Being in debt has a bigger impact on your financial future than you might realize. Bad debts can continue to to haunt you and your credit report for years, especially if you don’t deal with it now. The first step is knowing where you stand. You can monitor your credit easily using Credit.com’s Free Credit Report Card. It provides you with your credit scores, and breaks down the various components of your credit file in an easy to understand way. When you’re ready to do a deeper dive and look at your actual credit reports, go to AnnualCreditReport.com when you can pull each of your three credit reports once a year for free (though they can be tricky to read and you’ll probably find our Credit Report Cheat Sheet useful).
Once you’ve set your goal to get out of debt, you have to figure out how to achieve that goal. But with so many different experts touting different solutions, how do you pick the one that will work for you? Here are five options:
DIY Debt Reduction
With the DIY approach, you make the minimum payments on all of your debts except the one you are targeting. There are two main variations on this strategy: the snowball method, and the avalanche approach. With the snowball method you pay off the account with the smallest balance first. With the avalanche approach, you pay off the credit card with the highest interest rate first. Either way, once the first debt is paid off, you apply the payment you were making to the next target debt, and so on until they are all gone.
DIY debt reduction may work for you if: You have a clear plan and are committed to sticking with it; you are able to stop taking on new credit card debt for the duration of the program; and you have enough cash flow to pay off your balances in approximately 3 years or less. (Any longer than that and you increase the risk that unexpected expenses will derail your plan.)
To make it work: Create a written plan using a program like SavvyMoney, ReadyForZero or Zilch, all of which will allow you to create a specific repayment plan and try out different scenarios. For some borrowers, for example, the avalanche method may represent significant savings over the snowball method. For others, it’s not a big difference. But unless you run the numbers, you won’t know that and you may leave money on the table by choosing the method that “feels right,” rather than the one that will get you out of debt fastest.
Another tip: combine this approach with consolidation for maximum savings.
Consolidation
If you are able to consolidate your debts, you will get a new loan to pay off other debts. Then you will pay off the new loan as quickly as possible. You may be able to consolidate with a personal loan or by using balance transfers to low-rate or 0% credit cards. The danger? The new loan will make you feel like you solved the problem, and soon you’ll be pulling out the plastic again.
Consolidation can work for you if: You are able to significantly reduce your interest rates, and are able to pay off the new debt in roughly three years or less.
To make it work: Combine consolidation with a DIY debt reduction plan. Put your credit cards somewhere that they won’t be easy to get to, so you won’t be tempted to run up new debt while you’re still paying off this loan.
Credit Counseling
A reputable credit counseling organization will typically review your budget with you for free, and help you figure out if a Debt Management Plan can help you get out of debt faster. If you enroll in a DMP, your credit card issuers will typically reduce your interest rates, and you’ll make one monthly payment to the counseling agency, which will then pay each of your creditors. According to the most recent Transparency Project report from Cambridge Credit Counseling, clients received interest rate reductions averaging 14.49%. As a result, the average new client’s payment was $141.58 less than what they had been paying on their own.
A DMP may work for you if: Your creditors lower your interest rates enough to provide breathing room in your budget, and you have enough income and cash flow to pay back your debts in five years or less.
To make it work: Be realistic about your ability to make the payments required under the DMP for as long as it will take you to pay off your balances. Take advantage of the education and support programs offered by the counseling agency, and reach out to them immediately if you experience an unexpected financial setback.
[Credit Score Tool: Get your free credit score and report card from Credit.com]
Debt Settlement
If your balances are too high to pay them back within five years, or if you’re dealing with significant debt that’s been turned over to collections, you may want to consider trying to negotiate settlements with your creditors. With this approach, the creditor or collector agrees to accept less than the full balance to satisfy the debt.
Debt settlement may work for you if: You are able to come up with the enough money — typically around 30 – 50% of what you owe — to settle your debts in a relatively short period of time (usually 24 months or less). The funds to settle may come from savings or a gift from a family member, for example.
To make it work: Educate yourself on how settlement works. You may have a stressful few months as you try to negotiate with the companies to whom you owe money. Before you go this route, it’s a good idea to also talk with a bankruptcy attorney to find out whether that might be a better option. Also make sure you investigate upfront whether you will owe taxes on canceled debt.
[Related article: How Do Debt Relief Options Affect Your Credit?]
Bankruptcy
If you file for bankruptcy, you may be able to eliminate most or all of your debts very quickly (in a Chapter 7 Plan) or over five years or less (in a Chapter 13 Plan). If you are being threatened with debt collection lawsuits, if your income has been to reduced to the point where you can’t make your payments, or if you are simply feeling overwhelmed with your debt, it’s a good idea to talk with a bankruptcy attorney to find out whether it may provide the relief you need.
