Debt Settlement Blog

Your Debt Elimination Options

When you’re drowning in credit card debt or other unsecured debts, there are really only five debt elimination methods to choose from. Let’s review each debt solution in detail so you have a better understanding of the options available to you:

1. Ignore the Problem and Hope Things Get Better
2. Debt Consolidation
3. Debt Consolidation
4. Bankruptcy
5. Debt Settlement

Option 1 - Ignore the Problem and Hope Things Get Better

Most of us are optimistic by nature, and since it’s quite normal to experience financial ups and downs in life, many people just ignore the problem and hope things get better down the road. Sometimes, problems do take care of themselves when we put our heads down and just keep working. Unfortunately, when you are buried under excessive personal debt, things will rarely get better on their own. Nothing will damage a family’s financial future faster than the record levels of personal debt carried by many households today. It’s quite common for families to carry $20,000, $30,000, even $50,000 or more of credit card debt.

When it comes to the mathematics of credit card debt, the deck is stacked against you right from the beginning, unless you pay your balances in full every month. If you’re barely able to pay the minimums each month, that’s a sure sign you’re already in trouble. And if you’ve borrowed from one card to make payments on another, that’s a recipe for financial disaster. The problem here is that a household budget that’s stretched to the limit like this leaves no room for the unexpected. So if you’re running along faster and faster just to keep up with your payments, and there’s nothing left over for savings at the end of the month, then you’ve provided no cushion for emergencies. One little bump in the road and you’ve set foot on the slippery slope toward financial ruin. Once you start missing payments on your credit card obligations, those 9.9% interest rates that seemed so attractive suddenly jump to 25%, 29%, even 32%. As if that wasn’t bad enough, the banks start tacking on penalties in the form of late fees and over-limit charges at $35 or more per incident. So all of a sudden, a debt you were previously able to keep up with becomes a monster that starts growing like a financial cancer.

Procrastination in the face of credit card debt is a no-win proposition. The problem will not get better on its own, and you cannot expect mercy or understanding from your creditors. It really doesn’t matter if you’ve been a loyal customer and made your payments on time for 5, 10, even 20 years. Once you start falling behind, you’ll learn that the banks are not sympathetic when clents are down. They are in business to make profits for their shareholders, and most of those profits come from people trapped in the cycle of endless minimum payments.

Option 2 - Debt Consolidation

Debt consolidation is the solution people automatically tend to think of when facing problem levels of personal debt. At first glance, it makes sense to lump several smaller, high interest-rate accounts into one monthly payment at a lower interest rate. Let’s say you owe $25,000 on five different credit card accounts. The average rate of interest is 25%, and you’re paying $525 in minimum payments every month. At that rate, it will take around 20 years to retire the debt, and you’ll have paid back more than $120,000! So why not consolidate debt by borrowing $25,000 from a lender at a much lower rate of interest, say, 12%? Then it will take less than six years to retire the debt and you’ll only have paid back around $34,000.

It sounds great in theory, but there’s one huge problem: Who will lend you the money at that low rate of interest? The odds are greatly against your being able to borrow enough to satisfy the balances on the smaller accounts unless you borrow against your house. This is a very risky strategy. It’s quite popular, of course, but that doesn’t make it safe. Why? Because you’ll have traded unsecured debts (which are backed only by your signature and not tied to your home or property) for secured debts (which are usually backed by your home). That means if you run into trouble again and have difficulty making the payments on the new loan, you could lose your house to foreclosure! It’s almost always a bad idea to pay off unsecured debts (like credit cards or medical bills) by borrowing against your house.

Remember, you got into trouble in the first place by borrowing money, right? You cannot borrow your way out of a debt problem without creating another debt problem!

