Debt relief can free you from some or all financial obligations. Taking some of the weight off your shoulders gives you more flexibility to cover remaining debts and rebuild your credit and finances. While debt relief can reduce personal debt, borrowers consider it a last resort. Debt relief may come with ramifications for your credit score. Some borrowers are okay with the tradeoff, but you should know the pros and cons. We’ll share how different types of debt relief affect your credit score.
Types of Debt Relief
Borrowers in financial distress can choose from several types of debt relief. We will first cover what each debt relief method provides and then discuss how each one impacts your credit score.
- Debt Consolidation Program: Some borrowers pay several loans with varying interest rates. You might get stuck with high-interest loans such as credit card debt and payday loans. A debt consolidation program makes debt easier to manage by putting it all under one umbrella. You can pay off your smaller debts with a personal loan, consolidating your obligations in the process. You can use a personal loan with a lower interest rate to pay off loans with higher interest rates.
- Debt Management Plan: Not every borrower has sufficient credit for a debt consolidation program. These borrowers look at debt management plans as the next viable solution. A credit counseling agency acts as a third party between you and the lender. Both parties agree to a new payment plan that provides the borrower with more breathing room to make monthly payments.
- Debt Settlement: Borrowers considering a debt settlement program find themselves on the brink of bankruptcy. Borrowers repay the debt as a partial lump-sum payment or a structured settlement agreement.. Bankruptcy is a last resort since it will have the most significant impact on your credit score. Lenders follow the logic that something is better than nothing, but they are not obligated to reach a debt settlement.
- Credit Counseling: Borrowers can reach out to a credit counselor and seek guidance. Counselors check your credit report and conduct a soft credit inquiry to obtain information. They will review the credit report to offer personalized suggestions. A credit counselor doesn’t wipe away your debt, but you may have questions about the best plan to pay off debt. Counselors can provide you with clarity and move you in the right direction. Some counselors can advise on which debts to prioritize. Focusing on secured debt such as car loans and mortgages protects your collateral. Being late on unsecured debt is often less risky than missing payments on secured debt.
- Bankruptcy: Bankruptcy is the last resort for financially distressed borrowers. It leaves a dent in your credit score for 10 years and may not eliminate all of your obligations. You’ll still owe taxes, child support, and likely student loan debt as well. Chapter 7 absolves most debts except the ones mentioned, while a Chapter 13 bankruptcy establishes a 3-5 year payment plan. Chapter 13 bankruptcies allow you to hold onto your property, while you can lose your home due to a Chapter 7 bankruptcy.
How Does Debt Relief Affect Your Credit?
Debt relief may significantly impact your credit score. We’ve explained the different types of debt relief. Now, we’ll explore how each one affects your credit score.
- Debt Consolidation Program: Consolidating your debts into one loan may improve your credit score. You’ll have a lower interest rate and only have to consolidate debts with high-interest rates. Lower interest rates make repayments more manageable. Payment history makes up 35% of your credit score, and debt consolidation makes it easier to keep up with costs.
- Debt Management Plan: Flexible payment terms help you stay up to date with payment history. You’ll begin paying on time instead of falling behind. While a debt management plan can help your payment history, you will have to close your credit card accounts. Closing old accounts can hurt your credit in the short term. You also can’t improve your score with credit card spending and on-time payments. However, making your current debts more manageable improves your payment history. A better payment history outweighs closing old credit card accounts for most borrowers. You can still use your debit card after a debt management plan.
- Debt Settlement: Debt settlements hurt your score and remain on your credit report for seven years. Lenders won’t like to see a debt settlement on your credit report as it shows you couldn’t pay a debt in full. However, most people use debt settlements to avoid bankruptcy. Bankruptcy may have worse implications for your credit score.
- Credit Counseling: You’re simply talking with a professional about your finances. Credit counseling doesn’t have any impact on your credit score. Credit counseling will trigger a soft pull, but this will not hurt your credit score. Talking with a credit counselor will not improve your credit score, but the insights from the conversation can help in the future.
- Bankruptcy: Filing for bankruptcy will hurt your credit score and remain on your report for ten years. It is the worst-case scenario where you could lose your house or have to establish a 3-5 year repayment plan. Borrowers who already have decimated credit scores won’t feel the impact as much. These borrowers don’t have as much to lose. Most people have poor credit scores by the time they file for bankruptcy. Struggling to pay off debts will continuously hurt your credit score until you solve the problem. Bankruptcy is the only solution for some borrowers, but not the best.
Should You Resolve A Debt By Yourself?
Some borrowers try to resolve debt by themselves. You can save money this way and talk with creditors and ask them to consider a lump sum payment. However, debt settlement is complex, with many wrong turns and countless hours wasted. Some people would rather work with professionals who have the experience. Debt relief companies have helped consumers get rid of debt, and they may help you too.
If you try resolving the debt on your own, you’ll spend many hours negotiating with creditors. Some won’t entertain a debt settlement, while you may negotiate with other lenders for over a year before reaching a conclusion. During this time, your debt will accumulate, and you’ll have less time to earn money on the side. You’ll need the extra cash for a lump sum payment. Most relationships between borrowers and creditors get strained before a borrower asks for a settlement. The creditor may not want to hear from you about a settlement since they’re already frustrated with the loan’s progress.
A third party can smooth the tension and act in your best interests. The third-party can make a “nice talk” with the lender and negotiate a favorable payment plan. t. Third parties reduce the emotional nature of phone calls. Borrowers can get tense and upset with their lenders and fracture negotiation efforts. Third parties won’t become emotional during calls, but they will still help you get the best deal possible.
