So you’ve run up a little credit card debt. How much do I mean by ‘a little’? Well, I’m not really sure, but enough that you are aware of it. For the sake of this blog post, let’s say it’s enough that the minimum payments are perhaps a struggle some months. Maybe it’s even enough that you are not making payments because you can’t afford them that month.
Well, let’s talk about your options for dealing with debt.
First of all, we have clients coming in who deal with a fair amount of anxiety, hopelessness, even depression because of their financial situation. They know how deep they are in and they don’t see any way out.
Yes, for all practical purposes, there is always a way out. In fact, there is often more than one option for dealing with large amounts of debt. They each have different impacts, both negative and positive, and can each be appropriate depending on the situation.
While there are other options, let’s look at just two of those options. They are
Option 1 – Settlement – With a settlement, you work out an agreement with the creditor to pay a portion of the total debt. Once you’ve paid the agreed upon amount, the creditor forgives and writes off the balance of your debt. Depending on the situation, you may pay as little as 50%-60% of the total.
Not so fast. Settlements do show up on your credit report. Because you did not pay off the total amount of debt, it will hurt your credit history and score. After all, lenders are in business to make money and they don’t make as much if you don’t pay it all back.
And then Uncle Sam steps in. If the forgiven amount of debt totals more than $600, the creditor may report that amount of forgiven debt to the government as your income. This is all legal and legit and may mean you end up paying income taxes on the amount of forgiven debt. But then again, paying 20% in taxes on the forgiven amount is less than paying 100% of the debt to the creditor.
Debt settlement agreements are sometimes referred to as “hardship programs” or “debt management programs”. Don’t be confused (keep reading for more) – a settlement is any time there is an agreement a creditor will accept less than the total amount due as payment in full.
Settlements can be set up directly with creditors or through debt settlement companies. Be very cautious of working through a debt settlement company. They may tell you to start making payments to them right away instead of to the creditor. If the settlement agreement isn’t set up immediately, you could end up showing delinquent or even in default for those lines of credit. That is NOT something you want stacked on top of a settlement on your credit history.
Option 2 – Debt Management Plan – A debt management plan is something that we at CFR and other credit counseling organizations offer as a service. Considering all of your income, debt, and expenses, we can often work out a 3-5 year payoff plan with your creditors. You make one regular payment to us and we divide it out from there.
Not all creditors are willing to work with a debt management plan. Some creditors do report to credit bureaus that an account is in a debt management plan. Also, if an account is put into a debt management plan, it needs to be closed. This is why most of our counselors have a big jar of cut-up credit cards in their office. It’s not saying you can’t have those credit lines available in the future, just not right now while we work on payments and building new spending habits. Finally, your budget needs to have room for the debt management plan’s payments. It may require some lifestyle changes on your part, but those will be for the better in the long run.
This is not debt settlement as the debt management plan is to pay off the full amount due. Rather, it is a structured plan with some built in accountability to help that payment happen. Because of that, a debt management plan can have significantly different impact on your credit history and score than a settlement or whatever name they give their program for debt elimination.
Aside from cleaning up your debt without delinquencies, settlements, and taxes, there is a certain personal satisfaction that comes with the completion of a debt management plan. You did it. YOU paid it off.
If you would like some help discerning which path to follow, the counselors at the Center for Financial Resources can help. Whether you are considering debt settlement, a debt management plan, or some other option, we don’t make the decision for you. Rather, we talk through the options and potential impacts of each of those options so that you can make the best informed decision possible. Just give us a call at 605-330-2700 or go online to schedule an appointment.
However you decide to deal with your debt, the most important decision is when you decided to actually deal with it and make forward progress. Start there, and we can help you figure out the rest.
written by Breck Miller
images courtesy freedigitalphotos.net