When Debt Relief Makes Sense: Finding the Right Route to Financial Health

By Arthur Khmura

If mounting debt followed you into the new year, you’re not alone. In fact, almost 70% of American households understand the burden weighing on your shoulders to some extent according to reports currently being released by members of the financial sector. Contrary to popular belief, only a fraction of these cases are the result of irresponsible spending.

Where Does Our Debt Come From?

Inflation might be considered a short answer to this question, but the explanation points to a bigger problem. Over the last 10 years alone, the prices of basic necessities like food have grown more than 35% while the cost of medical care has surged almost 60%. Utilities are up well over 40%.

Although reports from the real estate industry indicate housing prices have only climbed 7% over the last year, they’re also close to recovering from the nearly 40 point drop of the infamous housing bubble pop almost a decade ago. Overall, the jump in this department adds up to about 45%. With the cost of student loans forging ahead 26% during this same time frame, most of us are actually starting out in debt before the cost of living even comes into play.

Despite the swelling expenditures of mere survival, the average household income has only crept up 28%. In order to make up the difference, many of us are being forced to turn to credit cards, personal loans and other forms of debt, the interest rates of which are following suit with all those other elements. A vicious cycle ensues, and we find ourselves drowning.

As opposed to the conventional theory of a decade ago, crawling out of the swirling monetary vortex is no longer necessarily a matter of staying in on the weekends and taking advantage of coupons at the grocery store. Of course, plenty of financial life preservers are at your disposal. Which alternative might best serve you depends on a number of factors.

Debt Consolidation

What is it?

As the name indicates, debt consolidation is essentially combining your current bills into a single lower monthly payment. If you’re currently weighed down by numerous forms of unsecured debt like credit cards, student loans and medical bills, this might be a good option for you. Your lender would offer up a loan covering the total amount of your debt, thereby paying it all off and allowing you to repay the loan over a period of time.

How does it work?

Say you’re $25,000 in debt right now. Perhaps you still owe $15,000 on your student loan for a graduate degree with the typical 6.8% interest rate attached. Another $9,000 of your total amount is earmarked for your credit card companies at the current going rate of 15%, and you have a $1,000 medical bill hanging over your head at 5% interest, which is roughly the industry norm.

For student loans, the term is usually 120 months, but $15,000 is about half the standard amount most graduates find themselves owing, so you’ve probably already been paying for 60 months. Over the next five years, interest accounted for, you’ll actually be paying $295.60 on a monthly basis. Just over $90 per month will pay off your medical bill in a year. As far as the credit card payments go, at a 4% minimum payment of $360 per month, you’ll have your balance down to zero in a whopping 12 years. Incidentally, interest on this particular portion of your debt will add up to almost $4,000 over that 144-month span.

Now, with you currently paying almost $746 each month just on those three components of your total debt, imagine you stumble upon a lender offering a debt consolidation loan at $290 per month with an interest rate of 7%. Just like that, your credit card is paid off, student loans are behind you and the looming medical bill is no more. How long will you be paying on this magical answer to your problems?

Well, with those figures, you’re looking at 10 years with total interest hovering near the $10,000 range once all is said and done. Remember, before the new loan, you were only five years away from paying off your degree and had one left on your medical bill.

Is it the right option for you?

If you need your monthly payments lowered to avoid foreclosure after taking a pay cut or experiencing a reduction in household income, this may ultimately be the solution for you. On the other hand, if you’re hoping to get out of debt faster, consolidation under these circumstances does lengthen the process.

Bankruptcy

What is it?

If you’re in the throes of constant threats from collection agencies or on the verge of losing your home, vehicle and other property, bankruptcy may be the right choice for you. Once you get the filing process underway, the court will grant you an automatic stay preventing creditors from taking action and even disconnecting your utilities in some cases. Of course, you have to meet certain prerequisites in order to be eligible.

How does it work?

For Chapter 7 bankruptcy, the court will compare your income to that of other households like yours. If you make more than the average for your state, you’ll need to proceed to the next level of qualification: the means test. This entails comparing your household income against your debt and figuring in locally determined allowances for essentials like housing, food, vehicles and insurance to determine if you have enough money left over to cover some of your debts.

If you have more than the predetermined amount of disposable income left over each month after expenses, you don’t qualify. Should you be deemed eligible for Chapter 7, some of your unsecured debts may be discharged providing your creditors don’t object in court. You may be expected to give up certain items like non-essential vehicles, valuable family heirlooms, and your savings account in order to pay off other financial obligations.

