Three Options to Get Out of Debt. What People Need to Know

Every day, people across the U.S. are bombarded with messages about how to repay debt. In this article we will discuss some of the reasons these options may be,” too good to be true.” That does not mean these cannot be good choices in certain situations, but we caution people to examine their options with someone who can help them wade through the pros and cons, before it is too late.  We begin with home equity loans.

Home equity

For someone looking for a way to reduce their credit card payments and eliminate the debt, a home equity line of credit may seem like a great option. However, there are four points people must be aware of when moving the debt from a credit card to a home.

• There must be sufficient equity (the difference between the value of the home versus what is owed on the home) in the home to cover the credit card debts.
• When a home is used as collateral for debt, people run the risk of foreclosure if they do not make payments. The credit card debt becomes secured by the home.
• Often, payments on a home equity loan will be less than the payments on credit cards. However, the amount of time to pay the loan off may stretch over 10 or more years. This could increase the amount of debt repaid.
• Also, the lender will charge fees for processing the loan.

Consolidation

Consolidating accounts to get out of debt is an option that many people consider. A home equity line of credit is a form of consolidation, but there are several ways to consolidate.

• Consolidate onto one credit card,
• Loans through banks, credit unions or finance companies,  or
• Loans through alternative lenders such as Lending Club or Avant.

Considerations for these types of loan include:

• The credit score of the borrower
• The debt-to-income level of the borrower
• Fees charged for processing the loan
• The overall interest rate that will be charged. Some alternative lenders, as well as finance companies, may charge interest rates in the 20’s and sometimes even higher. This can significantly increase the cost to borrow the money.

Settlements

When someone settles a debt, it means they pay off a portion of what they owe to the creditor. A person can settle a debt themselves or they may use a debt settlement company.

If a person uses a settlement company, they make monthly payments to the debt settlement company, who then deposits the payments into a savings account. As payments continue to be received, the funds grow until the debt settlement company feels there is enough money to make a deal (negotiate) with the creditor.  That may sound very enticing, but that discount in debt comes at a very high cost – namely someone’s credit and their pocket book.

• People can be sued during the debt settlement process. Typically, during the time frame that the person is making payments to the debt settlement company, the creditors are not receiving any payments. During this period, a creditor can pursue legal action that may result in wages being garnished or in a lien against a property. They may also send the account to a third party collection agency.
• Whether someone negotiates the settlement themselves or uses a company, debt settlements may also result in higher taxable income. The Internal Revenue Service considers most of forgiven debt or cancelled debt as taxable income, depending on a person’s asset-to-liability ratio (is debt more than assets are worth) at the time the debt was forgiven. The creditor will send a 1099-C tax form if $600 or more is forgiven. In some cases, creditors have been known to sell the unpaid portion of the debt to a collection agency. The bottom line is that people may still be responsible for repaying an additional part of the forgiven debt.
• The credit report is also damaged by settlements. Rather than reflecting as paid, the account is marked as settled or settled as agreed. Some debt collectors may offer to mark the account as paid in full, but that is not permitted. The credit report may only reflect true and accurate information.

Final Concern

A universal concern for any consolidation and pay off option is how the cards are handled once they are paid in full. If credit cards are left open after they are paid off, people run the risk that they will use the cards again and run up balances. This can result in having double the debt to repay and any ground gained is lost.

This article does point out the many negative points of consolidating debt. There can be positive aspects as well. If these options are used appropriately, it is possible to get out of debt and focus income on the things in life that are important.

Working with a non-profit credit counseling agency allows people to analyze all of their options and select the one that will be most beneficial to them. From credit cards to student loans, American Financial Solutions can help people determine the best way out of debt.

Published May 24, 2016.