Option 3: Debt Consolidation

Credit Counseling is a debt management program where you make a single monthly payment to a debt counseling agency. In turn, that agency distributes the money to your creditors on your behalf, ideally at lower interest rates so you can pay off the debt faster. Of all the available debt options, Credit Counseling is by far the most popular, with millions of Americans participating. Does this mean it’s the best choice for most people struggling with debt? No! There are numerous problems with this approach, and in recent years, Credit Counseling has come under heavy criticism from impartial consumer groups and government regulators. One of the most misleading aspects of Credit Counseling is the “non-profit” status of most agencies. Consumers often think that “non-profit” means there are no fees involved, but this is not the case. Another huge problem with Credit Counseling is the divided loyalty of the agencies. Credit Counseling organizations are dependent on creditors for the majority of their income (in the form of kickbacks of 7-15% of the monthly payments), yet the agency supposedly represents the consumer. How can the consumer expect truly objective advice from an agency that directly accepts compensation from his or her creditors? That’s why one of the criticisms of the Credit Counseling industry is that it acts like a big collection agency for the credit card banks.

Also, even if these problems are taken into account, the simple fact remains that at least three out of four people who start a Credit Counseling program do not complete it. Yet you’ll rarely hear anyone from the industry or financial media discuss the alarming failure rate of Credit Counseling programs.

The basic problem here is that the math doesn’t make sense for the average consumer who’s struggling with their monthly payment load. An example will help to clarify this problem. Let’s assume you owe $25,000 in credit card debt at an average interest rate of 20%, with minimum monthly payments of $500. It will take about 9 years to pay off the debt with this structure, assuming you don’t miss any payments and start getting hit with late fees.

After enrolling in a Credit Counseling program, how much better off will you be? It all depends on how low the agency can get your interest rates. Lately, the banks have squeezed the industry, so the discounted rates are not as attractive as before. We’ll use 12% as the new average. So if you keep your payments at $500 per month as before, how long will it take you to get out of debt? First, we need to deduct the fee charged by the agency. We’ll be conservative and only allow for $25 in monthly fees, so $475 of your $500 goes toward debt payments. On paper, it looks a little better, with a payoff time of 75 months (6 years, 3 months) to become debt-free.

Here’s the problem though. What happens if you can’t keep up with that $500 per month? After all, you sought debt help because you were struggling, right? Let’s say you drop down to $450 per month. Now you’re looking at 90 months (7 years, 6 months), which is not much better than the 9 years you started out with. Cut your payment even farther, and you’re right back where you started from. Bear in mind here that in our example, we’re assuming you’re working with a top notch Credit Counseling agency that charges low fees and obtains greatly reduced interest rates for your accounts. Yet even with the best of agencies, you’re still looking at a 5 to 9 year program to get out of debt. That’s why most folks never complete these programs.

Credit Counseling does not tackle the root cause of the debt problem itself, which is the principal balance owed. That’s why this method doesn’t work for most debt-burdened consumers. Most people struggling with debt simply cannot afford to pay back the full balances, plus interest and agency fees. This debt solution might be helpful during a short-term financial situation, but over the long-term, $25,000 of debt is still $25,000 of debt. Just reducing the interest rate a little does not provide enough debt relief for the average consumer.

Option 4: Bankruptcy

Bankruptcy is the “last resort” for the individual who cannot meet his or her debt obligations. A formal declaration of bankruptcy stops the creditor collection process. In the 10-year period from 1994 through 2003, more than 12 million Americans filed for personal bankruptcy. This is double the number of filings for the prior 10-year period. This is simply a staggering number of bankruptcy filings, and the tremendous increase is likely due to the huge increase in credit card debt as well as rising costs of medical care.

With personal bankruptcy, there are two basic approaches. The most common is called “Chapter 7″ and usually involves the full discharge of unsecured debts, so that the debtor no longer owes anything to his or her creditors. The other approach is called “Chapter 13″ and normally requires the debtor to pay back a percentage of the debt, usually over a 3-5 year period, on a payment schedule determined by the court. The court decides which system applies, and while most people qualify for the more lenient Chapter 7 procedure, many people are required to pay back part of their obligations under Chapter 13. Without going too deeply into the technical reasons for this, the difference commonly comes down to how much equity the debtor has in their home or real estate. The bankruptcy laws vary from state to state, and in some states a person is not allowed to keep much equity if they are filing bankruptcy. So, many individuals end up with Chapter 13 to avoid losing their home in the bankruptcy filing.

