Debt Settlement vs Debt Management - aka Credit Counseling
I'm a fan of nonprofit consumer credit counseling services. They serve a great purpose for people who would rather not settle their debts or for those who require assistance with budgeting, managing their money, or reducing their interest rates.
However, I take a bit of a different perspective to credit counseling and debt management plans compared to what you'll normally read on the Internet.
When I encounter consumers who are behind on their debt, I base a lot of my opinion on what's best for each situation on the amount of time it will take to recover and reestablish credit again.
That is one of the reasons why I only offer debt settlement to consumers who can settle all of their delinquent debts right away. By limiting my services to simultaneous debt settlement, I'm able to provide my clients an outlet where they can resolve their debt and begin the process of recovery, on average, in just a few months.
What I commonly read on the Internet, and you may have too, is that credit counseling should be the first thing you look into when struggling with your finances.
Then the conventional wisdom starts talking about debt settlement if you don't qualify for credit counseling.
Then bankruptcy if you can file a Chapter 7.
And then back to debt settlement if you can only file a Chapter 13.
That's the typical waterfall of suggestions.
Why this waterfall of advice is somewhat of a misnomer...
Keep in mind, if I only knew about 3- and 4-year debt settlement programs as the only available alternatives for debt settlement, I would offer the exact same waterfall of advice.
However, with my coming from the collection industry previous to starting Debt Relief á la carte, I had the chance to identify the two biggest issues with the typical debt settlement approach that so often causes harm to consumers.
What are they?
Premature representation and lengthy program durations.
I hope the sarcasm in the above picture is obvious
I wrote an article on getoutofdebt.org about a year ago, describing the aspects of premature representation that take place when consumers hire a debt settlement company to represent them previous to possessing the financial ability to settle.
It's a huge issue, because when this takes place, consumers are immediately put into an adversarial situation with their creditors merely due to the debt settlement companies' premature involvement. When in reality: that's the last move people who are behind on their debts with no money to resolve them should ever make.
If you were in the Wild West 150 years ago, would you go to a gunfight without a loaded gun? That's exactly what these long-term debt settlement companies encourage consumers to do.
If you want to succeed at settling your debts, your safest and most reliable approach is to settle them right away in a simultaneous way. And if you can't do that, it's vital that you find a way to do it fairly quickly. To avoid the aspect of premature representation, you'll want to do it yourself.
Program durations: otherwise known as the projected length of time to complete the plan.
The other issue is the program duration's that are commonly offered. I personally don't recommend debt settlement if it can't be completed within 24 months or less. And ideally 12 months or less.
The reason why I make this recommendation is due to the dangers that you will be exposed to as your accounts age and flow through the collection cycle. Read about how debt settlement works to gain a better understanding of the dangers I'm referring to.
Yet, even though the debt settlement industry as a whole realizes that the longer the debt settlement plan is projected to take the less likely it will be successful, the most commonly advertised program duration's, virtually by all debt settlement companies in the industry, are 36-48 months.
Again, I'm a proud owner of a debt settlement company and I'm saying straight from my mouth that debt settlement programs that are projected to take longer than 24 months should be avoided.
My point here is that the misnomer I'm referring to is due to the author of the content you're reading not knowing about these more intelligent and consumer friendly programs that are out there. We're a two-person company. Trust me, they definitely don't know about me and my unique service.
And most of them don't know about another amazing company: ZipDebt. ZipDebt is a one-person company who limits his service to consumers who can settle in 18 months or less. Charles Phealan, the owner of ZipDebt, is smart and more importantly: highly ethical.
He too saw the problems with premature representation and program durations as being the main causes for failure and harm to consumers.
And what did he do about that? First: he limited his services to consumers who can settle in 18 months or less (with strong encouragement to fund the settlements with additional financial resources in order to expedite the process). And second: he decided to teach people how to settle debt on their own so they wouldn't be prematurely represented.
And please know, I used to offer a DIY debt settlement service myself. But once I found Charles and got to really know him, I discontinued it and refer to him instead.
If more people knew about these more safe and reliable approaches to debt settlement, I think you would find that credit counseling wouldn't be the first thing commonly suggested.
Why I think you should consider debt settlement and credit counseling...
Now let's get back to the waterfall stuff. As I mentioned earlier, I base a lot of my opinion on the amount of time it will take to recover and reestablish credit again.
It takes roughly 2 years to begin to reestablish your credit after resolving ALL your delinquent debts through debt settlement.
Credit counseling is a bit murky. On the one hand it doesn't impact your credit score directly. On the other hand it does, due to the common closure of accounts once a creditor agrees to accept a debt management proposal. The closing of your accounts, commonly reported as "account closed by credit grantor," generally has a negative impact on your credit score.
Furthermore, most credit counseling plans are projected to take 5 years. And most creditors report a special remark to your credit report while you're participating in a credit counseling plan (it generally states: "account included in a debt management plan").
That's not to say that you couldn't unenroll from the credit counseling plan 2 years into it and take over again. And if you do, the remarks about your involvement in a credit counseling plan will soon be removed. But if that isn't a realistic opportunity that you foresee, you will more than likely reestablish your credit more quickly by settling your debts.
