Debt Free

Debt relief is on the minds of millions of people due to the credit industry problems and the huge levels of consumer debt in the U.S., but what do people really mean when they talk about debt relief? Are there programs that will simply get rid of your debt so you can start anew?

Actually yes, there are debt relief programs that can help you do that, but it's not really that simple. After all, you don't get something for nothing, although it could be argued that if you get a portion of your debt eliminated, you actually did.

There is some confusion among many debtors about the differences between the various debt relief programs. Are debt settlement, debt relief and debt counseling all synonymous? Actually no, they're not. They actually mean different things, and if you choose to avail yourself of one of these options to handle your debt, the option you actually choose could have long lasting effects on your credit and future financial picture.

Debt settlement is a term that most often refers to the process of negotiating with creditors to only repay a portion of a debt. Although that may sound like a fantastic option to many creditors, remember the whole free lunch thing. Using debt settlement services will impact your credit in a negative way and affect your ability to secure future credit, and the interest rates you pay for years to come. There are a few basic ways that these programs work, and before you enter into any such program you absolutely must go over any agreement with a fine toothed comb, preferably with the advice of an attorney who's well versed in such matters. It may seem like spending money to seek the advice of an attorney may just be compounding your debt problems, but a few hundred dollars up front may save you thousands of dollars and some financial migraines later.

Some debt settlement firms will simply charge you a flat fee for their services, but the more common scenario is for them to charge you either a percentage of the total outstanding debt or a portion of the savings they provide through the negotiated settlement. With most debt relief negotiations, the debt relief company will negotiate a settlement with each of your creditors that will represent between 40% - 50% of the original debt amount. They must negotiate independently with each credit card account. Debt relief companies can handle other types of debt as well, but credit cards are far and away the most common. Typically only unsecured debt is negotiated through this process, as unpaid secured debt will be satisfied by the creditor repossessing the security for the debt, such as a vehicle or land.

As the debtor, you will be required to set up a debt repayment plan for the agreed upon amount with each open account. This will include the payment to the debt relief company, the creditor, and the time frame for the repayment plan. You will then make payments either into an account set up by you, or an escrow account set up by the debt relief company. Once you have accumulated the requisite amount your debt will be satisfied. The process repeats with each debt until all your debts are paid at the individually agreed upon amount.

This is one of the places where things can go wrong for you as the creditor. Stories abound of less than scrupulous debt settlement companies simply keeping all the funds you've already paid should you miss a payment. This does happen, and needless to say that could cost you a bundle. If you feel that you realistically will not have the money to maintain such a settlement plan, you may want to consider another option, but even more important is to thoroughly evaluate any such agreement before you enter into it.

This highlights the importance of having a qualified, independent party look over the contract before you sign it. If you sign a contract that permits the firm to keep any funds paid to date should you miss a single payment, it's really your fault for such a debacle. If you feel such a clause is worth it in order to secure a substantial reduction in the amount of your debt, that's a decision only you can make. Remember that you will have your debt reduced a substantial amount, but there is also the debt company's fee to consider when calculating your total savings. In total, the savings may not be as large as you think.

The process lasts from 1 – 4 years in the majority of cases. It is exceedingly rare for the debt relief company to offer any sort of guarantee for their services. The key is that you should be using this technique as a way to avoid bankruptcy.

Debt Settlement Pros -

• Debt settlement / relief / negotiation can help you avoid bankruptcy.

• Debt relief companies can make creditors stop hounding you.

• Debt relief companies can get you debt free in less time than if you simply tried to repay your debts on your own.

• Debt relief will improve your credit in the long term because you will have no outstanding debt. It's up to you to stay debt free, however. Since about 30% of your FICO score is your amount of outstanding debt, reducing it to zero will improve your score.

Ah, but with anything there is also the not-so-bright.
Here are the -

Debt Relief Cons -

• Debt relief will give you a big drop in your credit score in the short term, however it will not be as bad for your credit as declaring bankruptcy.

• Debt relief programs require you to pay as agreed. If you fail to stick to the debt relief plan, you could lose every cent you've paid to date. Think of the rent to own scenario. Miss a payment, and there goes your TV. If you don't have the requisite amount of money in a single lump sum, it's time for some negotiation of your own. Before you enter into the debt relief arrangement, have the contract stipulate an installment payment system.

• You will owe more taxes to the IRS and possible the state department of revenue. In a spectacular example of hitting you when you're down the IRS views forgiven debt as taxable income. For example, that means that if you are in the 10% tax bracket and owe $18,000 in credit card debt, of which $9,000 is forgiven through the debt relief settlement, you will incur a $900 income tax liability. This will be reported to the IRS with a 1099 form. If you've ever been an independent contractor, you'll be familiar with such a form, as it's the same one used by those that hired you to report the income they paid you. Make sure you figure the increased tax liability into your calculations when deciding to use a debt relief or settlement company's services. This is an area where consulting a professional is vital, because you may be able to eliminate all your tax liability due to your financial status.

• The same process used by the debt relief companies to make the credit card companies stop hounding you, will also prohibit them from contacting you for anything positive. You may be able to do some debt negotiation on your own, but try this before you make the decision to use a debt relief company, because they will probably prevent the creditor from initiating any further contact with you.

Debt settlement or debt relief is not the same thing as credit counseling. Credit counseling is usually a precess whereby you meet with a person or team who looks at you financial state and makes recommendations about how you can improve it, and get debt free. There are for profit and non profit credit counseling services, although the non profit services are not necessarily free. See a post I did last year on non profit credit counseling for more information. It details 6 questions you must ask a credit counseling service to help make sure you're making the right decision.

Your credit is nothing to mess around with. There are pros and cons to any decision and the decision on weather or not to use a debt relief company as a solution to your financial problems is a mighty big one. They may be just the solution you've been looking for. On the other hand they could plunge you deeper into a financial pit of despair. Just make sure you go into a debt relief agreement, as with any of life's big decisions, with both eyes open. Don't make such a decision on emotion. To help avoid an emotion based decision it's sometimes better to take a few days to make your decision.

Here's to getting debt free, no matter what plan you use to get there.