set aside a certain amount of money, for an extended period of time, in order to fund a special account that will be eventually used to extend a reasonable settlement offer to your credit card company (ies).
Once the account is set up, you immediately stop paying your creditors directly and inform them that you are now being represented by the settlement agency. The agency will then begin, once a lump sum set aside is accumulated, to negotiate down your debts. After the negotiation process is completed, money is withdrawn from the account to pay off whatever balances remain.
However, be aware: Debt settlement is, at its core, all about you stopping your monthly payments to creditors to set aside funds for an eventual settlement offer. While this certainly may be the best course of action for financially-strapped people facing bankruptcy, it will raise concern on the part of your creditors that you could fall into default on your accounts. With these concerns, your credit score will almost certainly be negatively impacted - and, as with a debt management plan, this can affect your ability to secure a large loan for a major purchase.
I've heard about non-profit debt management. What's that all about?
There are many different agencies that exist today to help you alleviate your debt - some for profit and some non-profit. Often, a financial institution like a bank or credit union will operate a non-profit division solely dedicated to assisting members with their debt relief needs.
However, you should be aware that just because an organization is labeled as non-profit, this doesn't mean that they won't charge you for their services - nor does it always mean that the company is acting in your best interests. Sadly, there are lots of debt relief agencies that should be carefully scrutinized, so you need to be aware of companies that can assess "hidden" fees or try to persuade you to make "voluntary" contributions - contributions that will "assure" you get the relief you need. <.p>
Working with one of these agencies could put you into even more debt than you are currently, so be careful about choosing the right agency to assist you with debt relief. The federal government, through the Federal Trade Commission, has new regulations in place to assist consumers in need of debt relief, and we provide a direct link to this information from this site.
How do I choose the right agency?
When you start down the path of choosing a debt management company to assist you with your financial recovery, there are some key questions you need to get quality, honest answers to:
- What types of services are offered here?
- Do you give me educational materials - books, blogs, links, seminars, etc. - that will help me to better understand this entire process?
- What if I can't afford fees or make any contributions? Will my debt relief efforts suffer as a result or will we still be able to get my debt down?
- Let's say we eliminate my debt - do you offer services or instruction on how I can keep my manage my debt in the future?
- What licensing do you have to perform these services? Are you in good standing with the Better Business Bureau and other local consumer protection agencies?
- What qualifications do your debt relief specialists possess?
- Why should I choose this agency over all the other options available?
- Any respectable agency will be more than happy to provide you with information on their company and the services they can provide you, without ever making you feel pressured to sign up or pay anything. So if you begin encountering pressure from any representative, take that as a clear sign that this is an agency you don't want to work with, and begin exploring other options.
Debt Management: The bottom line
It is possible to manage your debt yourself - there are even a variety of debt management software packages available on the market to help you with such an endeavor. However, whether you do it yourself or seek professional assistance to lower your debt, you're going to need to be comfortable making a few financial concessions along the way. Since many of the debt management solutions can involve a negative impact to your credit rating, you may have to put off major home improvements or large purchases for several years. However - keep in mind that in the larger scheme of things, this is a relatively small price to pay for being able to get on a proven path to wipe your debt clean and start with a fresh financial slate.
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