So many people wrestle with debt and credit problems, even years after the Great Recession. Maybe you’re one of them. If so, there are several different ways to try to fix your credit and get out of debt. In fact, there might be a dozen or more ways to do this.
Still, most people focus on debt negotiation, debt settlement or bankruptcy. Let’s do a deep dive into these three topics to help you determine if one or more of these might be a good solution for you.
Before we get too far down the road let’s consider the question that needs to be asked first…
How Do You Know It’s Time to Fix Your Credit?
Most people wait too long before they seek out credit help. It’s understandable because most of us really want to honor our credit promises and will often exhaust every possible alternative before looking for outside assistance.
But if your debts have reached a level where it has become virtually impossible for you to pay survival expenses and still service your debts, it’s time to do something different.
When you are buried under a mountain of debt it’s just a question of time – a series of missed paychecks, an unexpected major expense, or even a medical catastrophe – before the situation will become totally unmanageable. Isn’t it better to deal with your credit situation before such an emergency happens? Of course it is.
Bottom line? If you find it almost impossible to pay your living costs and service your debt, it’s time to do something about it. Life is way too short to live with that kind of pressure.
When you work with a debt negotiation company they often advise you to put money each month into a trust fund that they set up for you. They tell you to do that instead of paying your creditors. Once you’ve deposited a healthy amount into that account (but far less than what you actually owe), the negotiation firm goes to the creditor and tries to get them to agree to accept that money as payment in full.
If all goes well, this process can help you get out of debt (assuming you work through the entire program) and pay much less than you owe.
But even if all does go as planned, there are a number of problems with this approach. First, these companies charge high fees. That only adds to your overall debt problem. And keep in mind that this industry is filled with unscrupulous participants, who often fail to do anything close to what they promise – other than collect their hefty fees.
And even if they do get the job done, your credit history will usually be much worse after the plan than it was before. Here’s why.
I mentioned that these firms usually advise you not to pay the creditor during the process. This isn’t universally true but it is for the most part. Well…..if you don’t pay those creditors, what do you think is going to happen to your credit file? The creditors are going to report your delinquencies and it’s going to flush your credit score right down the toilet, that’s what going to happen.
If your credit history is already completely trashed, this may not make matters much worse…..but it’s sure not going to help you any.
Debt negotiation companies focus on the debt. They don’t really concern themselves with your credit score but you should. Why? Because you’ll be the one left to work on cleaning it up after the debt negotiator is long gone.
Debt settlement works very similar to debt negotiation. In fact, it’s often hard to tell the difference and the names are used almost interchangeably. The process works very similar to debt negotiation, except that the debt settlement company will try to negotiate a lower debt payoff, and make monthly payments to the creditor to achieve that end.
Like debt negotiation, debt settlement will ultimately try to get you out of debt (again, only if you faithfully complete the program), and will attempt to do so for far less than the full amount that you owe.
But like debt negotiation, the debt settlement process can destroy your credit rating because they too often suggest that their clients suspend making payments to their creditors.
Not only that, both debt settlement and debt negotiation have a large number of questionable firms operating in this industry. That means you could waste time and scare financial resources without even getting the results.
To top it off, it’s important to remember that when you settle your debt for less than the full amount owed you can get stuck with a tax liability. That’s because the amount of debt that is forgiven can be reported to the IRS as income to you. You will then be forced to report this income on your tax return, and pay income tax on it.
Last, with both debt settlement and debt negotiation, if you fail to complete the program you will undo any benefit that either plan could provide.
To be frank, neither of these options seem very attractive. Let’s continue.
Unquestionably, bankruptcy is the most dramatic way to solve credit and debt problems. That’s because it is a legally binding process that will eliminate your debts, and force your creditors to stop harassing you for money. You no longer need to make payments to your creditors (though you will have to make payments to the bankruptcy trustee under a Chapter 13 bankruptcy) and your creditors will no longer be permitted to contact you.
Best of all, there are no tax consequences to debt settled in bankruptcy, even if a debt is fully discharged.
But there are two major downsides to bankruptcy. First, under a Chapter 7 bankruptcy, you may lose some or all of your assets (above certain minimum thresholds), which will leave you with little capital to rebuild your life with. And second – as is the case with debt negotiation and debt settlement – bankruptcy will leave you with seriously impaired credit.
The Effect Each Will Have on Your Credit and Credit Score
It’s ironic that the very programs that you would use to help you work out financial problems can also cause you additional credit problems. Sadly, that’s exactly what will happen no matter which option you choose.
For example, a bankruptcy can sink your credit score by well over 100 points, and it will remain on your credit report for seven to ten years. And either debt negotiation or debt settlement can leave you with a multitude of serious late payments and even collections and charge-offs, even if your debts are ultimately settled and closed.
This will not only make it difficult for you to borrow in the future, but it can also impair your ability to get certain jobs, buy a car, and especially to rent an apartment or house. It’s easy enough to see how those outcomes – all stemming from a collapse in your credit scores – can make it very difficult for you to move forward in your life.
If you are facing impossible debts, chances are good that your credit score has some pretty serious marks on it already. But it’s still very important that you make the right move when it comes to doing something about those debts. The last thing you want to do is make your situation worse.
If I was in that situation, I’d consult with a reputable bankruptcy attorney first. And I’d make sure that he or she was well versed in debt settlement and negotiation as well bankruptcy law. Last, I’d insist that the attorney understand the credit report fallout of any course of action and advise me accordingly.
Ask the attorney to describe what your financial situation might look like 7 to 10 years down the road (including what your credit score might look like of course) under each of the three alternatives. That is probably the best way to judge which option is best for you. That’s because all three have very ugly short-term consequences. And remember, debt problems are one thing. Credit report problems are another. You might need one professional to solve the debt problem and another to solve the credit report problems. If that’s the case, make sure they work together.
Have you ever been in a situation where you had to rebuild your credit? What methods and strategies did you use? And how long did it take before you reached a respectable credit score level?