Is debt resolution a good idea?

Life’s curve balls aren’t an “if.” They’re a “when.” Even if you had every intention of repaying your debts, circumstances change. Financial hardships happen, and when they do, there are a handful of strategies for knocking down your debt, even if you can’t afford to pay it back in full. 

Let’s look at whether debt resolution is a good idea, and whether it can help you.  

What is debt resolution?

Debt resolution—or settling your debts—involves asking creditors to accept less than what you owe to clear a debt. For example, say that you owe $5,000 on one of your credit card accounts. You could ask the credit card issuer to accept $3,500 instead. If the creditor agrees, then the other $1,500 in debt is forgiven and the debt is resolved.

Creditors want you to pay what you owe, but they may be willing to give you some leeway if they believe that you can’t afford to fully repay the debt.

When is debt resolution a good idea?

Debt resolution can be a good idea if you truly can’t afford to pay off your debts in full. It could be the right strategy if you are experiencing a significant financial hardship—such as a medical emergency, a major unexpected expense, divorce, or the loss of a primary breadwinner.

Types of debt resolution

There are two ways to resolve debt. You can do it yourself (DIY) or work with a professional debt resolution company. 

Do-it-yourself debt resolution

With the DIY method, you contact each of your creditors, explain your situation, and make an offer. You can do this with unsecured debts like credit cards or medical bills. It doesn’t work with secured debts like auto loans and mortgages because those are guaranteed by something valuable that can be sold to pay the debt. 

The creditor can review your offer and either agree, make a counteroffer, or reject it. If the creditor takes you up on your offer, then you'd pay the agreed-upon amount, and the debt is resolved. You can settle a debt with a one-time lump sum, or a series of payments that your creditor agrees to.  

DIY debt resolution can be time-consuming and nerve-wracking. It may take some back and forth to work out an agreement. Letting a debt resolution company advocate on your behalf can eliminate a lot of the stress. 

Work with a debt resolution company

Here's how a professional debt resolution program works. 

• You tell the debt resolution company which debts you want to include. 

• Each month, you make a regular deposit into a Dedicated Account. This builds up money the debt resolution company can use to make offers to your creditors.

• The debt resolution company negotiates with your creditors for you.

• When an agreement is reached with a creditor, the debt resolution company will ask for your approval. Once you agree to it and authorize payment, the creditor gets paid using the money in your Dedicated Account, and your debt is resolved. The debt resolution company’s fee is then paid from the same account.

• Once all the debts you included in the program have been resolved, your program is complete—and your debt is behind you.

There's a lot less hassle, and it’s less scary than dealing with creditors directly. Also, a reputable debt resolution company has experience working with most creditors and may be able to get you a better outcome than you can get for yourself.  

Debt resolution benefits

Debt resolution can benefit you in more ways than one. The most obvious advantage is that you could reduce what you owe. Depending on how much you owe and what your creditors are willing to agree to, you could save a lot of money. 

Resolving debt could help you pay off what you owe faster. Instead of spending years making minimum monthly payments, you could resolve your debts in two to four years. 

A professional debt resolution program could improve your cash flow. The amount you contribute to your Dedicated Account each month is typically lower than your monthly minimum payments to creditors—so you could have more money on hand each month to pay for essentials or build your savings.

Reputable debt resolution companies don’t charge upfront fees. They aren’t legally allowed to. You shouldn’t pay a fee until after the debt resolution expert works out an agreement with your creditor, you approve it, and at least one payment is made toward satisfying that agreement.

Bottom line, working to resolve debts can give you some breathing room financially. And you might sleep better at night knowing that you're getting closer to debt freedom. 

Disadvantages of debt resolution

Like any solution, debt resolution has its pros and cons. Here are some things to keep in mind when you consider debt resolution. 

For one thing, creditors don't have to participate. If you've got a particularly stubborn creditor, then you might not be able to get rid of the debt this way. In a worst-case scenario, some creditors may try legal tactics to try to get you to repay your debt in full. The creditor might sue you and ask a judge for access to your wages or bank account. A reputable debt resolution company may be able to provide or refer you to legal support if a creditor takes legal action so that an attorney can negotiate the debt.

Debt resolution might impact your credit. Typically, creditors aren't willing to negotiate unless you've fallen behind on payments. If you're several months late on bills or even in default, then the damage is already done. But if you stop making payments when you start a debt resolution program, you can expect a negative impact on your credit profile. 

The last potential drawback to be aware of is that for some people, the IRS will treat the forgiven debt as income, and you’ll have to pay taxes on it. This is only true if your assets are worth more than your debts. If not, you’re insolvent (your debts are worth more than your assets), and you won’t owe income taxes on the forgiven amounts. Talk to a tax professional about your specific situation.

Other ways to get rid of debt

Debt resolution isn't the only way to get rid of medical bills or pay off credit cards or other debts. If you're looking for some alternatives, you might consider a debt management plan, a debt consolidation loan, or even bankruptcy. 

A debt management plan allows you to consolidate debts without a loan. This may be a good option to consider if you can pay off your debts in full with assistance from lower interest rates. You make one monthly payment to your plan, which is managed by a credit counseling agency. The agency then spreads the payment among your creditors. Your payment plan will be set up to pay off your debts in full, so the amount can be high. 

The agency may be able to negotiate with your creditors to lower your interest rates and waive some fees. You’ll probably have to agree not to use credit while you’re in the plan, and you could be dropped from the program if you miss a payment.

A debt consolidation loan is a new loan that pays off one or more other debts. It’s a possible option if your credit is good and you have the self-discipline to use the lower interest rates to make headway against your debts. A common pitfall, for example, is to pay off credit cards with a consolidation loan and the run the credit card balances back up again. 

Debt consolidation loans move your debt—they don’t reduce it. They can be a good strategy if you can afford to repay your debts in full, but reorganizing it would help you. You might reduce the number of bills you pay each month, get more time to pay, or lower the cost of your debt. (A debt consolidation loan doesn’t make sense unless you can qualify for an interest rate that’s lower than what you’re currently paying on your debts.)

You could consider a personal loan or a home equity loan to consolidate many kinds of debt, including credit cards, medical bills, and other loans.

Bankruptcy can help you get rid of debts completely, but there's more than one catch—bankruptcy can be complicated and isn’t always successful. 

Not everyone qualifies for Chapter 7, the kind of bankruptcy that lets you walk away from debts. For those who file Chapter 13, the bankruptcy that lets you make payments for 3 to 5 years, the success rate is low. It’s possible to file for Chapter 13 bankruptcy and end up financially worse off than you were when you started because you’ll pay attorney fees and court fees but you might not save any money on your debts.

When you’re in overwhelming debt, review all of your options because one might be a better fit than another. If you have serious debt, the most important thing is to deal with it. Get a free debt evaluation. The sooner you do, the sooner you can get your finances—and your life—moving in the right direction.