What is Debt Relief?
Debt relief is defined as the process of complete or partial forgiveness of the debt taken by individuals, corporates or nations which is mainly aimed to stop the debt growth or slowing of it from shooting to a bigger number and mainly involves restricting the debt to provide relaxation to the debt taker.
Debt relief primarily occurs when there is certain relaxation provided on the debt taken by one by the creditor since the debt taker is in no position to repay the complete debt or the partial debt taken. This program has many disadvantages too over the advantage that it provides an option to the debt taker to pay a lesser amount than what was agreed to be paid. Generally, there are also debt settlement or relief companies available.
They are the ones who negotiate with the creditors to permit the debt seeker to pay a lesser amount in one go which is paid by the debt relief company and then the debt seeker pays the third-party company via monthly payments. This can sometimes be asking the lender to reduce the rate of interest or monthly payments or reduce the actual amount of debt owed or like extending the repayment tenure of the loan or debt.
Types of Debt Relief
#1 – Debt Consolidation
This involves collecting all the unsecured debts and collating them in a one-time monthly payment mode. Based on a good credit score both the interest rate of payment and the monthly payment can be reduced.
#2 – Debt Management
This is a case where the debt seeker works with a non-profit credit counseling agency which basically aims to lower the interest rate of payment and the payment to be made monthly based on the affordability of the debt seeker. The credit score here is not a factor that the counseling agency considers.
#3 – Debt Settlement
Here too a company will enter a negotiating term with the lenders to reduce the debt burden than what was owed. Lenders are not obligated here to pay the promised amount but entering this sort of agreement damages the credit score of the debt seeker for seven years.
#4 – Credit Counselling
Counselors from the non-profit organization will join this program to work upon a budget plan which works upon the utilization of money flow i.e. where it goes and where it comes from and curtailing the points where the money is spent excessively.
#5 – Bankruptcy
This can be the last resort when all the other mentioned four types of programs fail. If the timeline to repay the debt go beyond a longer timeframe like more than 5 years, bankruptcy can be a choice to start fresh and prevent oneself from making the same old mistakes.
How Does Debt Relief Work?
- These programs are primarily aimed at providing relaxation to the debt taker during crisis time when the debt taker is finding it tough to repay back the debt taken. This can be in various forms depending upon the situation. Some may hire an external third-party company that acts as a counseling house and becomes an intermediary between the creditor and the debt taker and who further negotiates on the payment terms.
- Sometimes the best solution is like the reduction of the rate of interest or the monthly amount to be paid. Sometimes it asks the creditors to drastically reduce the total amount of sum owed. Sometimes it may ask the creditor to increase the number of years which we also call the repayment term.
- A very common example of debt relief can be stated as credit card debts. It is seen suppose a person has taken a debt via credit card for a sum of $5000 and due to a crisis he/she is unable to repay the debt after some of the points of time so the credit card company starts charging the person extra cost in the form of interest on the credit card. The amount because of non-payment after few years stands to be $10,000.
- To offer relief, the credit card company may sell the account receivablesAccount ReceivablesAccounts receivables refer to the amount due on the customers for the credit sales of the products or services made by the company to them. It appears as a current asset in the corporate balance sheet. which here is the case of credit card payment to another company. The other company enters a negotiation with the part of the debt seeker to restructure the debt owed and thus write off a portion of the actual debt and agree with the lender or of debt to get back paid a certain amount. This will offer some relaxation to the debt taker but on the other hand, this impacts the credit score the debt seeker too.
As discussed above there is a total of five options of debt relief which includes consumer debt counseling, debt settlement, debt management, debt consolidationDebt ConsolidationDebt consolidation is a process which streamline several loans into a single one to receive the benefit of a lower interest rate. The reduced periodic payment leads to a reduction in liability. and finally when none of the four works the individual or the company needs to file for bankruptcy and start fresh from scratch without repeating same old mistakes. The affected person or company either can pay the debt on his own by agreement with some debt restructuringDebt RestructuringDebt restructuring is a refinancing process whereby the company facing cash flow issues arranges with lenders to renegotiate favourable or flexible terms, saving themselves from bankruptcy. The lenders may choose to lower the business rate or increase the time limit for paying the interest and principal amount. with the lender or involve a debt counseling company that negotiates with the lenders to reduce the debt or the rate of interest and instead charges certain fees.
- Repayment of debt is made with a low rate of interest or sum paid repaid back is lower than what the actual amount was owed to the creditor
- The debt can be repaid quickly in a short span of time usually in 2-4 years under a good debt settlement program.
- It prevents an individual or a company to fall in a debt trap wherein the pressure of paying a debt, more debts are taken to pay the previous debt owed and thus soon or later the debt figures become a huge amount.
- As mentioned above there are 4 types of debt relief before we finally move into the last type which is bankruptcy. Thus, the program is typically aimed to protect an individual or business from getting bankrupt.
- The main disadvantage of debt relief is that though some part of the debt is written off, this also comes with the lowering of the credit score. The late payments of the written-off amountWritten-off AmountWrite off is the reduction in the value of the assets that were present in the books of accounts of the company on a particular period of time and are recorded as the accounting expense against the payment not received or the losses on the assets. are recorded at the credit rating agency and thus the credit score is reduced.
- This program comes with a lot of hidden fees and charges which need to be paid to the debt relief companies which may at times be of a higher amount.
- If the amount we settle or we are forgiven is more than $600, this is treated as taxable income and we must pay tax on it.
- The creditor can file a debt collection lawsuit against the debt seeker.
- There is no guarantee lender will be obligated to accept the offer of settlement. Some lenders don’t like working with debt relief companies and thus the debt seeker will be fined with more late charges and penalties on the existing debt.
Debt relief has more disadvantages than just advantages when brought into practice. It is very important for a company to have a properly balanced debt which is capable to repay it for on a timely basis. These programs are good when there is absolutely no option left for the company to pay its debt and this prevents the company from going totally bankrupt.
This has been a guide to What is Debt Relief & its Definition. Here we discuss the types of debt relief and how does it work along with examples, advantages, and disadvantages. You can learn more about from the following articles –