Debt Management: Which Program is Best for me?

person managing debt

Outstanding card debt has hit $1 trillion, and 86 percent of card debtors regret it. So, if you’re looking at charging some major medical bills, student loans, or even your taxes -- think again.

Because if you’re unable to pay your credit card off in full by the end of the month, you’re making your debt worse.

Here’s why.

Credit cards have double-digit interest rates tied to them, often between 16 and 24 percent APR (Annual Percentage Rate). By putting large charges on your credit card and not paying on time, you’re compounding your interest which costs you more money in the long run.

Don’t let debt, especially high-interest debts, get the best of your finances. There are debt management programs that can help you with living debt free.

Debt consolidation

Instead of charging more bills or expenses to your card, you can take charge of your spending and look to consolidate debt. With debt consolidation, you are moving high-interest debts into a new, lower rate mortgage. At the time of this article’s publication, mortgage rates are in the mid 4’s — much less than your double-digit credit card rate, which can save you thousands in the long run. Plus, your monthly payments are far more affordable, and there’s no damage to your credit.

Another debt consolidation benefit is you’re able to combine multiple debts into one payment. Focusing on one payment can eliminate the potential for late charges if you forget to pay one of your many bills.

Cash-out refinance  

You can also look into a cash-out refinance, which again puts you into a new loan. As the product name suggests, you can cash-out your mortgage. And in this particular solution, even though you collect cash, there’s no income tax to worry about.

It works like this: you refinance for more than you owe. If you owe $200,000 on your home, but it appraises for $275,000 — you have $75,000 in home equity. Most loan programs will allow you to access up to 80% or in this case $20,000, which can be distributed as cash. That cash can be used to pay off significant debts that have not yet hit your card, or they can even pay off your credit card. A bonus of paying off your card right away — you can improve your credit score since you are reducing your credit utilization ratio (the available credit you use).

Just keep in mind, you must have equity built up in your house to use a cash-out refinance.

First Lien HELOC (Home Equity Line of Credit)

A First Lien HELOC can allow you access to your home equity without having to refinance, assuming you are in good credit standing. It’s a solution for people who manage debt well but may have experienced an unexpected medical procedure or a similar unplanned expense that they’d like to pay off immediately.

It’s a great debt management option because it also helps households by eliminating tens or possibly hundreds of thousands of dollars in excessive mortgage interest payments. Though it doesn’t require immediate payback or resolution, mortgage interest can often be a problematic debt to pay down.

This solution truly leverages a borrower’s ability to budget and maximizes their wealth building to secure a bright financial future.

Debt settlement

Another debt management plan is hiring a company to negotiate or settle your debt so that you can pay a reduced amount. This solution is specific to unsecured debt, like credit cards or personal loans. It will not help you with your house or car debts since they can be foreclosed or repossessed. It’s also not for federal student loans. But if you have significant credit card debt, it may be an option for you.

You’ll likely be advised to stop making monthly payments until the settlement company can convince the creditor to accept a negotiated, reduced amount. Sounds incredible, right?

No, no it’s not. It’s not incredible because those missed payments are going to damage your credit score, which can result in higher interest rates on future loans and credit cards. You may not realize it right away, but you’ll be charged fees for that debt settlement service, often around 25%. And, let’s not forget the tax implications. The IRS considers any forgiven debt over $600 as income. So, if you had $15,000 forgiven, you’ll pay taxes on that amount, which will likely be around $5,000.

Those long-term effects do not make the short term relief attractive. The Consumer Financial Protection Bureau (CFPB) encourages consumers to explore other options first, stating debt settlement is risky. There have been over 330 complaints (mostly fraud and excessive fees) to the CFPB since 2014.

Chapter 13 bankruptcy

Chapter 13 bankruptcy is for people who make enough income to repay part or all of their debts, but cannot make immediate payments. Meaning, they can overcome their deficit, but not right away. It often includes a settlement plan with a designated time frame to repay debt, generally three to five years.

If student loans are the majority of your debt, don’t consider Chapter 13 bankruptcy as your debt management plan. It’s not an option.  It only applies to unsecured debt (again, we’re talking about credit cards or personal loans), so long as that debt does not surpass $394,725 (as reported by debt.org). It’s an option primarily used by applicants to eliminate unsecured debts while catching up on missed mortgage payments. And it almost always results in the debtor having a difficult time borrowing money in the future. Be sure to consult a bankruptcy attorney before moving forward with this option.

No matter what debt management program you choose to try, it’s important to remember that your spending habits also need to change. Otherwise, you can easily fall right back into debt. Work with a financial planner to go over your current debt and to discuss these (and other) options. If a debt management solution is the suggested next step, be sure to give one of our salary-based mortgage consultants a call.