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If you have multiple credit card balances that you’re working to pay off, it can feel like you’re stuck in an endless cycle of debt. You make the minimum required payments month after month, but your balances never seem to go down. You can’t save money for emergencies, so every unexpected expense goes on a credit card. That just increases your debt and sets you further back. The good news is that there is a free service that can help you find relief from credit card debt that won’t negatively affect your credit or your taxes. It’s called consumer credit counseling.
This guide explains what credit counseling is, how it can help you customize a strategy to eliminate debt, and how it compares to other solutions. We also explain why credit counseling can be beneficial for other solutions because it won’t increase your tax liability as you work to get out of debt.
Consumer credit counseling is a free service that helps people identify the right solution for getting out of debt. Many credit counseling agencies are 501(c)3 nonprofit organizations. As a result, getting certified advice about getting out of debt is free. This makes it easier to identify the best solution for your needs, credit, and budget without incurring another bill.
Credit counseling agencies also offer debt management programs, which consolidate debt into a simplified repayment plan at the lowest interest rates possible. This makes it easier to pay off your balances, because you can focus on eliminating the principal, instead of wasting so much money on accrued monthly interest charges. It also eliminates the need to juggle bills, since you only have one monthly payment that covers all your debts.
Credit counseling is a two-part process. The first part involves a free debt and budget evaluation with a certified credit counselor. This part is beneficial for anyone working to get out of credit card debt. The second part of the process involves enrolling in a debt management program (DMP). Not everyone who goes through the first step to get free credit counseling will enroll in a debt management program. Here’s how each part of the credit counseling process works:
Free credit counseling is usually done over the phone. Although you can start the process online by completing a form, you simply provide the information that the counselor needs to complete your evaluation.
Once you’re on the phone with a certified credit counselor, here’s what you can expect.
- First, the credit counselor will ask you to explain your financial situation and how you got into debt.
a. The goal is to determine the root cause of your challenges with debt so that once you get out of debt, you can stay that way.
- Next, the counselor will ask about your debts, as well as your income and expenses to get an accurate picture of your budget.
- They will also ask for the last four digits of your social security number so they can pull your credit report.
a. This is a “soft pull,” so it will not negatively affect your credit score.
- Then the credit counselor will begin to review your options for debt relief. Depending on your financial situation, the counselor may recommend:
a. A personal debt reduction plan b. Debt consolidation, such as a consolidation loan c. A debt management program d. Debt settlement
- Finally, the counselor will make a recommendation on your best way to get out of debt.
a. If a debt management program is the best solution for your needs, then the counselor can help you enroll, and you'll move on Part 2 below. b. If there’s a better solution for your needs, the counselor may also be able to direct you to resources and companies that can connect you with the right solution.
If it turns out that a debt management program is the best solution for you, you can enroll directly through the credit counseling agency. A debt management program is a professional-assisted repayment plan that consolidates all your debts into one monthly payment.
1. First, you the credit counselor will find a monthly payment that works for your budget.
2. Then the credit counseling agency will contact each of your creditors to negotiate. The goal is to get your creditors to:
a. Accept payments through the program
b. Reduce or eliminate interest charges applied to your debt
c. Stop future penalties
3. As each creditor agrees to the program, you will receive acceptance letters that they are willing to take payments through the DMP.
4. Once all your creditors agree, your program officially starts.
5. You make one monthly payment to the credit counseling agency and they distribute the money to your creditors as agreed.
6. You still owe your original creditors even as you make payments through the agency. You can track your progress by watching the balances on your accounts go down.
7. Once all your accounts are paid off, you graduate from the program. Most of your credit card accounts will be closed, but you will be able to apply for new credit freely.
A free credit counseling consultation will have no negative impact on your credit. The credit check is a "soft" credit inquiry, which has a neutral effect on your score. This means there's no risk of getting a free evaluation to learn which debt relief option is right for you.
