Many people who may be in debt may not be aware they have options when it comes to dealing with that debt. Those options range from credit counseling at one end of the spectrum to debt settlement and then finally to bankruptcy at the other end of that spectrum. Each approach differs in terms of how aggressive it is towards reducing your debt as well as the effect it may have on your credit score and, consequently, your financial future over both the short and medium term. Each of the three debt management solutions has a place for the right person and may be the right solution for you depending upon how bad of shape your personal finances are in and your own unique personal circumstances.

Credit Counseling

Credit counseling involves working with a credit counselor and developing a global repayment plan to enable you to become debt-free. It is focused primarily on educating the person who is in debt, including teaching you how to make a budget and stick to it, and discussing various debt repayment plans that the consumer can implement (sometimes on his or her own and oftentimes with the help of the credit counselor). You typically will enroll in a debt management plan, into which you make a single monthly payment that is then distributed to each of your creditors by the credit counselor acting on your behalf. Credit counselors can also undertake other efforts on your behalf to assist in dealing with your debts, such as negotiating lower interest rates with your creditors and/or convincing them to waive late fees or penalties that you may have had tacked on to your debts or lower your monthly payments. One of the main benefits of credit counseling is that it is free.

Simply speaking with a credit counselor does not do anything to your credit score, but if you enroll in a debt management plan and repay your creditors a lower negotiated amount than what you owe each of them, this will be reported to the credit rating agencies and your credit score likely will drop as a result. The debt management plans put together by credit counselors often will not work for those with significant debts, so this approach may not work if you are up to your eyeballs in debt and have little to no breathing room in your finances every month. The other problematic issue is that if you do enroll in a debt management program and miss even a single payment, any reductions in the amount of debt you owe or interest rate decreases that your credit counselor may have negotiated for you will no longer apply.

Debt Settlement

Debt settlement is a more aggressive option than credit counseling and it involves working with a debt settlement company that will negotiate with your creditors on your behalf. It does not result in the complete wiping out of your debt without having to make any (or minimal) repayments like bankruptcy sometimes does. Instead of coming up with a global repayment plan for all your creditors and then sometimes leaving you to voluntarily implement that plan like a credit counselor might do, a debt settlement company will negotiate with each of your creditors individually to convince them to accept less than 100 cents on the dollar for your outstanding debts.

Creditors who are paid less than they are owed, even if they voluntarily agree to accept that amount through negotiations with the debt settlement company working with you, will report to the credit reporting agencies that you paid less than they were owed on your debts. Your credit score will therefore take a hit if you utilize a debt settlement company, but not as serious a hit as if you declare bankruptcy.  

Bankruptcy

Bankruptcy is more of a final or last-ditch solution to your debt problems. One of the requirements before you file for bankruptcy is that you work with a credit counselor, so if you are at the point of filing for bankruptcy or thinking of it, then you may already have worked with a credit counselor and that approach did not work for you in resolving your debt problems. As a required part of filing for bankruptcy, the bankruptcy court will also require that you disclose all your debts and assets and may require that a certain amount of your assets be divided up among your creditors to pay your outstanding debts. (However, you are permitted to keep/exempt certain amounts and assets, such as a car or your retirement accounts, set by law for purposes such as still being able to have reliable transportation and to afford to pay your utilities, buy groceries and some of the other necessities of life.)

Although bankruptcy has the advantage of completely wiping away your debts once you emerge from the process, it does so at a significant cost: wiping out your credit score. A bankruptcy will stay on your credit for seven years and will likely prevent you from being able to obtain many types of credit (such as a mortgage or a vehicle loan) for that time period.

Which Solution Is Right for You – Credit Counseling, Debt Settlement or Bankruptcy?

Credit counseling, debt settlement, and bankruptcy are all viable options for anyone who may be in serious trouble financially. Each of the three works for people in different situations. While all three options have the possibility of negatively impacting your credit score, and thus your financial future, this may not be that big a deal given each of these three options can assist you in resolving your financial issues. A short-term hit to your credit score may ultimately be worth it if you are able to get yourself out of debt and on to the road to recovery in your personal finances as a result of whichever of the debt solutions described above that you choose. Seeking the services of a qualified professional is the best thing you can do if you are in serious debt.