Chapter 13 bankruptcy is generally for those who exceed the disposable income requirements of Chapter 7. Rather than eliminating expenses, this option is more of a debt restructuring situation in which you won’t have to sacrifice your belongings. You’ll need to develop a repayment plan with the help of a professional and submit it for the approval of the court as well as your creditors. You’ll then have three to five years to pay off all those bills without missing any payments.

Is it the right option for you?

In most cases, bankruptcy is a last resort. Using our previous debt example, you’d likely stand to lose more than you gain with either of these routes. Expenses like student loans are exempt from bankruptcy, so you’d still have the $15,000 plus interest on your shoulders. On the other hand, if your $25,000 obligation lies mostly in credit cards, these could be eliminated under Chapter 7 parameters or greatly reduced over the long term with Chapter 13 due to interest rates being discharged. Saving $4,000 in interest alone could go a long way toward paying down your other debts.

Debt Relief

What is it?

Debt relief (or debt resolution) has some similarities to other options. You’ll submit your income and a list of your expenditures to your debt relief specialist who’ll add up your monthly expenditures. He or she will then subtract this amount from your total household income to determine how much you can afford to set aside for unsecured debt.

Once your debt relief budget has been figured out, you’ll begin sending monthly payments to an account created specifically for that purpose. Typically, after you’ve been diligently making deposits for three to six months, your debt relief advocate will begin calling your creditors to negotiate new balances on your behalf. Though creditors aren’t legally required to accept a reduced amount, they’re often willing to recoup part of their losses rather than risk forfeiting your entire balance.

How does it work?

With debt relief, you’ll have three major benefits on your side. For one, the money you deposit into the account earns interest, so it grows while you’re waiting. Secondly, your debt relief expert may be able to significantly reduce your total debt. Lastly, since your obligations are settled with a lump sum, no interest accrues on your overall balance.

Is it the right option for you?

In comparison to a debt consolidation loan, your monthly payments will be higher with a resolution program. Sticking with the running example, you might expect to pay around $400 per month as opposed to just under $300. Even so, lower total debt combined with disappearing interest is bound to add up quickly in the form of extra money for other expenses.

Keep in mind, you’ll probably be advised to stop making monthly payments directly to your creditors once you begin the debt resolution process. This means you’ll most likely receive some threatening letters and calls until negotiations are complete. Some debt relief companies will actually ask you to switch your contact information with these creditors over to theirs to help intercept these messages.

If you’re over $10,000 in debt and are struggling with paying off the balance, debt relief might be the best option for you since the total amount owed will likely be less than the original amount. And that’s huge.

Bottom Line

In certain situations, crawling out from under the weight of debt is as simple as spending a little more wisely. Some have succeeded in making budgetary adjustments on their own, but sometimes more extensive measures are needed.

Those with multiple credit cards or those who’ve fallen behind due to an unexpected income deficiency like job loss or divorce may fare better with debt consolidation. Payments tend to be significantly lower each month through this outlet, but you’re bound to pay more in the long run thanks to interest. If you’re looking to get out of debt completely and have your sights set on a fairly short time frame, this may not be the best option for you.

Bankruptcy shouldn’t be your first line of defense against mounting debt, nor should it be entered into lightly. In order to be eligible for relief through this route, your debt-to-income ratio has to fall within parameters that vary by state, and you may lose more than you gain once the bigger picture comes into full focus. Not all of your creditors will be willing to go along with this outlet, and quite a few restrictions apply. Expenses like student loans, child support, alimony and court-ordered restitution aren’t affected when you file bankruptcy.

Debt resolution makes sense if you’re over $10,000 in debt, on the verge of being pulled under water by exorbitant interest rates and if you’re hoping to wipe your financial slate clean in a relatively short amount of time. It’s also important to remember that debt relief programs have the potential to lower your total amount owed significantly — so see if you qualify here.

On last report, more than 90 million households in America were faced with rising levels of debt. Credit cards have become more of a crutch over the last decade, but they’re still part of the problem. If you’re among the millions who need a life preserver to help rescue you from these financially tumultuous times, you have plenty of options: it’s just a matter of finding the one best suited to your unique situation.


Originally published on National Debt Relief’s blog on February 16, 2017.

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