Got Bad Credit? Debt Relief Options Worth Considering
Like the chicken and the egg, it can be hard to determine which came first between bad credit and debt.
High debt can drop a credit score.
Having a low credit score can lead to difficulty getting good loan rates and could cause a borrower to take out high-interest loans they can’t afford. Their debt could then mount.
However it works out, improving one can also help the other.
For some people, that can require help getting their debts under control. Here are some debt relief options that could help:
Debt Relief Companies
You can do many of the below tasks yourself, but sometimes it pays off (literally) to pay someone to do it for you. Debt relief companies, also called debt settlement companies can be the first place to start if you have more than $10,000 in debts.
Their main goal is often to help you consolidate debts into a single payment that’s cheaper than what you’re paying now. They do that in part by negotiating your debt repayment amount, with the idea that it’s better for a creditor to get some money on a debt than nothing at all.
Debt settlement may sound like a good thing. After all, you no longer have to pay the full outstanding balance after a debt settlement company has negotiated a lower payment. That can be half to 80% of the balance.
A big downside is that it will probably hurt your credit score. The debt settlement company doesn’t pay your creditors while negotiating lower payment, so the late payments will be reported to the credit bureaus.
Before hiring a debt relief company, be wary of ones that ask for upfront payment from you, promise to improve your credit score, or make any guarantees. They typically charge a high percentage fee of 15% to 25% of the amount settled.
A legitimate company may ask you to pay into an escrow account to cover payments it negotiates for you. Or, it may advise you how to pay your creditors.
Debt Consolidation Loans
If a lot of your debt is from multiple smaller loans, such as credit cards with different interest rates, then one large loan at a lower rate than the average for the other loans will lower your costs.
You can do this on your own by transferring high-interest credit card balances to one with lower rates. However, having bad credit can make it difficult to find low interest loans, and subprime loans could be higher than the rates you’re already paying. Personal loans can also be used to consolidate debt.
Debt consolidation loan companies may not be able to move your debt into a lower interest rate, but they can often lower your monthly payments by stretching out your loan over a few years.
That means paying more interest over the new loan term, but it can at least make the payments more affordable.
Another benefit from making one payment to one lender instead of multiple lender is that you’re less likely to miss payments. That could improve your payment history, which accounts for 35% of a FICO credit score.
Home Equity Loan
A home equity loan is another way to pay off your debts. You can borrow up to 80% of the equity you have in your home and pay it back over years.
These loan rates are easier to get if you have good credit, but even with bad credit there are lenders that will work with you. They include Lending Tree and the home mortgage divisions of big banks such as Wells Fargo, Bank of America, and CitiMortgage.
A lump sum of cash is provided in a home equity loan. How much equity do you have in your home? A simple calculation is to subtract the balance of your current mortgage loan from the value of your house. Your home’s value is likely higher than what you paid for it. An appraiser will determine the value for your loan.
Suppose you bought a home for $200,000 and made a $40,000 down payment. That immediately puts your equity at $160,000. After years of payments, suppose the total due on your mortgage is now $150,000. That increases your equity to $50,000.
But that assumes your home hasn’t increased in value over the years.
Let’s assume your home’s value has increased to $300,000, as determined by an appraiser. That puts your equity at $150,000, assuming you owe $150,000 on the mortgage.
The math is: 300,000 - 150,000 = 150,000.
From that $150,000 in equity, a lender will allow you to borrow up to 80%. You don’t have to borrow that much, but you can. In this case, 80% of $150,000 is $120,000.
Debt Management Plan
Nonprofit credit counseling agencies can set up a debt management plan, or DMP, for you. A credit counseling agency can be found by searching the National Foundation for Credit Counseling, and the Financial Counseling Association of America.
The agency will create a debt management plan that lowers interest rates and fees, and negotiates reduced payment amounts with your lenders. You’ll still pay off the principal amount, so it shouldn’t affect your credit score.
A DMP is similar to what a debt relief or debt settlement company does, though DMPs are administered by nonprofit credit counseling companies. Debt settlement companies, on the other hand, are for-profit.
The DMP could last three to five years, when you’ll generally be unable to use credit cards or open new lines of credit. Missing a payment could derail the plan and end your interest rate reductions.
Renegotiate Your Debt By Yourself
Instead of paying a fee for a company to negotiate better terms with your creditors, you could do the work yourself.
Calling a credit card company before you start falling behind on payments and explaining your problem is likely to at least get you a temporary reprieve. Losing your job during the coronavirus should allow you to put off payments for a few months and gives you time to set up a payment plan.
Some financial problems are temporary. Losing a job, hospitalization or totaling your car and needing a new car to get to work are issues that can be overcome. You may need some time to get back on your feet, and a call or letter to creditors can let them know that you have a plan to repay them, but need some relief now so you can get there.
If they won’t renegotiate credit terms, tell them that you might have to declare bankruptcy. They would then have to get in line with other creditors for your money, and that’s likely a scenario they don’t want to deal with.