How do you get into debt?
Unfortunately, getting into debt is something that can happen easily. According to Experian’s 2019 Consumer Debt Study, Americans carry an average personal debt of $90,460 with such figures including mortgage loans, credit cards and consumer loans. While sometimes it may occur because you lived a little too high on the hog, it can also happen when life tosses you a curveball.
Events like losing your job, losing a loved one, unplanned medical expenses, emergencies, broken appliances and even broader economic changes outside of your control can lead to debt.
And this all makes sense when you also consider that day-to-day costs keep increasing while the average paycheck keeps the same purchasing power it did 40 years ago, according to Pew Research.
It’s important to understand why and how you got into debt in case there is a way to prevent it from happening in the future. But it’s also essential not to dwell on your situation for too long. Take the lessons you can from it and then focus on putting together a plan for debt relief. Your financial future can be bright by using the tools, resources and available knowledge at your disposal.
Debt settlement companies
One of the options you may be considering if you’re in debt is debt settlement. With debt settlement, you begin a contract with a company to negotiate lower rates and pay off amounts on unsecured debts with your creditors. While this may sound like a great option on the surface, there are a lot of pitfalls and drawbacks to consider.
When you begin working with a debt settlement company, you’re instructed to stop making payments to your creditors. Instead, you make payments to the debt settlement company. Once you have collected enough money with the company, it reaches out to your creditors to make a deal to close out and pay off your debt. If you owe more than one creditor, you’ll have to go through the same process for each one as well.
The problem? When you stop paying on your debts, it can destroy your credit and open you to lawsuits, which accounted for 1 in 4 civil cases in all state courts in 2013. And according to a report from the Pew Charitable Trusts, the trend keeps rising.
Additionally, there is no guarantee that a company will accept the debt settlement offer. If they don’t, you’re left holding the bag and now with more accumulated debt from late penalties and added interest.
If you find yourself in need of a short-term answer and don’t want to declare bankruptcy, a few popular debt settlement companies with high customer service reviews include < and .
Debt management companies
Another option that you have to get your debt back under control and paid off is a debt management company. These companies, known as debt management programs (DMPs), are put together by non-profit credit counseling companies. Because these companies aren’t trying to make a buck off your hard times, the advice and direction can be geared much more to helping you.
Debt management companies still work with your creditors to negotiate lower payoff amounts, just like with a debt settlement company. The difference is that the arrangements still have you paying off the full principal (actual debt you owe) but with lower interest. Additionally, the programs don’t have you defaulting on your payments to help provide some leverage against the company.
Instead, the negotiations happen upfront. On top of that, the companies have credit counselors to help coach you through money management, budgeting and keeping yourself out of debt once you’re able to get to the other side.
Consolidating your debt
A popular alternative for getting a better handle on your debt is debt consolidation. What debt consolidation does is pays off all of your existing debt and then bundles it together into one new loan.
This can be beneficial in two ways. First, it simplifies the payment process if you have a lot of different creditors you owe. Instead of having to make several payments every month, you only have to make one now. Not only is this more convenient, but it can help prevent you from accidentally getting mixed up and missing a payment, which can significantly damage your credit.
- Related: Best Debt Consolidation Loans
Second, it can help lower your monthly payments and your interest costs. If your financial picture has changed where you may qualify for a better rate, you can get that through your debt consolidation. Additionally, you don’t have to consolidate all of your debt if you have some pieces that are lower rates you want to leave alone.
Paying off your debts
When you have multiple sources of debt, it can be confusing to figure out which you are supposed to pay off first. Ideally, you should always make your minimum payments on all accounts before deciding what to do with any extra money you want to put towards the debt.
From there, you have multiple different options to choose from. The avalanche method is the most fiscally responsible as it pays off your debt with the highest interest rate first. You don’t start with the largest debt you have, but the debt costing you the most money.
If you need emotional help to motivate you, though, this might not be the ideal method. Another option is the snowball method, where you start by paying off your smallest accounts first. Having easy access at the accounts you close can drive you to tackle the more significant amounts you owe.
The latter method may have a quicker short-term effect on your credit score, as you will be closing out debt accounts. If you have the motivation, though, the avalanche method will save you the most money.
Debt forgiveness and taxes
Something that many people are unaware of is that forgiven debt is treated as income by the IRS. For many people, this is unexpected and something they aren’t prepared to handle. For example, if you have $20,000 in debt and your debt forgiveness company gets an agreement for you only to pay $5,000, you have to report the $15,000 difference as income. This could be a substantial bump in what you owe in taxes or a reduction of your refund.
There are a few exceptions to this rule, like some student debt, already tax-deductible debt, qualified farm debt and principal residence debt. To determine if your forgiven debt qualifies for an exemption, you are best served to speak to a tax specialist.
Too long, didn’t read?
Getting out of debt is certainly doable. You have plenty of information, resources, tools and programs at your disposal to help you fight the fight. It won’t happen overnight, but with good decisions and great resolve, you can find your way to the other side of the valley.