Is Debt Relief a Good Idea?

“Debt relief” is one of those quirky financial terms that can have several meanings. Government agencies sometimes use it to refer to debt forgiveness programs, for example. Others use it when talking about credit counseling, debt consolidation loans, or other debt management options. 

But if you’re searching for debt help ideas, it’s more common to find debt settlement companies marketing themselves as “debt relief” options. These companies operate by helping you save up a bargaining chip to negotiate a settlement for less than you owe—but the unintended side effects can sometimes cost you more.

Table of Contents

1. How debt relief works
2. Pros and cons of debt relief
3. When is debt relief right for you?
4. What to do if debt relief isn’t right for you 

How debt relief works

The basic idea behind debt relief is that you negotiate with a creditor—or a debt relief company does it on your behalf—to accept less than you owe. To get creditors to accept your offer, you need to make it seem like it’s their best shot at getting repaid—which is why it generally works best if you’ve stopped making payments and are seriously overdue.  

Instead of making payments to the creditor, debt relief companies have you make monthly deposits into a savings account they choose. When the balance is high enough, they begin trying to negotiate with your creditors. 

The debt relief company will use these savings to pay off any accepted offers, although studies show that about 58% of people still end up on a term payment plan. If your creditors don’t negotiate or accept any offers, you won’t owe any money to the debt relief company—but you’ll be further behind in debt and credit damage than when you started. 

Pros and cons of debt relief

Working with a debt relief company to settle your debt for less can be a solid strategy under the right circumstances. But it’s important to ask companies upfront whether you’ll face any downsides with the program. Customers can experience unintended consequences. 

Here are the main benefits and drawbacks.

Pros

• Handholding

  You can do everything a debt relief company does on your own. But if you need extra guidance or a referral for legal services if creditors sue you, a debt relief company can help.

• Potential to save money

  After paying the debt relief company fee, extra taxes, and monthly savings account costs, it’s still possible to save money—but maybe not as much as you first thought you would.

• No charge if unsuccessful

  By law, the debt relief company can’t charge you upfront fees. You’ll only pay if it’s successful with at least one of your debts.

Cons

• Cost

  You’ll typically pay $10 per month to use a savings account the debt relief company chooses. If it’s successful in negotiating, you’ll owe up to 25% of the settlement amount. If it’s not, you’ll end up paying added late fees and penalties to your creditors.

• Lawsuits

  About one in every 10 people in debt settlement programs end up being sued by their creditors for nonpayment.

• May not work

  Creditors aren’t obligated to negotiate, and many choose not to. Even if they do, they may choose not to accept any proposed settlements.

• Shady actors

  You can find several responsible debt relief companies—here are the ones we think are most trustworthy—but there are many unscrupulous companies that take advantage of desperate borrowers.

• Credit damage

  Debt relief companies rely on you not keeping up with payments to your creditors to gain leverage to negotiate a settlement. But if you stop making payments intentionally, it could tank your credit score.

• Surprise tax bill

  Any amount your creditors agree to forgive is instead counted as taxable income, similar to earning a bonus at work. You don’t see that money, but you will owe taxes on it as if you did.

• High failure rate

  A Federal Trade Commission study found that half of people who sign up for debt relief drop out before the program is finished.

• Lengthy process

  The debt settlement process often takes three to four years to complete—longer than some forms of bankruptcy.

• Many debts are not eligible

  Debts secured by collateral, such as your home or your car, can’t be included in a debt relief program. Neither can federal student loans.

Read More

What Should You Do If You Can’t Pay Your Taxes?

When is debt relief right for you?

Debt relief isn’t the best option for most people. Several other ways to handle debt are less risky, less expensive, and offer more guaranteed outcomes than debt settlement. 

But at times, it’s appropriate. 

We recommend debt relief if you match all the following criteria:

• You’re already behind on your debt payments.
• You’re still able to make monthly deposits into a savings account.
• You’re willing to accept the possibility of being sued by your creditors.
• You can identify a reputable debt relief company and avoid scams.
• You’re confident your creditors would be willing to negotiate a settlement.
• You’re willing to accept the risk that it won’t work, causing you to end up deeper in debt.
• You’ve ruled out all other options, including credit counseling, debt consolidation loans, and bankruptcy.
• You’re not confident in your ability to negotiate a settlement with your creditors on your own.
• You’re aware of the potential tax bill if you accept a settlement and can save up for it.
• You understand how the debt relief company will be paid and can pay monthly if needed.

You can see why many people might not fit these criteria. From the math perspective alone, debt relief might be a good idea if your income is high enough to make monthly savings deposits but not so high that you can afford normal debt payments. 

After all, if you can make your normal debt payments, another alternative, such as a debt management plan or debt consolidation loan, may work better and cause less havoc with your finances. 

Debt relief programs are usually a last resort once you’ve evaluated personal loans, HELOCs, debt negotiation with the creditor, and likely even a 401(k) loan. 

If this is your last opportunity, search out groups that specialize in this area and are not overly pushy in trying to get you to move forward. These are likely bad actors just looking to take your money and not do much to help you. Also, always know and watch the associated costs closely.

Rand Millwood, CFP®

How to choose a debt relief company

In general, wise to avoid working with companies that reach out to you first. This is a common tactic scammers use. Instead, take some time to research reputable companies and read reviews or our guide to the best debt relief companies.

Here are the debt relief companies that rate highest using our stringent editorial rating process:

What to do if debt relief isn’t right for you 

If you don’t think debt relief is the right path, here are alternatives to consider. 

Debt consolidation loans

Debt consolidation loans allow you to combine multiple debts into one loan with a potentially lower interest rate. This can simplify your monthly payments and help you save money over time. Unlike some debt relief programs, debt consolidation typically doesn’t hurt your credit score and can even improve it with on-time payments.

Read More

Best Debt Consolidation Loans: Compare Rates

Balance transfer credit cards

A balance transfer credit card can help you pay off high-interest credit card debt by offering a 0% introductory rate for a set period. If you’re disciplined about paying off the balance during the promotional period, this option can save you significant money on interest without the need for a formal debt relief program.

Read More

Balance Transfer Card vs. Personal Loan

Credit counseling

Working with a nonprofit credit counseling agency can help you create a personalized plan to manage your debt. Credit counseling is a solid alternative if you’re looking for expert guidance without damaging your credit or entering a formal settlement agreement. Counselors may also help you negotiate lower interest rates with creditors.

Negotiate directly with creditors

If you prefer to avoid third-party involvement, you can contact your creditors to negotiate reduced interest rates, waived fees, or an affordable repayment plan. This option avoids the fees associated with debt relief companies and allows you to maintain control of the process.

Home equity loans or lines of credit (HELOCs)

If you’re a homeowner with substantial equity in your property, a home equity loan or HELOC can provide a low-interest option to consolidate debt. These loans often have lower rates than personal loans or credit cards because they’re secured by your home. 

While using home equity to pay off debt doesn’t damage your credit like debt settlement might, it comes with the risk of foreclosure if you fail to make payments. This option is best for disciplined borrowers who have a clear repayment plan.

Read More

Best Home Equity Loans & Rates, Best HELOC Lenders & Rates

Bankruptcy

While bankruptcy has significant consequences for your credit and finances, it may be the best option if you can’t repay your debts through other means. Chapter 7 or Chapter 13 bankruptcy can provide a legal pathway to eliminate or restructure your debts while offering protection from creditor harassment.

Each alternative has unique pros and cons, but exploring these options can help you decide on the best way to manage your financial situation.