Is Debt Reduction Right for You?

Filed under: Credit Card Debt Add Comment

If you are drowning in debt, negotiating a reduction of that debt might seem like a good solution. But, depending on your situation and how much you owe, debt relief could actually wind up costing you more than it’s worth.

Debt reduction involves negotiating with your creditors to reduce your debt. It is not the same as debt consolidation, in which you get one lower-interest loan to pay off several higher-interest debts. And it doesn’t simply involve lowering the interest rate on the debt you owe. In a debt-reduction situation, you actually seek some debt forgiveness from your creditors. For example, if you owe $15,000 that you can’t pay, you may convince your creditors that you can pay $10,000.

Though debt relief can have the benefit of getting you out from under an unmanageable debt load, it does come with consequences.

For one thing, debt reduction has a tremendously negative effect on your credit score. So while reducing your debts can save you thousands of dollars now, it could cost you thousands more in the long run in the form of higher interest rates. And the effect is more pronounced the higher your credit score is. This can make it difficult to get credit cards, a mortgage or other loans. One thing to take into consideration is how long it will be before you seek new credit. A debt-reduction plan will negatively affect your credit score for at least a couple of years.

Because of this, a debt reduction plan may not be the right option for you if you have other options available. If you can refinance your home or get a home equity loan and use the money to pay off debt, that may be a better option than seeking a debt-reduction plan.

Another situation in which debt reduction might not be the best solution is if the balances you owe aren’t that high. If you owe only a few thousand dollars and can afford the minimum payments, it’s likely worth it to continue paying and not risk the hit to your credit score that comes from seeking debt reduction.

If you do wind up deciding that a debt-reduction plan is the best option for you, make sure you can afford the payments. If you work with a debt firm that charges you fees for a program, you will lose those fees if you don’t complete the program.

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Disadvantages of Credit Counseling Services

Filed under: Credit Card Debt

With the economic downturn, many people have turned to credit counseling services as a solution to their credit card debt problems. Although credit counseling can be helpful, there are many criticisms of the credit counseling process and you should be aware of potential problems before committing to any credit card debt solution services.

Credit Counseling Compensation

One of the strongest criticisms of the credit counseling industry is that very often, the counseling services receive compensation from credit card companies themselves as payment for their services. This practice has lead to accusations that consumer credit counseling services serve as de facto collection agencies for creditors. In order to participate in a debt relief program, the consumer pays a single monthly payment to the counseling service, which then makes payments to individual creditors on their behalf. Credit card companies pay what is called a “fair share” fee to credit counseling companies and this fee accounts for approximately $5 billion in fees annually paid to credit counseling organizations.

Hidden Fees

Another criticism of the credit counseling industry is that there are often hidden fees that are not disclosed to consumers when they sign up for debt relief services. Both the Federal Trade Commission and Better Business Bureau report literally thousands of complaints about credit counseling agencies. Frequent complaints include the inability to “opt out” of what are supposed to be voluntary programs, undisclosed fees being charged and payments made not being applied to consumer accounts.

Effect on Credit Rating

Participation in a credit counseling program is not supposed to affect your credit rating. However, one of the strongest criticisms about the credit counseling industry is that participation in one of their programs is reported to credit reporting agencies. As a result, not only are credit card accounts usually frozen or cancelled, but potential creditors will consider you a higher risk and may be reluctant to grant credit.

Although consumers usually eventually see an improvement in their credit rating once their credit card balances are significantly reduced and regular payments are made, future creditors view participation in a credit counseling program as an indication of problems with making credit payments. This can result in difficulty obtaining credit for purchasing a home or a car, or in higher interest rates being charged.

If you find yourself mired in credit problems and are having difficulty making your credit card payments, there are numerous alternative solutions to working with a credit counseling company for debt relief. Consider talking directly to your credit card companies and trying to negotiate a reasonable payment plan or single payment settlement. As a final option, you might also consider bankruptcy as a solution if your credit obligations are large and it is clear you will not be able to recover from them.

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