This is why I think people should review debt settlement and credit counseling, side by side. Except instead of thinking 36- and 48-month debt settlement program durations, think about your ability to settle right away. And if that capability doesn't exist, think about debt settlement with program duration's of no more than 24 months. And ideally, 12 months or less.
And while we're on the subject, if you don't find yourself financially able to settle your debts in 24 months or less: cross the option of debt settlement completely off your list.
Not only is it way more dangerous for you to go beyond 24 months without paying your creditors, but from a recovery standpoint, it doesn't even make sense. Except for a small segment of consumers who can only qualify for a Chapter 13 and who lack the financial ability to settle quickly. And even then, most of those consumers are better off utilizing a hybrid approach of debt settlement and payment plans.
How long does it typically take to reestablish credit after credit counseling, debt settlement and bankruptcy?
Now let's get to the mathematical reason why I recommend considering debt settlement along side credit counseling: the cost.
Credit counseling monthly payments can average 2% of your balance. So think about that for a moment.
You will pay approximately 48% of your current balance in two years via credit counseling.
That's more than the average cost of my debt settlement service, with my fees included.
That's also what you may be able to settle your debts for over a 24-month debt settlement plan, when settling yourself.
For a similar monthly cost, you may be able to settle your debts in 2 years or less.
Debt settlement timeline vs debt management timeline
For roughly the same payment amount as a 5-year debt-management plan, you potentially can settle your debts in 3 years less time. And if you do, you reestablish your credit in 3 years less time. And, more importantly, you also eliminate the monthly payment from your budget in 3 years less time.
Although, I don't want to sugarcoat 2-year debt-settlement plans, they do still come with some risk. Which is why I highly recommend hiring a debt coach when doing it yourself.
So do credit counseling services make sense for anyone?
They do. When you settle your debts over time, your creditors will attempt to collect from you. You're going to get lots of phone calls and communications from debt collectors. At first these calls and letters will be fairly customer-service oriented. But as your accounts age and become more delinquent and travel through the collection-cycle, the collection efforts will become more intense.
Not everyone can handle the exposure to that stress. In fact, I've written another article about how to match your debt relief options with your personality. It is designed to help you take a realistic perspective of your situation, so you may determine if you can handle the stress associated with settling over a longer period of time.
For those who can't, a debt management plan can make sense. They're much safer than a debt settlement plan, in the sense that your accounts will be receiving monthly payments and your creditors won't be attempting to collect from you while you're participating in the plan (assuming that your accounts aren't already charged off).
Additionally, credit counseling is generally a more intelligent approach versus debt settlement for people who don't owe a significant amount of debt and are not yet behind on their payments and possess a positive net-worth (if you have a positive net-worth, you won't be exempt from any of the income tax associated with the settlements).
For example: If you owe $40,000 in debt and were to go the debt settlement route, your total cost (assuming a 10% increase to your current balance, 40% settlements, a typical 20% of what you owe debt-settlement fee, and 25% federal and 5% state income tax) after paying the settlements, the typical debt settlement fee, and the federal and state income taxes, you would end up saving around $6,480.
Which in my view, is not enough savings to make debt settlement worth it. For people who are in this situation, or for those who owe even less, credit counseling can make a lot more sense.
However, I would definitely recommend to also meet with a bankruptcy attorney, so you can compare all of your options against each other.
If you end up taking the option of debt settlement off the table, and your remaining logical choices are bankruptcy and credit counseling, something you'll want to consider is that most people who file Chapter 7 bankruptcy generally begin to reestablish their credit within 2 years of filing. Whereas if it takes you the full 5 years to graduate from your debt-management plan (as it often does), you'll be looking at a full 5 years before you will really begin to reestablish your credit again.
Simply put, you'll generally begin to reestablish your credit 3 years earlier by filing Chapter 7 bankruptcy.
Have debt management plans been rendered obsolete?
As demonstrated, people who qualify for a 5-year debt-management plan have a high probability of settling their debts in 2 years or less with a similar monthly expense.
I believe this math and information illustrates the need for creditors to revisit the concept of old-school credit counseling, since the terms are creditor controlled and not actually negotiated. Credit counseling used to be a combination of debt settlement and debt management, by reducing the principle (sometimes by as much as 40%) with the option to pay it over a 5-year plan.
If concessions of 40% were available over 5-year terms, it would lower the monthly payment by 40%. Thus, making credit counseling more relevant in today's society by providing a solution for more consumers who are otherwise forced to turn to more unreliable long-term debt settlement programs (programs greater than 24 months).
Which credit counseling program do you recommend?
I recommend Cambridge Credit Counseling Services because they're the only credit counseling service that publishes their success rates. Their report states that approximately 40% of their clients fully complete the program.
For comparison, here is a link to a report conducted by our Federal government about debt settlement that reports a less than 10% completion rate for customers of long-term debt settlement companies (see page 2, paragraph 1 when clicking the link).
If you would like to learn more about settling your debts, please see my 4-part series on how debt settlement companies work.
If you would prefer to learn more about how to make arrangements on your own, please read my article about how to talk to debt collectors.
For a more in-depth view about credit counseling, I recommend reading Michael Bovee's article about credit counseling options.
I hope this information about debt settlement vs. credit counseling helps you. Please feel free to contact me with any questions.