What you don’t know about the business of getting out of debt will cost you. The question you must ask yourself is how much are you willing to pay for freedom. Quite simply, the options are (1) pay for everything in the usual way; (2) negotiate for less than what you owe through negotiation; (3) consolidation; (4) debt relief payment plans; and finally, (5) bankruptcy. Certainly, if you’re struggling to pay what you owe, you’re most likely in too much debt. Let’s look at the costs and benefits of each of these options. We’ll skip “pay as usual” because if you did, you wouldn’t be reading this article.
NEGOTIATE DEBT
When we negotiate our debt, we are asking the creditor to accept less than what is owed. Let’s say you owe $5,000.00 and you convince the company to take $2,500.00 instead. You will pay them the $2,500.00 and then you will receive a tax bill for the other half that the creditor paid off on a 1099 tax form.
CONSOLIDATION
When you take all your debt and consolidate it, you are usually taking out a new loan. When you’re turned down for a consolidation loan, you’ll need to look at other options. A new loan will pay off all other debts, and you make one payment for the agreed terms, plus interest. This is not a plan to reduce what you owe. The average annual percentage rate (APR) on this type of loan is around 18.56%. To put that in perspective, the average range of interest rates charged on consolidation loans is typically between 8.31% and 28.81%.
For a total debt of $30k with an average interest rate of 48.56%, the monthly payments would be approx. $771.00 for 60 months and the total payment would be $46,258.00, this being the most expensive way out.
DEBT RELIEF PLANS
Debt relief companies are everywhere these days, advertising for you to “speed up your debt free date” and get a payment plan you can afford. Some of these companies have been sued for violating telemarketing rules, charging up-front fees to help, and failing to inform you of your rights to deposited monthly payments.
What you are paying for here is for the company to take your monthly payment and negotiate a settlement of your debts for less than what you owe. This is a trading strategy with a payment plan. There will be a 1099 tax bill after these accounts are settled, so be prepared for that as well. Below you can pause and read the fine print I found in an ad:
“Clients who make all of their monthly program deposits pay off approximately 70-75% of their original enrolled debts over 24-60 months. Not all clients are able to complete their program for various reasons, including their ability to save sufficient funds. Our Estimates are based on past results, which will vary depending on your specific enrolled creditors and the terms of your individual program We do not guarantee that your debts will be resolved by a specific amount or percentage or within a specific time period We do not assume your debts, do monthly payments to creditors or provide credit repair or tax, bankruptcy, bookkeeping or legal services The company does not offer debt settlement services in all states and rates may vary from state to state In some states, we can refer you to a trusted business partner who can provide you with alternative debt relief services. Contact a tax professional to discuss the potential tax consequences of a less than full balance debt resolution. Read and understand all program materials prior to enrollment. Using debt settlement services will likely negatively affect your creditworthiness, may result in you being subject to collections or being sued by creditors or collectors, and may increase the outstanding balances of your enrolled accounts due to accrual of fees and interest . However, the negotiated settlements we obtain on your behalf resolve the entire account, including all rate and interest increases.”
This means that your savings are a nominal discount of 25% to 30% of your debts after you pay the company’s fees and costs to maintain that account for you. In the meantime, they can’t stop interest from accumulating, nor stop creditors from stepping up their efforts or even filing a lawsuit. This could add to costs over time and still cause you to end up in bankruptcy. So maybe you can save time and money by considering the latter option.
BANKRUPTCY
There are two chapters of the Bankruptcy Code that anyone may want to file. Chapter 7 bankruptcy is a liquidation case where you do not have money to make a payment plan. The other is a Chapter 13 bankruptcy case, which is a 5-year repayment plan case. Let’s compare a bankruptcy payment plan to the plans just mentioned.
Let’s level the playing field so you have enough information to make an informed decision for yourself.
In reality, it is extremely difficult to pinpoint the full cost of these debt relief plans because interest continues to mount while you create an account for the company to use to negotiate a discount. What’s worse is that the discount they get is probably more than what you’ll see because there’s a trade-off in their fees for the service.
In the event of bankruptcy, fees and costs are established and included in the monthly payment. For that same $30k debt, and adding the 11% trustee fee and the $5k average attorney fee, and even discounting the debt by 30%, you’ll get a monthly payment of $470.00 per month for 60 months for a total cost of only $28,200.00 for a Chapter 13 case.
Bankruptcy offers protection against creditors by invoking the Automatic Stay, which is a court order that prevents creditors from filing lawsuits against you or trying to collect while you make your payments under Chapter 13 of the Bankruptcy Code. Other benefits include avoiding interest accruing on unsecured debts (ie credit cards), and no income tax consequences for debts discharged in bankruptcy. Oh, and did you know that credit scores actually improve when you’re on a payment plan case? They do. How much are you willing to pay to speed up your debt-free date, and do you really understand the price you’ll pay?