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Becoming Debt-Free: Your Options

Are the bills starting to pile up? Are debt collectors calling you nearly every day? Financial crises can happen to anyone, whether it is caused by illness; job loss; or simply living beyond one's means. Becoming debt-free may seem unattainable, but there are several options for getting out of crippling debt or at least minimizing the pain. There is no one-size-fits-all approach, however, since everyone has their own unique situation and needs.

This article provides an overview of how to get out of debt, organized into the following categories:

  • Self-Help
  • Credit Counseling and Debt-Management Plans
  • Debt Consolidation
  • Bankruptcy
  • Debt Negotiation Programs

See FindLaw's Debt Relief section for additional articles and resources to help you achieve your goal of becoming debt-free.

Helping Yourself Become Debt-Free

Develop a Budget: A budget is a guideline for how much money you can realistically spend, based on your income and assets. To get started, list your income; your fixed expenses (such as rent and health insurance premiums); and expenses that vary from month to month (such as clothing or entertainment). With this information, you can identify necessary expenditures (those related to housing, food, transportation, etc.) and then prioritize the rest.

See Creating and Sticking to a Budget for more suggestions. 

Contact Your Creditors Directly: Creditors do not want you to default, since they would rather collect monthly payments from you. Therefore, it is in your best interest to contact creditors directly when you're unable to make payments and work out a modified payment plan. Once your account is in collections, it is too late to negotiate with creditors.

Know Your Rights with Debt Collectors: Debt collectors must abide by rules set forth by the Fair Debt Collection Practices Act. As governed by the Act, collectors may not call you between 9:00 p.m. and 8:00 a.m. or when you're at work (if the debtor's employer does not approve of such calls). Also, collectors may not lie, harass or otherwise use unfair practices when trying to collect debts.

Manage Your Secured Debts: Secured debts are those that are tied to (or "secured" by) an asset, most commonly a house or a car. Defaulting on a secured debt can result in the loss of your car, house, or other asset (including anything of value that is put up as collateral). Unsecured debts, such as credit card or medical care debts, are not tied to a particular asset.

When you finance an automobile, you usually agree to have it repossessed without notice if you default on the loan. Similarly, if you fall behind on your mortgage you could have your home foreclosed by the bank. In either case, you may be able to work out an agreement by contacting your lender immediately if you fall behind on a payment.

For more details, see 10 Tips to Avoid Foreclosure and How to Get a Repossessed Car Back.

Credit Counseling and Debt Management Plans

Credit Counseling: Consumers often need help becoming debt-free. Credit counseling organizations are tasked with helping debtors devise a budget and come up with solutions to both pressing matters and long-term financial concerns. While most credit counselors offer services online and via telephone, it is advantageous to choose an organization that also offers in-person consultations.

Most credit counseling operations are set up as nonprofits, but that does not necessarily mean their services are free, low-cost, or legitimate. An illegitimate or substandard credit counseling organization may charge hidden fees, ask for a "voluntary" donation, and often will not provide much up-front information about the details of its services or fees. See Avoiding Credit Repair and Credit Counseling Scams to learn more.

A reputable credit counseling organization will offer services to help you better manage your cash flow and debts; work with you to develop a budget; and often provides free workshops or other educational support. Look for counselors who are trained in debt management, budgeting, and consumer credit.

Debt Management Plans: Debt management plans (DMPs) may be a viable option, but only if credit counseling alone is not effective. But only sign up for a DMP after a reputable credit counselor has thoroughly reviewed your finances and has suggested ways to manage your money and debts.

DMPs allow you to deposit a certain amount of money with a credit counseling organization each month, which is then used to pay credit card bills, student loans, and other unsecured debts. The credit counselor managing the DMP also works directly with your creditors, who may agree to lower rates or drop some fees.

Debt Consolidation

Consolidating multiple debts into one, typically through a home equity line of credit or a second mortgage, is one way to lower your overall interest payments. But if you default on debt secured with your home, for example, keep in mind that you could lose your house through foreclosure. However, you may have to pay "points" for additional money borrowed, which can add up.

See Finding a Bankruptcy Alternative to learn more about debt consolidation and related options to help you become debt-free.

Debt Negotiation Programs

Other options to consider include debt negotiation programs (DNPs). DNPs are often touted as alternatives to credit counseling and DMPs, often are quite risky and can hurt your credit rating. Not all DNPs operate legitimately or in the best interests of the debtor, which is why many states regulate them, so make sure you do your research before working with one.

These types of firms often claim they are nonprofit and often promise to negotiate payments creditors that are only 10 to 50 percent of the original balance owed. For example, a DNP might claim to negotiate with a bank to reduce your $15,000 credit card balance to $7,000 or less. These firms may also claim that this type of arrangement will not hurt your credit rating or ability to get credit in the future.

But these services too often do not help debtors become debt-free. For instance, there is no guarantee that any of your creditors will agree to partial payment of your debts. And if you stop making regular payments to creditors (as DNPs sometimes have you do), you could end up with extra late fees or an increased interest rate. Also, DNPs typically charge a relatively high fee for services, including a final payment based on a percentage of your supposed savings.

In addition, creditors may sue you, garnish your wages, or put a lien on your home for nonpayment of debts. Failure to make monthly payments—which may result from the terms of your agreement with a DNP—could result in negative information on your credit report. If that isn't enough of a warning, the Internal Revenue Service (IRS) may consider the amount of forgiven debt to be taxable income.

While some DNPs may provide valuable services for certain individuals in some situations, be wary and do your homework before hiring one. Lastly, you should always get the terms of your agreement in writing and make sure you fully understand those terms.

Bankruptcy: The Last Resort

Personal bankruptcy is often considered a last resort if other methods of debt relief have been exhausted (other than DNPs, which should be avoided in most cases). The results of filing for bankruptcy can last a long time and often are far-reaching. For instance, a bankruptcy filing will remain on your credit report for 10 years and affect your ability to secure credit in the future. But bankruptcy is an effective solution for those who are unable to pay off debts.

The two main types of personal bankruptcy are Chapter 13 and Chapter 7. While Chapter 13 may allow those with income to keep their assets and property while making regular payments under a bankruptcy plan, Chapter 7 may result in the liquidation of non-exempt assets in order to pay off creditors in exchange for a full discharge of many types of debt.

To learn more about bankruptcy, read the articles and resources in FindLaw's Bankruptcy Basics and Benefits of Bankruptcy sections.

Becoming debt-free can be quite liberating, but make sure you explore all of your options and choose wisely.

Next Steps
Contact a qualified debt and bankruptcy attorney to find out your options
for navigating the best path forward.
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