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Oscar Wilde
If You're Not Afraid of Debt Relief and Bankruptcy, Maybe You Don't Understand Them

As you start to look into debt consolidation, you may hear about debt relief. It can be confusing, because not everybody uses the term “debt relief.” You may hear about companies with helpful sounding names that can help you get out of debt. They can promise to restore your credit, get rid of your debt, and help give you a better financial future. Many of them are actually selling what is known as “debt relief.”

Debt relief is not the same thing as debt consolidation, and it’s very important that you know the differences.

Debt consolidation pulls all of your debts together and then takes out a giant loan to pay them all off (the loan could be a mortgage rather than a traditional loan). You wind up with one loan and one payment. Since your creditors all get paid, you have no bad marks on your credit report. In fact, in the world of high finance, forms of debt consolidation are done all of the time and are considered sound financial tactics.

People like Donald Trump and other financial big shots consolidate debt regularly; it's a smart way to manage money, particularly in business.

Debt relief (sometimes called debt negotiation) negotiates with your creditors in an effort to write off some of your debt. In other words, you still have the same debts, but the debt relief company acts as your agent to help settle your debts for less than you actually owe.

Many times, debt relief companies can actually manage to get your creditors to settle for less than you owe them. For example, let’s say you owed $35,000 in total to numerous creditors and the debt relief company worked with these creditors and managed to arrange for you to settle the debts for a total of $28,000. Before you cheer that you’ve saved $7,000, let’s see how this actually works.

First of all, the IRS considers the $7,000 windfall you "received" as income. That’s right. The debt relief company will report this and the IRS will add it to your income. You’ll pay taxes on it. If you’re a low-income family, it may mess you up. And it will increase the amount of taxes you’ll have to pay, because you’ll owe income tax on that $7,000 even if you never see the money in your hand.

Second, any sort of arrangement like this will put a red flag in your credit report. If you’ve gone to debt relief before, companies are very unlikely to want to lend money to you. After all, if you charged $10,000 to MasterCard but only paid them $8,000 (and they agreed to accept this, thinking they couldn’t get any more from you), no sound business will want to lend you more money.

You might think that will just apply to credit card companies, but a bad credit report can affect other areas of your life. It’s going to be harder to rent an apartment or buy a car. Some businesses actually check credit reports when a person applies for a job. The theory is that a person with a bad credit report may not be the most desirable employee, particularly for jobs that require a person to handle money or make financial decisions.

Now that you know this, you might wonder why anybody would consider debt negotiation or debt relief at all. Actually, debt relief has a very real and important place in our financial landscape, but it’s not really the “easy answer” that TV commercials sometimes make it sound like.

Debt relief is better than bankruptcy. If you are drowning in debt, your first step should be to seek remedy in debt consolidation and talk that over with a certified credit counselor. That is by far the best solution for almost everybody. It’s ethical, honest, honorable, and won’t mess up your credit. On top of that, if you handle it properly, it's a good financial move besides being the best thing for your ethics and integrity.

Bankruptcy is the other end of the spectrum. In terms of your lifestyle and your future and your finances, it’s a disaster. But bankruptcy is an important option because sometimes a person has no other choices.

Debt relief falls between the two. Debt consolidation is a good solution; bankruptcy is the least good solution. Debt relief can be the last stop before bankruptcy—and that's about the best thing you can say about debt relief. It’s better than going bankrupt

Why? Well, for one thing, debt relief stays on your credit history for just three years, while bankruptcy lingers for at least ten. Furthermore, bankruptcy takes a lot of control away from you. For one thing, bankruptcy may result in your losing possession of some of your things.  In some states, you can lose your house. You can certainly lose your car and other possessions. It may also dictate who you pay and how. If you declare bankruptcy, life as you know it now, is over.

Another aspect to bankruptcy that many people don’t talk about. Bankruptcy affects every one of your creditors. Let’s say you have debts with eight different organizations, but you are only really in trouble with four of your creditors. The other four have had no problems. If you file for bankruptcy, that bankruptcy affects all of your creditors equally. Even the companies with whom you were in good standing now are impacted.

This means instead of having four companies mad at you, you now have eight companies with a financial beef.

Don’t panic. In truth, very few people need to file bankruptcy. Bankruptcy exists because it’s needed, but it is not needed by most people, even most people in financial trouble. If you have some form of income, you can probably qualify for debt consolidation, which is a better option. A certified credit counselor can help you. Besides, you need to talk to a counselor before you’re eligible for bankruptcy anyway, and chances are very good the counselor can steer you toward a less frightening solution to your debt problems.

Your certified credit counselor may also mention something called a Debt Management Plan with the unfortunate acronym DMP. A DMP is an extreme form of debt consolidation. You need to work with a certified credit counselor to set up a DMP.

In a DMP, creditors lower monthly payments in order to facilitate your debt consolidation. Of course, with a DMP, your creditors know that you’re working with a counselor and usually the plan is to repay them in full, you’re only renegotiating the terms of the loan (typically to buy you more time). However, some DMPs may try to also negotiate the payment amounts.

A DMP is a radical approach that often restructures your debt. If you can work with a more mainstream type of debt consolidation, that is preferable to a DMP. But, again, DMPs exist because sometimes they are the best option for people without many other choices.

All of this information can seem overwhelming, but take it slowly. If you’re in trouble financially, there are many ways out. Debt consolidation is the best option, bankruptcy is the worst. Debt relief (also known as debt negotiation) is in the middle, but it isn’t good. And DMP is better than debt relief. However, every family in financial trouble is unique and you’ll need to talk to a certified credit counselor to help you find the best plan for your individual circumstances.

Are there times when a DMP, debt relief, or bankruptcy are what a person ought to do? Absolutely. These programs exist because some people, in some very extreme situations, need them. But don't start exploring these programs until you have exhausted all of the avenues for debt consolidation. And be afraid. A little fear of these programs is a good thing. Even if you have to use one of them, be wary.

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