Debt Management & Paying Debt Off: A definitive guide for all readers
The best Debt Management, Debt Consolidation, and Debt Relief options for everyone
It seems like in today’s economy, carrying the burden of debt is just something that adults do. Imagine if we could add up all of the consumer debt that Americans owe, what do you think that number would look like?
Well, economists have already done just that. $13.86 Trillion. Trillion with a T. That’s how much consumer debt is currently owed in America. And with 189 million Americans having at least one credit card, with an average household credit card debt of $8,398, that $13.86 Trillion suddenly doesn’t seem as shocking (although it’s still pretty crazy).
As we ended 2019, many Americans were barely keeping their heads above water when it came to managing their debt. As we entered into a recession for 2020 as a result of Coronavirus, millions of consumers are now unable to properly take care of their financial obligations.
In short: If you’re suffering from crippling debt, you are not alone. The good news is that there are many, many options available when it comes to debt management programs, debt consolidation, debt counseling, and debt negotiation.
So sit back and take some notes as we take you through our definitive guide to consumer debt relief. Each plan will be discussed in detail, with indicators on how your credit may be affected.
Debt Snowball vs. Debt Avalanche vs. Debt Snowflake
Short-Term Credit Impact: n/a | Long-Term Credit Impact: Reliably Positive
For those of you that have various forms of outstanding debt — credit cards, student loans, car notes, medical bills,, etc.. — AND have the means to repay the debt but simply aren’t sure the most efficient route to take, then a debt snowball or debt avalanche plan may be the best way to tackle your debt and even save money in the long run.
Picture yourself rolling a snowball down a hill. As it gains traction, it picks up more snow and grows bigger and bigger. That’s the imagery needed to understand the debt snowball moniker.
The idea behind a debt snowball payment strategy is that you make the minimum monthly payments on all of your debt except for the debt that you owe the least amount on. For that debt, you want to try to allocate anything extra in order to pay it off quicker, although it’s not necessary.
Once the smallest debt has been paid off, you take the amount you were paying on that debt and add it to the minimum payment of your next smallest debt, all while maintaining monthly minimums on the other debts.
The debt snowball method can drive fiscally conservative people insane as they may advise on paying off the debt with the highest interest first. The debt avalanche method (see below) is for them. Some people simply need to free up extra money or need a much quicker gratification. For them, the debt snowball method is a good choice.
The debt avalanche has the same idea, but a few variables have been changed. Rather than paying off the smallest debt first, you pay off the debt that has the highest interest rates.
If you’ve got 3 credit cards with interest rates of 18%, 22%, and 29% then you would want to pay the monthly minimums on the first two cards and pay as much as you can on the 29% card. Once that card has been paid off, you take however much you were paying on it each month and put that towards the next highest card, the 22% card while maintaining the monthly minimum for the 18% card.
The debt avalanche method can sometimes take longer than the debt snowball method, but it saves you more money in the long run as you knock out the high-interest debt first. This is a great payoff strategy for consumers who want to be fiscally conservative and don’t need the motivation that often comes along with the immediate gratification of paying off other debts.
With the debt snowball and debt avalanche methods, you are using money that you have set aside specifically for the purpose of paying off those debts. With the debt snowflake method, however, you find tiny bits of savings throughout your normal daily routine and apply those tiny savings to your debt.
A snowflake by itself is small, but enough snowflakes make a snowstorm. A tiny little savings in your daily routine may seem like nothing, but over time it can certainly add up. You have to be quick to find these tiny little savings because, just like a snowflake, the savings can disappear far.
Find a $5 bill in the washing machine? Put it towards a bill payment. Do you normally get a large coffee on your way to work every day, as well as on the weekends? Get a medium instead. Maybe that will save you $1.20 each day which works out to be $432 per year extra that you can pay towards your debt. Imagine finding 2 or 3 snowflakes throughout your day. It can literally add up to be thousands of extra dollars that can now be allocated towards paying off debt.
Debt Consolidation Loan / Debt Restructuring
Debt consolidation, also known as debt restructuring, does just as the name implies; You simply consolidate all of your debt down to one monthly payment. This can be done in a variety of ways, depending on the type(s) of debt you have, the amount of debt, and whether or not your credit is in good shape.
You typically consolidate their debt as a form of debt relief from high-interest rates or high monthly payments that are causing a strain on their finances. The immediate impact on your credit will be minimal and can either be positive or negative depending on what kind of debt you’re restructuring.
