4 Ways to Get Out of Debt, Which Is Right for You?

erase debt

Half of all U.S. households carry credit card debt from month to month. At least 37 million Americans have student loan debt. A single significant event – like a layoff or a medical emergency – can bring a person to the brink of bankruptcy or beyond. Countless others simply get into debt over their heads and find that repayment is overwhelming and might last forever. Is it possible to erase debt and start over? Yes and no. A consumer who thinks he or she is unable to repay outstanding debt should understand what the options are for getting rid of it.

If you’re overwhelmed and trying to get out of debt, here are four options to help you determine which might work best for you.

Debt settlement

Debt settlement means a creditor – frequently a credit card company – agrees to take less than the amount owed, but calls the debt paid. You can negotiate a settlement yourself or through a debt settlement company (for a fee). Some debt settlement companies advertise that they can settle debt for 30 or 40 percent of its face value or even less. This may be true, but with a few caveats. First, the debt almost always has to be in default before a creditor will entertain a settlement offer, so the consumer’s credit score takes a hit before settlement is even an option.

Next, a company’s ability to settle the debt is never guaranteed. The debt settlement company will not attempt to settle the debt until the debtor saves an amount of money (in a designated account) sufficiently large enough for them to approach your creditor with a settlement offer. The debtor must deal with collection efforts – perhaps for years – and can be sued by creditors during the time it takes to accrue the funds needed for settlement.

The settled amount can be reported to the IRS as taxable income. Between the taxes and the debt settlement company’s fees, the consumer often pays as much as the original debt or close to it. Settled debt is reported as such to the credit agencies, and “settled” is a very significant derogatory item on a consumer’s credit report card.


Bankruptcy is legal protection from creditors. Bankruptcy law has changed over the last decade or so. If household income is low enough, a consumer can file for Chapter 7 bankruptcy. Non-exempt assets are liquidated and the proceeds given to creditors. The remaining eligible debts are forgiven. Under Chapter 13 bankruptcy, debts are repaid over time on a repayment plan approved by the court. Consumers file for Chapter 13 protection when they do not qualify for Chapter 7 or when they have assets they want to protect.

Bankruptcy can be the best option for consumers who have negative cash flow; their day-to-day financial obligations exceed their income. Bankruptcy is a significant negative mark on the consumer’s credit report.

Debt management

Debt management is an excellent option for many consumers who feel overwhelmed by debt.  It is typically facilitated by a certified credit counselor, often for free or for a very low fee. Under a debt management plan, creditors agree to reduce outstanding debt for a fixed period of time in order to help the debtor regain financial control. This might mean reducing the interest rate, as opposed to changing the actual balance owed. Payments are sent to the debt management plan agency, who distributes the money to creditors as agreed. When the debts are paid off (generally within three to five years), the creditors help  the consumer reestablish credit, usually via positive reporting to the credit bureaus (“paid as agreed” instead of “settled,” for example).

Debt management plans are tailored to the individual consumer’s budget, and are much less of a hit to a consumer’s credit score than either bankruptcy or debt settlement. Indeed, if the consumer has kept current with all debt payments, his or her credit may suffer very little during the crisis.

Student loan forgiveness

Relief from student loan debt is possible, but only if you meet certain criteria. Student loans are not subject to discharge in a bankruptcy, except under very rare circumstances. But they can be discharged under certain circumstances, such as if the borrower dies or becomes permanently disabled. Also, a balance can be discharged when the school closes and the borrower is unable to complete his or her education as a result, or when the loan was obtained fraudulently.

Some full-time teachers can have up to $17,500 of Direct or FFEL (but not Perkins) loan debt forgiven after five years of teaching. The loans must be no older than October 1, 1998.

Similarly, people who go into public service (are employed full time with a federal, state or local government agency, entity or organization or a non-profit that has been designated as tax-exempt by the IRS under Section 501(c)(3)) are eligible for forgiveness of their loan balance after ten years (Direct loans only). They must have made 120 regular, on-time payments and cannot be in default.

Other professions qualify for loan forgiveness on a sliding scale: Peace Corps volunteers, teachers, military serving in hostile areas, nurse or medical technician, law enforcement or corrections, Head Start worker, child or family services worker, early intervention service provider.

Direct, Direct PLUS and Direct Consolidation loan borrowers are now eligible for repayment plans that include forgiveness of any outstanding balance at the end of the repayment period. For example, under the income-contingent repayment plan, payments are calculated annually based on income, family size and loan balance. If the borrower pays as agreed under this plan for 25 years, the remaining balance is forgiven. Stafford and FFEL borrowers can enter into an income-based repayment plan that ends after ten years.

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Published April 9, 2014
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