It’s hard to believe how easily people can get themselves into credit card debt. Each year, thousands of Americans find themselves in financial situations they can’t afford. When you don’t have any money saved, you’re at the mercy of the interest rates charged by your creditors. Still, you don’t have to become another victim of this terrible debt trap. Here are five ways you can get out from under your past mistakes for less than what’s owed and the effects it will have on your credit.
1. Get A Debt Consolidation Loan
Getting a debt consolidation loan is an excellent way to reduce your debt obligations. Debt consolidation loans are fixed-rate loans that are used to pay off outstanding credit cards or loan balances. The goal is to stop paying multiple creditors with varying interest rates and streamline your debt pay-off to one monthly payment for a fixed amount of time. With a consolidation loan, you’ll still owe the principal amount of your debt but will be subjected to lower interest rates and will have a concrete deadline for when you’ll finally be debt-free.
A single hard pull from a debt consolidation loan will have little effect on your credit score unless you’ve had a significant number of additional pulls (five or more) done within the past three years. Your credit utilization ratio may increase, decrease, or not change at all, depending on how your new lender reports loans to the credit bureaus.
2. Transfer Your Credit Card Balances To A New Card
If you’re still in good enough standing with your credit history, you may qualify for a new credit card that has a promotional 0% APR and a small transfer fee (typically around 3 – 5% of the amount transferred). Once you’re approved, move as much of your outstanding debt as possible to the new card without going over your credit limit. Not only will you avoid the hefty interest rate your debt has been accruing, but you’ll have more time to get your debt under control without additional fees.
Your credit score might go down temporarily due to the hard pull for approval and while the balances transfer to the new card. Depending on how each company reports to the credit bureaus, it might look like you’ve doubled the amount of outstanding debt, which affects your credit utilization ratio. Once the balances are updated (typically within a month), your credit score will go back to normal or may even improve now that you have increased your total amount of credit.
3. Request A Debt Settlement
Debt settlement is a process of working with your creditor directly to find an amount that will remove your obligation to them by paying less than what’s owed. Your creditors will see this as a last resort before outsourcing your debt to a collections agency, so they’ll typically want terms that justify writing the rest of your balance off.
Requesting a debt settlement doesn’t guarantee your creditor will approve it, and you’ll need to have either a lump sum of money now or a willingness to stick to a stringent payment plan set on their terms until the debt is paid. You’ll need to show a period of financial hardship that includes missed payments to the lender and a documented record of how you got here (job loss, medical expenses, etc.)
You should expect a lowering of your credit score when using a debt settlement. Not only will there be a history of late payments, but your lender will notify the credit bureaus of an updated agreement due to your failure to maintain the terms of the original contract. However, the hit to your credit score won’t be as severe as the next two options, and you may still qualify for new credit or loans.
4. Wait For Your Debt To Go Into Collections
If you cannot make a debt settlement work and cannot keep up with making payments, your creditor may sell your debt to a collections agency. The collections agency will then assume responsibility for getting you to pay off your debts and are notorious for how aggressive they can be when trying to get a resolution.
Collections agencies buy your debt from creditors at a reduced rate, giving them some wiggle room with the amount you’ll owe. Suppose you’re able to make a lump-sum payment for a lesser amount than your total debt or a temporary regular ACH withdrawal for smaller recurring payments. If that’s the case, you might be able to walk away from the rest of your obligation.
Your credit score will take a big hit if your debt goes into collections. Not only will you get dinged for late payments, but your creditor will notify the bureaus that your debt has been transferred to a collections agency, which is a big deal. If for any reason, you’re unable to come to a resolution with the collections agency, you’ll see additional negative marks on your credit record. You can expect to not qualify for loans or new credit for a few years after your debt is considered paid in full but may be eligible for secured credit cards and loans.
5. Declare Bankruptcy
Bankruptcy is the last resort for anyone overwhelmed and unable to pay their debts. You’ll go in front of a judge and show documentation for why you’ve gotten into this situation. You don’t necessarily need to indicate an event that created financial hardship like a job loss, but if you have a good reason, your chances of getting a judge to approve your bankruptcy request will be higher.
During bankruptcy, your assets are sold to pay off whatever debt they can, and the remaining debt will either be absolved or put into a strict pay-off plan, depending on the type of bankruptcy you’ve filed.
Your credit score will be significantly impacted as bankruptcy is often the culmination of attempts to resolve your outstanding debt. You can expect to see negative marks for late payments, collections, and any approved debt settlements, in addition to a negative mark for having to file bankruptcy. Bankruptcies will typically fall off your credit history within a decade, and you may qualify for new credit during this time. Still, you will normally only see offers for secured lines of credit until you build a history of responsible usage back up.
The Bottom Line
Whether you’re seeking a consolidation loan, a settlement, relief through collections or bankruptcy, or a balance transfer, the best thing to do is start now. The sooner you’re proactive with getting your debt under control, the better chance you’ll have to become debt-free.