Know Your Options to Get Out of Debt
So the time has come to get out of debt. Whether you saw an ad, opened one bill too many, or had a fight with your spouse, you've finally decided to bite the bullet. Congratulations. But now the hard work begins, starting with one simple question: How will you do it?
Now this may seem like a simplistic question, but personal finance gurus know that it's anything but simple. There are at many different approaches to debt reduction and you should understand the differences.
- Do-it-yourself debt management. Of all the approaches to getting out of debt, this is the simplest, cheapest, and best for your credit. If you can currently make minimum payments on your debts without continuing to charge, you should start with a DIY debt management program. You can try doing it manually or through online tools. You'll be able to define a repayment strategy, and create a plan that you can track to over time. Since these services link to your debt accounts, they can dramatically reduce the effort and increase your success compared to tracking your plan manually.
- Debt consolidation. If you have home equity and good credit, you may wish to take out a home equity consolidation loan to pay off credit card debt. Although this will simplify your finances by consolidating many debts into one and may dramatically reduce your interest costs, it does come with risks. First, it takes unsecured debt that would be discharged in bankruptcy and effectively transfers it to your house. Second, it may not solve an underlying spending problem -- many experts believe that most people who take out a consolidation loan will run up unsecured debt within two years.
- Credit counseling. Borrowers who can demonstrate that they have a difficult time making payments may qualify for a debt management plans offered by qualified credit counselors. Under these plans, qualified borrowers generally receive forgiveness of some fees and lower rates.
- Debt Settlement. Debt settlement is the process of settling with your creditors for amounts less than the full value of the debt, making it easier to pay off the remainder. Usually a third-party firm is engaged to manage the process and negotiate on the borrower's behalf. In order to be successful, most settlement firms encourage participants to quit payment so the debt will be moved to collections or sold to firms who may be more willing to negotiate. This may strongly damage your credit. Several lenders -- notably Discover and Bank of America -- refuse to deal with settlement companies. Debt settlement has been banned in many states,because of marketing practices and exorbitant fees that are usually charged before the service is delivered.
- Chapter 13 Bankruptcy: A Chapter 13 is a 'reorganization' for borrowers who wish to repay their debts over three to five years. A Chapter 13 bankruptcy will show on your credit report for seven years.
- Chapter 7 Bankruptcy: Chapter 7 offers a chance to discharge many types of unsecured debts (like credit cards) and start again. You can retain certain property through bankruptcy and some debts (taxes, student loans, child support) will not be discharged. A Chapter 7 bankruptcy will show on your credit file for 10 years.
If you're in debt and determined to get out, there are many options. All have their pros and cons, but you should carefully consider the long-term ramifications before jumping to sign up for any particular plan. Pick both the strategy and company that are right for you.