Consumer finance expert Erica Sandberg, spoke with Investopedia to share her take on the topic of debt relief. Sandberg, the author of "Expecting Money: The Essential Financial Plan for New and Growing Families," has a background as a budget and debt counselor at the Consumer Credit Counseling Service of San Francisco. This wide-ranging interview dives into the topic of debt, which includes tips and strategies to reduce debt like debt consolidation, working with debt settlement companies, and negotiating with creditors yourself. Sandberg's bottom line is that people get themselves into debt and creditors aren't obligated to help them out but it's in both parties' interest to get debts settled and not have them go into collections.
Key Takeaways
- Debt relief or debt settlement is a way to reduce or completely eliminate certain debts.
- Debt consolidation, by contrast, can make debts easier to pay off but doesn't reduce or eliminate them
- Debt relief can have a negative effect on a person's credit score.
- People can try to negotiate with their creditors on their own or hire a debt relief company.
- Some companies that offer debt relief services may be scams, so consumers need to check them out carefully.
Defining Debt Relief
Investopedia: What is debt relief, and when does debt relief become an option for someone with debt they can't manage?
Sandberg: In general, debt relief refers to a reduction or cancellation of a consumer's legitimate financial obligations. To be eligible, the accounts usually are delinquent and/or in collections.
Investopedia: What's the difference between debt consolidation and debt relief?
Sandberg: Consolidation combines all your debt into one account with one payment. The payments are consolidated, but your debt isn't reduced. There are several ways to consolidate debt. It could be through a nonprofit organization, such as a consumer credit counseling service, where you close your accounts, then make a single payment to the agency, which distributes it to your creditors.
You could also consolidate your debt with a new loan or credit card. With a loan, you take out a fixed sum of money, which is enough to assume the outstanding debts. The advantage is that the interest rate is lower than what it was on the original debts, and the single account is easier to manage than multiple accounts. You're also converting revolving balances into an installment loan, which can help your credit report and credit scores.
Consolidating debt is also possible with a balance transfer credit card. As long as you qualify, you can shift balances from other credit cards onto a new card and in many cases receive a 0% APR (annual percentage rate) for a fixed number of months. In all these scenarios, you would pay the entire balance owed.
Debt relief or settlement, on the other hand, is a process where you would pay less than the amount owed, often in a lump sum.
About Debt Collectors
Investopedia: What's the best way to handle debt collectors?
Sandberg: First, with legal knowledge. The Fair Debt Collection Practices Act is very specific about what a debt collector can and can't do.
Second, with personal responsibility. When you take out financial products, you sign an agreement. The lender's role is to lend, the borrower's role is to repay. Do your best to meet your end of the contract. When you do communicate with collectors, stay calm. Be factual. This is business, not personal.
Impact of Debt Relief on Credit Scores
Investopedia: How does debt relief impact your credit score or general creditworthiness?
Sandberg: If you receive formal forgiveness, it usually shows up on your credit report as settled. It's better than not paying at all but still an indication that you did not fulfill your contractual obligation. Delinquencies, charge-offs, and accounts that have been sent to collections show up on a credit report for seven years. These dings will not be purged when you settle the account.
Investopedia: Are there ways to minimize the negative impact of entering a debt relief program?
Sandberg: If you're going to do it, do it quickly. The longer you delay, the longer you will have to wait before it is removed from your credit report.
Investopedia: How does debt relief compare to bankruptcy?
Sandberg: A Chapter 7 bankruptcy is a clear indication that you've wiped out your debts in court. It's usually the worst thing that can happen to credit reports and the scores that are derived from the information on the reports. Evidence of a collection account that you settled while paying your other accounts on time and in full will have much less impact.
Where to Seek Debt Relief
Investopedia: Where should people go to seek debt relief?
Sandberg: If you want to settle your debts, you can do it without a third-party company. You can negotiate a reduced sum on your own. But if you want to hire, look to debt settlement companies that have excellent reputations.
Don't choose a debt settlement company that comes to you without you doing your research. Read other people's experiences with the company. Some have thousands of positive reviews, while others are far less well known or have poor reviews.
Investopedia: What are typical fees charged by debt relief companies?
Sandberg: Most charge fees as a percentage—usually 15 to 20%—of the amount that was forgiven. If they eliminated $5,000 and charge 20%, your fee would be $1,000.
Investopedia: Who protects consumers from unscrupulous debt relief companies?
Sandberg: The Federal Trade Commission enforces federal consumer protection laws, including those that prevent fraud, deception, and unfair business practices.
Impact of COVID-19 on Debt Relief
Investopedia: How did the pandemic affect the need for debt relief?
Sandberg: A lot of people fell behind on their consumer debts during COVID because they couldn't work as normal. The good news is that credit card companies stepped up to assist. Almost all provided hardship plans to people who were negatively impacted by COVID, so the accounts remained in good standing even though they were technically behind. This prevented accounts from being routed to collection agencies for nonpayment.
Investopedia: What do you see as the long-term impact of COVID-19 on debt and the need for debt relief?
Sandberg: COVID showed that credit card companies and other lenders can come together and help people in dire circ*mstances. Accounts don't always have to go into collections. It would be great to see that flexibility continue.
Final Thoughts
Investopedia: What's your message to people with overwhelming debt?
Sandberg: Remember that when you borrowed the money, you agreed to repay it as per the contract. A creditor is not required to give you a break, even if you have a great reason for needing it.
That said, all a creditor wants is to be repaid. When an account goes into collections, they lose money. Try to work with a creditor before the debt goes bad.
Keep in mind, this originated as an agreement between two parties: the lender and you. They upheld their end of the bargain. They loaned you the money. When you don't uphold your end, you have failed to live up to the agreement you struck with the lender. Yes, things happen beyond your control that are not your fault. Nor are they the fault of the lender. Remember, you are not a victim, and the lender is not the enemy. Borrow with all this in mind, and bargain with all this in mind.
Investopedia: All that said, in your opinion, what's not available in the area of debt relief that should be?
Sandberg: There should be more encouragement to help people be motivated to pay off their accounts. If they don't get a positive credit-reporting boost, it eliminates much of the motivation.
What Happens When You Settle Debt?
When you settle debt, you will typically pay the creditor a portion of what you owe and they will forgive the rest. You account will likely be reported to the credit bureaus as "settled" and your credit score will generally take a hit.
Who Qualifies for Debt Settlement?
You may qualify for debt settlement if your debt is significant enough that you can't afford to make the payments. Typically, debt settlement is only used for credit card debt.
How Long Do Debt Collections Stay on Your Credit Report?
Generally, negative information like debt collection stays on your credit report for up to seven years. A bankruptcy may stay on your credit report up to 10 years.
The Bottom Line
To get debt under control, you can take steps like paying more than the minimum amount each month or using a new loan for debt consolidation. For more extreme debt situations that you cannot pay down, you can turn to debt relief options like debt settlement or filing for bankruptcy. If you are struggling with debt, consider consulting a professional financial advisor or credit counselor who can explain the options for your specific situation.
