Have you ever stopped to think how many ways there are to get out of debt? Can you guess how many ways there are? If not, here’s the answer.
• Debt management plan
• Consumer Credit Counseling
• Debt Consolidation Loan
• Debt settlement
• Bankruptcy
That’s basically it. Believe it or not, there are really only five ways to become debt free – though there are variations on these. For example, if your debt consists entirely or almost entirely of credit card debts, you could use a technique called snowballing to pay them off, which would be a subset of a debt management plan.
Consumer credit counseling
You’ve probably heard of consumer credit counseling or may have even heard or seen advertisements for it. It’s a very popular way to pay off debts. You may be able to find a consumer credit counseling agency near where you live. If not, there are numerous ones available on the Internet. All of the honest, ethical ones work about the same way. You sign up for counseling and are assigned a debt counselor. This person will review all of your finances – including your debts, earnings and expenses – and help you create a budget. He or she will contact your creditors and attempt to negotiate reductions in your interest rates and to have any penalties you’ve been assessed waived.
Next, you and your debt counselor will work together to develop a plan for paying off your debts. Your counselor will submit this plan to your creditors for approval. If they all sign off on the plan – which is far from a sure thing – you will no longer be required to pay them. You will send the credit-counseling agency a check each month and it will distribute the funds to your creditors per your debt payoff plan.
An example
Here is an example of how a debt management plan might work. Let’s suppose you have a credit card with an interest rate of 15%, a personal loan at 20% and interest on a medical bill of 25%. This yields an average interest rate of 20%. If you were able to combine those debts into a single monthly payment with an interest rate of 15%, you would reduce your average interest rate by 5%, which would save you $4000 by the end of the year.
Would you be a good candidate for credit counseling
If consumer credit counseling sounds like a good option, you might want to know whether or not you’d be a good candidate. Here’s a video featuring money management expert Suze Orman on who would or wouldn’t be a good candidate for credit counseling.
Why you might not choose credit counseling
While it might feel great to get all of those creditors off your back, this does come at a price. First, you have to give up all of your credit cards. Second, you will have to stay on a very rigid budget until you complete your debt payoff plan, which could take as long as five years. You will also be strongly urged to not take on any new revolving credit of any kind until you complete your plan.
It is because of these reasons that many people don’t complete their debt management plans. In fact, one recent study revealed that only about 20% of all debt management plans are completed successfully meaning that the failure rate is about 80%. Of course, not all of that is due to the factors described here. In many cases, people just decide they can handle the debt payoff plan themselves and no longer need the help of a credit-counseling agency.
Debt consolidation loans
A debt consolidation loan is just that – a loan you get to consolidate your debts. There are two types. You could get a secured loan or an unsecured one. Secured loans are where you are required to put up something as collateral. The most popular secured loans for paying off debts are second mortgages, homeowner’s equity line of credit and refis – all loans where your house is the collateral. If you don’t own a home or have some other valuable asset, you will need to get an unsecured loan. However, it’s difficult to get one of these for much more than $15,000 because of the risk the lender is taking as it would have nothing it could repossess in the event you were to default on the loan.
The advantages of a debt consolidation loan
Borrowing money to pay off your debts does have certain advantages. For one thing, the new loan should have a much lower interest rate than the interest rates you’ve been paying on your debts – especially credit card debts. As an example of this, if you were able to do a refi you could end up with an interest rate of 4% or less. Second, you would have a lower monthly payment than the sum total of the monthly payments you’ve been making.
The downside of a debt consolidation loan
The biggest negative of a debt consolidation loan is that even though you will have a lower interest rate and a lower monthly payment, you will most likely end up paying much more in interest than if you had
just paid off your debts. The reason for this is that it will take you much longer to pay off the loan and the longer it takes, the more you’ll pay in interest.
So which is best?
So, if you have a serious amount of debt to pay off which of these alternatives would be best for you? Of course, only you can answer this question. The biggest advantage of consumer credit counseling is that it doesn’t require you to borrow any more money but it does require that you be pretty self disciplined. On the other hand, a debt consolidation loan can get all of your creditors off your back almost immediately and get you much better terms. However, you’re just basically borrowing from Peter to pay Paul – as a debt consolidation loan does nothing to reduce your debts short-term. If this helps, here is a table showing the major advantages of each.
Consumer credit counseling
• Doesn’t require you to borrow more money
• Can get your interest rates reduced
• May help your credit report
• Provides a counselor who will help you create a budget and a debt payment plan
• Represents a way to consolidate your debts at a lower interest rate (probably)
Debt consolidation loan
• Gets your creditors off your back almost immediately
• Should result in a lower interest rate and lower monthly payments
• Offers a fast way to consolidate your debts
• Doesn’t require sign off on the part of your lenders
• Gives you more time to pay off your debt