Whichever system is used, Chapter 7 or Chapter 13, the bankruptcy laws exist for the benefit of the consumer. There’s no doubt that some people need the relief provided by bankruptcy. Someone who owes $80,000 in medical bills and only makes $20,000 per year needs the protection of the courts to avoid financial ruin. Bad things sometimes happen to good people, and in our society provision is made for the courts to intervene and help people come to terms with their creditors.

Yet bankruptcy should truly be viewed as a last resort. Many people file bankruptcy just to put an end to creditor collection harassment, when they would prefer to work out a plan to deal with their obligations rather than walk away from them. Unfortunately, there are serious consequences to a bankruptcy filing, including some hidden costs that make it an unattractive option. For one thing, bankruptcy will stay on your credit report for 10 years, and this will definitely have an effect on the interest rates you will qualify for on future mortgages and auto loans. For example, let’s say you purchase a new home after recovering from bankruptcy. The mortgage is $180,000. Your interest rate will probably be two or three points higher than the person who has not filed bankruptcy. While it may not seem like much, the difference between 7% and 9% over the life of a mortgage is huge. That “small” difference will cause your monthly payments to jump from $1,198 to $1,448, and you’ll pay more than $90,000 in extra interest as a consequence!

Aside from the financial consequences of bankruptcy, there are personal effects as well. Frankly, even though the shame associated with bankruptcy has diminished in recent years, it still feels like failure to most people. You’ll never find a single person who feels pride in having filed bankruptcy. Most people would rather fight their way through financial difficulties on their own two feet, without help from the courts. The pride and self-worth that results from becoming debt-free without bankruptcy is simply priceless.

Option 5: Debt Settlement

You won’t hear about it in the mainstream financial press, but there is an honest and effective alternative to all of the above debt reduction options. It’s called “Debt Settlement” or “Debt Negotiation,” and it’s really nothing more than good old-fashioned haggling. While Debt Settlement is not perfectly suited to everyone with a debt problem, those seeking a viable alternative to bankruptcy will discover that Debt Settlement is a great solution to problem debt. Unlike Debt Consolidation or Credit Counseling, where you pay back the full balance on your debts, with Debt Settlement, you only pay back a portion of the balance, usually 50% or less. What happens to the rest? The creditor forgives the balance in a transaction called a “settlement.” In other words, through the process of negotiation, our professional staffs at American Financial Service are able to reduce the total amount of money that you owe (called the “principal”) and not just the interest rates as with other programs. This makes a huge difference in how quickly you can become debt-free. Instead of 5-9 years as with Credit Counseling, with American Financial Service’s Debt Settlement Program, you can be debt-free in 3 years or less, depending on the pace at which you fund the program. Also, you’ll save thousands of dollars through Debt Settlement versus other programs.

Here are some of the major advantages of Debt Settlement:

• Provides an ethical and honorable alternative to bankruptcy.
• Allows the client to maintain privacy over their financial affairs (unlike bankruptcy, where everything becomes a matter of public record).
• Lets the client take charge of the program and control their own destiny (unlike bankruptcy, where the courts decide everything).
• Program duration of only 2-3 years versus 5-9 years or more for Debt Consolidation or Credit Counseling.
• Requires the lowest total payout versus Debt Consolidation or Credit Counseling.
• Provides the most flexibility of any program in terms of monthly budgeting.

The tremendous savings obtained by Debt Settlement versus other methods is certainly an attractive benefit, but the built-in flexibility of this approach is also critical for many consumers who struggle with monthly payments. If you’re like most folks, your expenses differ from one month to the next. With a Debt Consolidation loan, a Credit Counseling program, or a Chapter 13 Bankruptcy, if you miss a payment the whole program can go haywire. With the Debt Settlement approach, if it’s necessary for you to skip a month, the only thing that will happen is that the program may take a little longer to complete. You can also “make it up” down the road by funding over and above your basic level. You can even add lump sums from time to time to speed up the process. No other program provides this kind of real-world flexibility. That’s why Debt Settlement is quickly growing in popularity among consumers seeking to eliminate credit card debt and other types of unsecured debt.