Bankruptcy may work for you if: You have significant debts that can be discharged (eliminated), and your income does not prevent you from doing that.
To make it work: Talk with a qualified bankruptcy attorney, one whose practice is largely devoted to bankruptcy and helping consumers in debt. Ask for referrals from financial professionals you trust, or visit NACBA.org. When you do meet with an attorney, bring all the documentation he or she instructs you to bring, and be completely honest about your situation. And don’t wait until you’ve been sued or you raided your retirement accounts to talk to an attorney.
[Related article: Six Dangerous Words if You Are in Debt]
Image: lemonjenny, via Flickr
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Gerri Detweiler Gerri Detweiler is Credit.com's Director of Consumer Education. She focuses on helping people understand their credit and debt, and writes about those issues, as well as financial legislation, budgeting, debt recovery and savings strategies. She is also the co-author of Debt Collection Answers: How to Use Debt Collection Laws to Protect Your Rights, and Reduce Stress: Real-Life Solutions for Solving Your Credit Crisis as well as host of TalkCreditRadio.com.
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Some good advice but I would add one other thing. Whatever method is used to pay off credit card debt you must stop using any and all cards until your goal is met. You can’t get out of CC debt while still using the same cards that caused the problem.
So true Sandy!
Great tips ..thanks a lot for the valuable information ..Really what a brilliant way to combine your interests. I admire your creativity.
The credit counseling has worked great for us. Family Credit Counseling has been handling our credit card debt for 8 months. They negotiated lower rates and payments and no late fees with 5 cards. The only one that refused to work with them was Capital One, even though we have been with them for over 10 years. So they are the only one we have to pay out of pocket and we are paying extra on it to get rid of them forever!!
Glad to hear you are on the right track Meg!
But remember when useing these services it is treated the same as a bankruptcy when you are trying to get a home loan. Its better to just try to talk to them yourself to get a lower rate. Also many of these companies have terrible service.
I agree with calling the companies yourself. You may have to wait until you are behind one month but most have debt reduction plans that have no late charges and a lower interest rate to help. And since a condition is that you close the card, you cannot accumulate more debt. I have been on plan with Bank of America for a few years and it has worked well.
Learn self control and know what you can afford and what you can’t. Learn to save up for items you want and pay for it with cash. Find ways to make extra cash vs using a credit cards. Need to take responsibility for what you purchase. People buy things and then can’t pay for the things they should take care of. People that struggle with finances may have it for a lifetime, and it is repeated over and over again. People that file for bankruptcy will more then likely file bankruptcy again it ends up being a easy way out. The sad thing about all this is, alot of people are starting to feel they are entitled not to pay and find a easy way out. All the talk about debt reduction, well don’t spend. Learn self control and only spend on the necessary things, eliminate using any credit cards, work your self down to only one card and you be the one that sets the credit card limit you want not the credit card company. People it’s your money you earn, why give it to the banks. If you pay for things for cash, you don’t have that bill coming in the mail. If you do decide to use a credit card learn to pay it off in a short amount of time.
Do the credit counseling programs ruin your credit? We have perfect credit but see a very large long term expense in the near future & I would like to work with credit counseling but am not sure if the stress of the debt is more or less than the stress of ruined credit.
K Richards –
I wrote about that very topic in this story: How Debt Relief Options Affect Your Credit. I will add that there may be a trade-off but even if your credit is affected, there is a time limit that negative credit information can be reported. Sometimes debt that isn’t dealt with can last longer than the credit damage!
Gerri:
I would’ve added a tip if you have multiple credit debt pay attention to those statements where they say if you pay a certain amount every month with no charges you can be paid off in three years. One thing I’m trying to do is to try to get the debts that won’t be a priority to get the payment closer to three years. It’s a symbol of process if you get one there and once you can start knocking off a debt totally this will help speed up the avalance you’re talking about.
Walter Hanson
Minneapolis, MN
Walter – I agree. And when we hope to hear your success story when you pay off all your cards!
What about someone who’s main debt is IRS and state taxes? Any advice?
I am working on a story on that topic. Takes a different approach.
Get a second job driving limo,taxi,shuttle van where you can earn cash tips to help with credit card debt. I got myself to blame for over spending no more cards!
Get a second job driving limo,taxi,shuttle van where you can earn cash tips to pay off the credit card dept.I got myself to blame for over spending no more cards!
WANTED FREE ANNUAL REPORT FROM ALL 3 CREDIT GROUPS
- STARTED W/TRANS UNION THEN GOT TOSSED OUT WITHOUT
THE OTHER TWO.