Even if the immediate impact is negative, it will only be temporary as long as you keep up with monthly payments. Long-term effects will be positive. Let’s take a look at some of the most common ways to restructure or consolidate your debt:
A homeowner can consolidate debt to potentially lower your mortgage’s interest rate with a cash-out refinance. With a cash-out refinance you will essentially replace your current mortgage with a new one. This new mortgage will also let you access the equity in your home to pay off debt. All of your debt and your mortgage will now be rolled into one monthly payment. If you don’t want to refinance your current mortgage but still want to tap into the available equity, then a second mortgage or a HELOC may work for you.
An unsecured loan is one that requires no collateral and is based primarily on your credit history and income. Because there is no collateral, the interest rates may be higher than that of other loans so make sure you shop around.
If you’ve really gotten yourself into a bad position, you may even be able to take a loan against your 401K. This should not necessarily be your first choice as you may lose out on potential gains, primarily from compound interest.
If all or most of your debt is from credit cards, you may want to consider a zero-balance transfer. Credit card companies will sometimes entice new customers to join by agreeing to take on their debt from other credit cards and not charge interest for usually around 12 months.
Debt Management Programs & Debt Management Plans
A debt management program, also known as a debt management plan, is one of the many ways that consumers can take control of their debt. First off, it is not a loan, nor is the same thing as debt consolidation.
With debt management programs, a company will work with creditors on your behalf in order to possibly reduce your monthly payments, reduce your interest rate, and maybe even get various penalties, fines, and fees eliminated. The company behind your debt management plan will often appoint you a debt management counselor or credit counselor to work with throughout the debt negotiation process.
Aside from working directly with your creditors to lower overall rates and waiving fees, the debt management program can take multiple debts and roll them into one payment. Imagine you have 6 high-interest credit cards. A debt management program may be able to negotiate lower interest rates and consolidate your 6 payments down to just one manageable monthly payment.
Let’s go over some of the most common questions related to debt management programs:
What Types Of Debt Can be Consolidated With Debt Management Programs?
Typically high interest, unsecured, and/or revolving debt. This is most commonly used for credit cards and lines of credit, rather than other debts like student loans or a car loan.
Do Debt Management Programs Affect Your Credit?
Yes, they most certainly do, but often in a way that’s much better than you missing payments. Missing or delinquent payments can severely hurt your credit. A debt management program or debt management plan will help you get back on a path to repairing your credit that was potentially damaged from missed or late payments. The exception is for debt settlements that we’ve outlined below.
What Is A Debt Settlement?
Sometimes the only option with a debt management program is to settle your debt. When this happens, your credit counselor makes a deal with your creditor(s) to settle the debt for an amount lower than what you owe. The debt settlement portion of a debt management program can negatively affect your credit but it is still not as bad as just not paying or ignoring the debt altogether. A debt settlement status for any unsecured debt will stay on your credit history for 7 years, barring any special deals made with your creditors.
Is A Debt Management Plan The Same As Credit Counseling?
While credit counseling may be a part of your debt management plan, the two are not exactly the same. Credit counselors are trained professionals that will help consumers find the root cause of their debt and educate them on ways to manage it going forward. For more specifics about credit counseling, see our writeup below.
Is A Debt Management Program A Good Idea?
As with any financial advice, it’s impossible to say whether or not something is a good idea as everyone’s financial situation and debt obligations are different. With that being said, if you’re inundated with tons of high-interest credit card debt (or other unsecured debt) and can commit to a 3-5 year payment plan, then going with a debt management program may be a good idea for you.
What Are The Best Debt Management Programs?
Here are out 3 favorite non-profit credit counseling agencies that have the best debt management programs:
- American Consumer Credit Counseling. A nonprofit credit counseling agency that helps consumers manage their finances by educating them all about debt consolidation,debt management programs, credit counseling and financial education.
- Cambridge Credit Counseling. It is a non-profit debt relief agency with a goal to help clients get out of debt quickly.
- Money Management International. They help people with debt repayment strategies,debt management programs, balance budgets, and find peace of mind while managing finances.
Debt Settlement & Debt Negotiation
Short-Term Credit Impact: Severe Damage | Long-Term Credit Impact: Long-Term Recovery
Debt settlement or debt negotiation is a bit different from a debt management plan. Debt settlement is whenever a consumer (or authorized representative from a debt settlement company) contacts a creditor and negotiates to pay off their bill for an amount lower than what’s owed. This can all be done without going through a debt management program.
Settling your debt can hurt your credit score. Your creditor will likely have it listed on your credit report for up to 7 years showing as settled. This may make it hard to get a loan or get credit in the future and, if you were to get approved, your interest rates would likely be higher. However, debt settlement is oftentimes the only option for those who have already missed multiple payments or are at risk of going to collections.
