Editorial Policy

Debt Assistance: The Good, the Bad and the Ugly

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By Eva Norlyk Smith, Ph.D.
June 17, 2011

If you’re struggling with credit card debt, it may feel like all the doors are closed, and there is no way out. However, there are a number of ways to get help — if you know where to look.

Here’s the good, the bad and the ugly in credit card debt assistance. Buyer beware.

The good: Credit counseling
As the name implies, credit counseling involves working with a professional coach who will look at your unique financial situation and help you pare back your debt strategically.

Millions of consumers enroll in nonprofit credit counseling programs every year and a significant number find that budget counseling and financial literacy education is enough to get them back on the right financial track, according to the National Foundation for Credit Counseling.

The impact to your credit score: Nil. One advantage of credit counseling is that it doesn’t damage your credit score, unlike some other credit card debt programs. Plus, it’s cheap. Monthly fees for nonprofit credit counseling services typically run less than $25 a month.

Tip: Be careful. Scam artists often pose as nonprofit credit counseling agencies. To find a legitimate nonprofit credit counseling agency, look for nonprofits associated with the National Foundation for Credit Counseling or the Association of Independent Consumer Credit Counseling Agencies.

Also, good: Debt management plans
A debt management plan (DMP) is a comprehensive repayment plan for all of your debt, which typically includes loan modifications, such as lower interest rates and lower monthly payments. It is often negotiated by credit counselors for clients whose credit problems can’t be dealt with by simple budgeting changes or loan consolidation.

“Creditors will do what they can to make sure the person is able to pay back, and in most cases, we know in advance what each creditor is willing to do,” says Sandy Shore, a manager at Novadebt, a New Jersey-based credit counseling agency. “If we don’t know of a program that will fit, we may refer people to other organizations that can help.”

A key benefit of a debt management plan negotiated through a credit counseling agency is that it takes your whole financial picture into account. You make one monthly payment to the agency based on what you can afford, and the agency forwards the agreed payment amounts to the creditors.

The impact to your credit score: It depends. FICO scores don’t punish consumers enrolled in a debt management program, according to John Ulzheimer, President of Consumer Education at SmartCredit.com. But it could hurt your score indirectly. For example, the credit cards affected by the program will be closed and that could hurt your credit utilization ratio.

In addition, Ulzheimer notes, lenders won’t extend credit to you while you’re enrolled. That said, once you’ve paid off your debt through the debt management plan, your credit will improve.

“Most people exit these plans with very solid credit,” says Ulzheimer. “This will give you all sorts of advantages, even if you’re not looking to take out a loan. It will benefit you when applying for insurance, a job or even a place to rent.”

Tip: It is possible to negotiate a debt management plan with card issuers yourself. However, a credit counselor may get better terms and develop a more comprehensive plan.

The bad: Credit card hardship programs
Also known as forbearance programs, hardship programs are sometimes extended by card issuers to cardholders who have suffered financial misfortune, such as a medical emergency, long-term unemployment or other factors beyond their control. Although the programs are not advertised publicly, most card issuers have them.

For those who qualify for a credit card hardship program, the main advantage is that the card issuer may agree to lower the monthly payment and reduce the card interest rate to as low as 2 to 9.99 percent. Your card will be closed and, depending on the balance, you will get six months to five years to pay off the debt.

However, if you have a complex debt situation, negotiating hardship programs with multiple card issuers may not result in an overall debt repayment plan that accommodates all your creditors.

The impact to your credit score: Considerable — depending on your issuer. Hardship programs may damage your credit if the issuer chooses to report the account as being on a partial payment plan, says Ulzheimer.

“I’d love to say that there are generally accepted guidelines for how they report hardship plans, but there isn’t,” notes Ulzheimer. “As long as it’s accurate, how they choose to report is up to the issuer. Lenders can really control whether they take it easy on the consumer or penalize him or her.”

Tip: If negotiating a hardship plan with your issuer, ask if the program will be reported as a regular payment or as a partial payment plan. If the latter, consider whether the damage to your score is worth it.

The ugly: Debt settlement programs
For consumers who are seriously behind on their credit card payments, it is sometimes possible to negotiate a debt settlement under which the card issuer agrees to a let you pay off only a percentage of the debt. How much of the debt the issuer is willing to forgive, however, depends on each person’s situation and the individual card issuer.

There are many debt settlement companies out there promising to settle your debt for pennies on the dollar, but they have earned a bad reputation for being big on promises and short on results. Such programs are typically expensive and use aggressive sales tactics to sign up consumers.

The impact to your credit score: Ugly.  Entering into any program in which part of your debt is forgiven will pull down your credit score for years.

Tip: The IRS views forgiven debt as taxable income, so if you’re considering debt settlement, don’t forget to take the tax consequences into account.