PLEASE ADVISE/CAN IT BE RESUBMITTED?
Jojo – If you can’t get them online have you thought about ordering them by mail? There are addresses available if you want to request copies that way. (Not sure what will happen if you try to go back and get the other two online. I don’t think it hurts to try…)
Wait for the Federal Reserve to inflate away the value of the currency, rendering the debt inconsequential. Of course, everybody’s wages and savings will be inconsequential as well.
This article is very useful to me especially in my financial world.
I have no credit cards but I have student loan debt that I don’t seem to keep up with. Can the same plan for credit cards work for student loan debt?
Lori,
Yes and no. You can use the DIY method, for sure, if you sit down and have an honest talk with your budget and decide that you can both afford the payments and be disciplined to pay them down in the suggested three years. You could also try consolidating/refinancing, but it is difficult to find lenders that will refinance student loans. I went through Wells Fargo to refinance mine, and have been pleased with their service so far. You may have other lender options available to you depending on your location.
As far as I know, student loan providers don’t generally go for settlement, and student loan debt is not dischargeable in a bankruptcy. But you can seek counseling for any kind of debt – a good place to start is with your primary financial institution, as they have experience working in the financial world and can at least point you in the right direction.
Additionally, student loans have relief options that other kinds of loans do not. Ask your provider directly what can be done – you may be eligible for deferment or forgiveness, depending on factors like your income, location, occupation, and deferment history.
Hi Lori –
What kind of student loans do you have? Private or federal?
I am 48, and finished nursing school in May. I found a part time job. I also am a single mom with 6 kids still at home, and one adult child at home. I have debt, my mortgage, home equity, a car loan, and two credit cards with debt. In addition, I have $20,000 in student loans. Right now, it is $0 to pay back for an income based repayment plan. My youngest child is in kindergarten. I don’t know if I will be better able to take care of my student loan debt later, if it will become easier to pay as the kids leave for school, or if I can anticipate more work. Right now I have three part time jobs, my income has gone up some since school, but I can’t get prime jobs. I suspect my age and not being as computer savvy as my younger colleagues. I have learned a lot, but didn’t have much education in it, unlike my kids who have classes in school and become high tech while learning basic skills. What will happen to my income based payback, will it be ballooning as I am hoping to retire, I am in uncharted water for me. I had plenty of debt for my master’s in a very small field, art therapy, and ended up rolling part of that debt into my house. I felt it made sense, I ran a daycare at home for a while, I was paying my debt with my income. When our income dropped to less than half in 2007, I felt going to nursing school would be a good financial move. It is giving me more income and more time, so I am happy, but don’t know what will happen to the debt and the best way to tackle it. Feedback?
Tracy – Congrats on going back to school and getting your degree while raising your family. That’s a huge accomplishment and you should feel very proud of it. You are in a field that is in demand, and I suspect that if you do a good job your career prospects will continue to improve.
It is true that over time you may pay more for your loan if you continue in IBR – unless you end up in the program for the entire 20 years at which time your balances will be forgiven (after 10 years if you work in public service). There’s more information about that here. However, it also sounds like this is a better option for you right now to keep you from falling behind (which is much worse) or from running up larger debts on your credit cards.
It probably makes sense for you to focus on paying off your credit cards and higher rate debt first, then when your situation stabilizes you can revisit what you want to do with the student loans. (I am not a financial planner though so please don’t take this as that kind of advice.) Another option: you may want to try to find out if there are nursing jobs in your community that would be considered public service as they may be eligible for student loan forgiveness.
If my bank decided to close my account will that affect my credit score?
I meant my credit card account
Pat – whether or not it affects your credit score will depend on a couple of things. The main factor being how closing the account would affect your revolving utilization. Here are two articles that will help explain what happens when an issuer closes an account and what revolving utilization is:
Help! They Closed My Credit Card Account – http://blog.credit.com/2013/04/help-they-closed-my-credit-card-account/
Credit 101: What Is Revolving Debt Utilization – http://blog.credit.com/2013/04/what-is-revolving-utilization/
Pat – whether or not it affects your credit score will depend on a couple of things. The main factor being how closing the account would affect your revolving utilization. Here are two articles that will help explain what happens when an issuer closes an account and what revolving utilization is:
Help! They Closed My Credit Card Account – http://blog.credit.com/2013/04/help-they-closed-my-credit-card-account/
Credit 101: What Is Revolving Debt Utilization – http://blog.credit.com/2013/04/what-is-revolving-utilization/
If I contact credit card companies and have my limits lowered does that reflect negatively on my credit report. I have no debt, just want to lower these high limits to ensure that I can’t charge more than I can afford to pay off.