Debt relief programs can provide a path toward financial freedom, but not all plans are created equal. Debt consolidation, debt settlement, debt management and bankruptcy are all pathways to relieving debt, but each option impacts your credit score differently.

Types of Debt Relief Approaches & Programs

Before choosing a debt relief program, it’s important to learn about each option, and what it could mean for the future of your credit.

Debt consolidation

The debt consolidation process involves combining two or more loans to pay off debts. Most types of debt can be consolidated including student loans, personal loans, mortgages, credit cards and vehicle loans. Not only is the number of payments reduced, but consolidating high-interest debts to lower-interest loans or credit cards can reduce the total amount paid.

Credit score impact: Consolidating your debts will pay off all the cards and loans included in the combined loan. As a result, you may see a boost to your credit score, so long as you don’t use your credit cards for fresh spending. On the other hand, opening a new loan or credit line can cause a temporary dip, but that can be improved quickly with smart credit use and paying off debts.

Debt settlement

Debt settlement is considered a higher-risk debt relief method. It centers on the debtor accumulating a designated amount of money, which a debt settlement company uses to negotiate a lower lump-sum payment to be paid in full.

Credit score impact: Debt settlement companies often advise their clients to stop paying creditors. Missing payments profoundly impacts credit scores — causing a significant drop — and makes it difficult to obtain a home loan, an auto loan and even new employment.

Debt management

A debt management plan (DMP) can reduce the length of time it takes to repay credit card debt and save money by reducing the amount of interest you pay. Participants receive ongoing education to develop effective spending habits, budget to meet living expenses, manage debt and save for the future.

Credit score impact: Since DMPs are not reported to credit bureaus, credit scores are not affected. This makes DMPs beneficial for anyone with large amounts of credit card debt to pay off. The only instance in which your credit score may initially dip is when certain credit cards are closed.

Bankruptcy

Chapter 7 bankruptcy enables consumers to be released from unsecured debt and Chapter 13 bankruptcy allows consumers to pay debt back on a longer timeline. As a debt relief option, bankruptcy should be considered as a last resort. It can be a long and arduous process, with long-term negative consequences. Before filing for bankruptcy, the federal government requires two online courses to be completed: pre-filing and post-filing. These courses detail all available options and further explain the bankruptcy process.

Credit score impact: Bankruptcy debt relief inflicts the most damage to your credit score. Chapter 7 bankruptcies can impact credit scores up to seven years and Chapter 13 for 10 years. It’s also important to note that credit scores can be negatively affected by as much as 200 points from filing bankruptcy. A bankruptcy discharge — while eliminating debt — does not prevent certain creditors from repossessing property (ex: a home or vehicle).

Considerations Before a Debt Relief Solution is Settled Upon

Other things to think about when choosing the right debt relief program include:

• Understanding the full terms and conditions of the plan (sometimes there are fees and specific requirements involved).
• Considering past payment history and credit utilization — it’s important to think about what has worked in terms of payments (or not) in the past and what will work realistically moving forward to resolve debt.

Determining which debt relief option to select may feel overwhelming, but a free and confidential credit counseling session can help provide insight into which pathway is right for you.