Debt Settlement Alternatives

Debt settlement allows you to resolve debts by paying less than the full balance. Creditors will often settle delinquent debts instead of selling the accounts to collection agencies. Generally, creditors will settle for around half the balance, resulting in a significant savings for you. However debt settlement can hurt your credit score and create tax problems, as the IRS treats the amount you saved as income. These are among the reasons some people seek alternatives.

Hardship Plans

Many credit card companies and other creditors offer so-called hardship plans. The plans give you time to recover from a financial setback by temporarily reducing your interest rate and monthly payment amount. You must qualify for the program by explaining your financial setback. If a hardship plan is offered, finance charges could be waived for up to one year, and your monthly minimum payment could be reduced to as low as 1 percent of the balance. Many people see hardship plans as a viable alternative to debt settlement because it does not harm their credit and provides the satisfaction of trying to pay off a debt rather than avoiding some of it through settlement.

Debt Management Plans

Debt management plans are similar to hardship plans. The difference is that debt management plans are typically directed by nonprofit credit counseling agencies, such as those affiliated with the Consumer Credit Counseling Service. The agencies ask you to commit to a four-year plan, during which time you will be kept on a strict budget.

You'll send one check each month to the agency for all your debts, and the agency will make individual payments to your creditors. The agency will seek better terms from your creditor, including smaller monthly payments, lower interest rates and a reduction of your balances through the waiving of some finance charges. During the four years, you're not allowed to use credit, with a goal of emerging from the program with much of your unsecured debt eliminated or greatly reduced.

Bankruptcy

Bankruptcy is the most extreme alternative to debt settlement. Chapter 7 bankruptcy allows you to eliminate credit card and other secured debt in about four months. Chapter 13 bankruptcy requires a five-year payment plan based on your income and living expenses. You'll pay as much as you can toward your debts over the five years, and any remaining unsecured debt will be discharged, or eliminated, at the end of the term.

There are strict income limits on filing for Chapter 7. The limits vary by state, but generally only those people with low incomes will qualify. Those who don't qualify can opt for Chapter 13.