How Does Debt Relief Work And What Are The Risks?

How does debt relief work in a world where many are struggling to survive, let alone pay off past debts? Debt Management Plan or debt cancellation is the partial or total forgiveness of debt. It is also the slowing or stopping of debt growth owed by individuals, corporations, or even nations. It sounds like a good deal, but how does debt relief work, exactly?

Before you sign up for a debt relief program, you should learn more about the debt management plan. This is because even though it has perks (i.e. debt settlement), there are still risks involved. One risk is that your future credit record is tainted by being forgiven of past debts.

How Does Debt Relief Work?

Relief works like so: You sign up with a debt settlement company. This company, in turn, bargains with your creditors to let you shell out a certain sum of money that is less than the complete total that you owe them. You then repay the program a specific lump sum each month.

Debt relief will help you reduce your monthly unsecured loan payments, and get you debt free within 2 to 3 years. you will not have to pay any interest rate to your creditors and your financial institution creditor has agreed to receive less than the amount you owe as full payment. It also means debt collectors can’t continue to chase you for the money, and you don’t have to be concerned about being sued for debt collection.

What Are The Risks

It’s what we all fall for; the idea that we may be paying a lower monthly payment, or that we will end up paying less than we owe. However, those are the only positive points. Here are the risks associated with debt relief.

Debt relief will hurt your credit

Here’s how debt relief programs work when you sign an agreement with the creditor. They will tell you to stop paying your unsecured debts, usually recommending to do so in six months or more. Once you stop paying, your creditors will start worrying about your credit cards, and whether or not you will actually pay for it. This is when the debt relief companies come in, negotiating a certain amount of money for you to repay. Sounds good? Well, as you’re no longer paying your debt, your creditors are continuing to report late payment updates to the credit bureau until your account is settled. Further, for seven years, your credit report history will show that you didn’t pay the full amount of your debt to your credit card companies! This is a serious impact on your credit score.

Debt relief has hidden fees

Most debt settlement companies do not clearly tell their clients how much of the monthly payment is used for the creditors, and what amount is used as their service fee. Usually, you pay a total of 18-25 percent of your debt, then the company charges 20 percent. However, there are many hidden charges within your overall bill. Sometimes, they even require an upfront fee for services they have not yet performed, as payment for ‘consultation.’ Be wary when contacting debt settlement companies.

You will have to pay taxes on your debt relief

Be aware that the Internal Revenue Service generally regards forgiven debt as income. You may want to consult a tax professional about additional tax obligations you’ll be taking on if you settle your debt. If your debt that is greater than $600 has been settled or forgiven, this amount will be treated as a taxable income that you will have to pay taxes for. For example, your total amount of debt is $10,000, and your debt relief company negotiated it down to $5,000. The remaining amount will be taxable income to you. So really, your debt amount hasn’t really changed!

A creditor can file a debt collection lawsuit against you

There’s not much information regarding this kind of lawsuit that debt relief companies file. They do say that they aim to finish the program as soon as possible to avoid any lawsuits, so tread at your own risk.

There is no guarantee of success

However, there’s no guarantee that the debt settlement company can resolve your debt for significantly less. Some creditors do not negotiate with them. According to a study by the Center for Responsible Lending, a nonprofit research and policy group, most consumers would have to settle at least four accounts to receive a net benefit. In addition, debt totals may rise as fees accrue, and aggressive collection attempts may continue.

Are you at the end of your rope in paying your debt? Don’t contact a debt relief company immediately, but instead, try a ‘DIY’ version first. Call each of your creditors, explain your conditions, and request information about your opportunities. Some companies will lower your interest rates, give you a grace period, or put you on a program to pay off your debt. That way, you’ll save your credit, money, and yourself.

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Conclusion

It can be seen that the world of debt relief and debt collection is stressful and intimidating. However, you do have options available to you. Are you still asking yourself, “How does debt relief work?”  Debt relief is dependent on the resources you use, so contact your local creditors and debt relief agencies to gather the details.

Published April 17, 2019; Updated May 15, 2019