If you decide to enroll in a debt management program, the overall effect is generally neutral or positive on your credit. Unlike other solutions, such as debt settlement, using a debt management program does not create a negative item in your credit report that would damage your credit score. Making all your DMP payments on time will help you build a positive credit history on all the accounts that you enroll. In addition, those accounts will be listed as paid as agreed on your credit report, which is also positive.
However, there are some things that happen as a result of a debt management program that can decrease your credit score:
Credit age, as well as the number of accounts you have, are both minor factors used in calculating your credit score. The length of time you've used credit accounts for 15 percent of your credit score, while types of accounts make up 10 percent.
By contrast, credit history accounts for 35 percent of your credit score calculation. Since a debt management program helps you build a positive credit history, this generally means that the overall effect of a debt management program is good for your credit. Still, if your credit score is high when you start the program, you may see a slight decrease in your score. If you have excellent credit, make sure to discuss the potential credit score impact before you enroll. There may be other solutions, such as consolidation loans, that would help you avoid any potential credit damage entirely.
A debt management program is generally the best solution for consumers who want to pay back everything they owe to avoid credit damage, but who haven’t been successful at getting out of debt on their own. This includes people who can’t qualify for debt consolidation loans because they have bad credit, as well as those that have too much debt.
Most lenders have a maximum cap on how much money you can borrow with a personal loan, including a debt consolidation loan. The amount varies by lender but generally ranges from $25,000 to, at most, $50,000. With a debt management program, there's no cap to how much debt you can enroll. The minimum debt amount you need to enroll in a debt management program is $5,000, but there is no maximum limit. Debt management programs have been proven to work even for credit users who owe upwards of $100,000.
So, not only can get you turned down for a consolidation loan if your credit score is too low, but you can also get turned down if your debt is too high. In both cases, you would be able to qualify for a debt management program, as long as you have some form of income to make monthly payments.
Another downside to a debt management program that you need to be aware of is the credit freeze you'll be under during your program. Any accounts you include will be frozen until you leave the program. You also can't apply for new credit cards. You can apply for other loans, including mortgages, auto loans, and student loans. So, you don't have to put your life completely on hold.
Even when it comes to credit cards, many agencies will allow you to leave a credit card out of the program for emergencies. This can give you peace of mind that you won’t be without any options if you face an unexpected expense, like a medical emergency.
Once you've passed the point of being able to solve your financial challenges on your own, you have three options:
1. Use a debt management program to pay back everything you owe to minimize any credit damage.
2. Use a debt settlement program to pay back a percentage of what you owe, which will damage your credit.
3. File for bankruptcy.
When it comes to the two programs, the tradeoff is time and total cost versus credit score damage. A debt settlement program will usually offer a faster, cheaper way to get out of debt than debt management. However, you will damage your credit and those penalties stick around for seven years. A debt management program will usually take longer and have higher monthly payments, but it minimizes the damage to your credit.
Debt settlement programs generally take 12-48 months, depending on how much you owe and how long it takes to generate the funds for settlement offers. A debt management program takes 36-60 payments, on average.
The final option is to file for personal bankruptcy. A Chapter 7 bankruptcy liquidates any assets you have to pay off at least part of the balances you owe. This is usually the fastest way to get out of debt and can take as little as six months to complete. Chapter 13 bankruptcy sets up a repayment plan that pays off a portion of the balances you owe and then discharges the remaining balances. It’s essentially a debt settlement program that you arrange through the courts.
The benefit of bankruptcy over debt settlement is that debts discharged through bankruptcy automatically qualify for an exclusion from the IRS. That means you won’t have to pay taxes on the discharged balances. With debt settlement, the IRS will treat any canceled debt as income. You must apply for an exclusion to avoid increasing your tax liability. You will only be granted an exclusion equal to the amount you can show you are insolvent.
A debt management program avoids this issue entirely because there is no canceled debt. You pay off your balances in full. The only thing you don't pay is all the added interest charges. So, with a debt management program, you don't have to worry about increasing your tax liability.