Debt settlement companies, by law, are not allowed to charge you anything upfront for their services. If any debt settlement company wants the money upfront, report them to the Consumer Financial Protection Bureau
Here are some of the risks involved with settling or negotiating lower debt:
- Negatively Impacts Credit
As we mentioned above, your credit will be impacted negatively. Although not as much as if you just outright ignored the debt.
- Debt Settlement Fees
You will likely face fees that may be as much as 25% of the debt that was settled. If you owe $10,000 on a credit card and your debt gets settled down to $5,000, you could owe the debt settlement company as much as $2,500.
- Debt Settlement Taxes
The IRS is going to ding you for around 25% of the amount that was settled. They often classify your settled debt as the same way they would your income.
Debt settlement should be used as a last resort. In fact, there are many instances where a Chapter 7 Bankruptcy may be better than settling your debt, for the sole reason that you can start rebuilding your credit faster. The only caveat is that bankruptcy costs money upfront whereas debt settlement costs you nothing to get started.
Credit Counseling / Debt Counseling Service
Credit counseling, as we touched base on above, is a debt counseling service where trained financial advisors will help walk you through all aspects of your debt. They will provide financial advice on eliminating your debt and ways you can manage your money better in the future.
The direct impacts a credit counseling service has on your credit are nonexistent. Because they are simply offering advice, there is no actual negotiation, elimination, or restructuring of your debt. As a result, there is nothing that they can report to the credit bureaus to hurt or harm you.
These trained professionals typically start out with a one-hour meeting that will help them paint a picture of your financial situation. They will then work with you through follow-up meetings to attack the root cause of your debt, help you develop a plan to pay off your debt, and give you advice on how to properly manage your finances to avoid going back into debt in the future.
There are many non-profit credit counseling agencies available. Be aware that just because a company has a not-for-profit status that doesn’t mean that they are free. While some are completely free, others may charge an initial fee upfront and/or for follow-up visits.
Depending on your exact financial situation, and the severity of your debt, your credit counselor may want you to enroll in a debt management program or debt management plan.
Discharging Your Debt With Bankruptcy
As a last result for dealing with debt, bankruptcy is the only option some consumers have. We know you’ve heard the term before, but what exactly does it mean?
Bankruptcy is a way to discharge most of your debt that you owe to creditors. There are some debts that will follow you and cannot be discharged through bankruptcy, such as tax liens, alimony, or child support. Most consumer debt can be discharged through bankruptcy.
What Is Chapter 7 Bankruptcy?
A Chapter 7 Bankruptcy is the most common way that consumers discharge their debt. Credit card debt is, by far, what most of the discharged consumer debt is made up of. During the process of a Chapter 7 Bankruptcy, a trustee (usually an attorney or someone appointed by the courts) will work with your creditors to get you relieved of all of your debt. At the same time, the trustee may end up selling some of your assets as a means to satisfy some of your obligations to the creditors.
What Is Chapter 13 Bankruptcy?
Another form of bankruptcy is Chapter 13. With this type of bankruptcy, you will not be completely off the hook for your debts. The courts and your attorney will work with creditors to come up with a plan to pay off your debts based on how much you owe and what your income is. This gives a little more wiggle room than something like a debt settlement or debt negotiation program.
Does Bankruptcy cost money?
Yes, absolutely. Even though you’re trying to rid yourself of all consumer debt and obligations, you still have to pay to file for bankruptcy. The average price around the U.S. sits at around $325 PLUS additional attorney fees. You must use an attorney because an individual cannot simply file for bankruptcy themselves.
Bankruptcy Takes Time. Any form of bankruptcy takes time. A Chapter 7 will usually take about 4-6 months to complete. On top of that, you will be required to attend credit counseling with an agency that has been approved as a Dept of Justice Trustee.
Chapter 7 or Chapter 13: Which one is right for me?
Only a trained financial advisor or a bankruptcy attorney can answer this one. However, if you’re earning decent wages and try to file for a Chapter 7, it may be denied due to the fact that you at least have some income that can go to your creditors which would then make you more likely to be eligible for Chapter 13.
Managing Your Debt: There’s always an option for you!
Whether you’ve racked up a ton of student loans, have 6 different high-interest credit cards, or simply can’t handle your mortgage anymore, there’s a specific plan of action that can help you better manage your debt. The important thing is to have the discipline needed to stick to a strict debt management plan. Whichever debt relief program that you choose, just be sure to remember that settling your debt is the end goal.
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