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Guest Post by Lyle Solomon Most of us will incur debt at least once in our lifetime, be it student loans, mortgage, or credit card debt. Depending on your financial situation, debt can be good or bad. However, all debts are not the same, therefore managing these debts is not the same. Mainly, there are two types of debt: secured and unsecured debt, with other subtypes of debt coming under each or both. It's essential to understand how each kind of debt works, if you'll be able to manage it along with the rest of your obligations, and how it can affect you. What is debt? Debt is defined as something, usually, money, loaned from one party by another. Many corporations and individuals use debt to make large purchases that they would not be able to make under normal circumstances. A debt agreement allows the borrowing party to borrow money on the condition that it be paid back later, generally with interest. Let's understand the different types of debt: Secured debt A secured loan is one backed by tangible assets. A credit check is essential to obtain a secured loan since it determines the borrower's repayment capabilities. If the borrower doesn't pay back the loan, the lender is protected by collateralized assets. The property can be seized by the lender if a loan is not repaid on time. If the confiscated collateral does not pay the entire debt, the creditor can sue you to reclaim the remaining amounts. Secured loans can help you acquire a large loan. The lenders know they will be paid back because of the collateral. Secured loans offer lower risks for lenders than unsecured loans, so you may be able to acquire a low-interest rate. Examples of secured debts: Mortgage Home Equity Line of Credit (HELOC) Installment loan Car financing Revolving credit Unsecured loans Unsecured loans are loans that you can get without any collateral. Loans without collateral are made solely based on a borrower's ability to repay and their promise to do so. In an unsecured loan, you don't have the risk of losing any of your assets. Lenders review a person's credit record to see if they qualify for a loan. But not all debts are equal. Lenders analyze your payment history, current debts, credit scores, total income, debt-to-income ratio, etc. In general, a higher credit score means more options. A good credit score can earn you a low-interest loan. As a result, unsecured loans are granted faster than secured loans. However, it may be challenging to get approved if you don't have a good credit score or credit history. Even if you get approved, you might get a higher interest rate. Examples of unsecured loans: Most credit cards Student loans Personal loans Payday loans Medical bills Installment loans Revolving credit Debts that are both secured and unsecured A few debts fall under both secured and unsecured loan categories. These loans are referred to by different names in each major category. Revolving debt Revolving debts are open lines of credit. Here, you borrow up to a certain amount, also known as a credit limit. You can keep borrowing from that line of credit as long as you make the minimum monthly payments. The best example of an unsecured line of credit is a credit card, and a secured loan is a home equity line of credit. Installment debt When a loan is paid back in regular installments, it is called an installment debt. Payments are usually made in equal monthly installments, with one part being interest and the other part being the principal amount. As this is also known as an amortized loan, the lender must create an amortization schedule outlining the payments made over the life of the loan. Customers prefer installment loans for bigger purchases such as homes, cars, and electronics. Lenders like installment debt because it provides a consistent flow of cash to the issuer over the life of the loan, with monthly installments based on a predetermined amortization schedule. Best ways to handle debt A single debt might be intimidating, but having many debts can be even more stressful. Debt management can become a challenge if there is no understanding or planning in place. Budgeting and debt management to pay off debt can be done in various ways. Let's explore a few of them: Budgeting If you have a favorable debt-to-income ratio, budgeting may help you better manage your debts. The best way to make a budget is by dividing your income into three portions: 50% of your income is for your needs. Rent/mortgage, car loan payment, insurance, health care, groceries, debt payments, and utilities fall into your "need" category; these are your essentials. This category may also include your "must-haves" like Netflix, takeout, coffee from Starbucks, indulgences, etc. 30% of your income is for your wants. Your wants or non-essentials include going out to eat, seeing a movie or sporting event, taking a trip, purchasing a newly released device, purchasing designer clothing and shoes, or joining a gym. Even though they are wants, you are not dependent on them. 20% of your income is for your savings. This last 20% of your income goes into your emergency fund, mutual funds, IRA contributions, investments, etc. This portion of your money helps you build more money. Debt consolidation When you are stuck with multiple debts and don't know how to manage all of them, debt consolidation is your friend. Debt consolidation uses numerous forms of financing to pay off your debts and liabilities, such as taking out a new loan to pay off existing debts. Multiple debts are frequently combined into a single larger debt, such as a personal loan, with more desirable repayment terms, such as a lower interest rate, a lower monthly payment, or both. You can consolidate credit card debt, student loan debt, payday loan debt, mortgage payments, etc. You can do debt consolidation through any of the following options: Balance transfer card Debt consolidation loan Debt consolidation program Debt management A debt management plan can be useful to help you pay off your debt. A debt management plan's goal is to reduce the debt's interest rate and monthly payment amount, as well as to assist you in creating a budget to accommodate the payments. You can receive debt management plans from non-profit or for-profit credit counselors. Credit counselors work on your behalf to negotiate lower interest rates and lower monthly payments with your creditors. A debt management strategy is often a component of a larger debt reduction strategy, such as a debt consolidation strategy. Three cardinal rules to follow when repaying debt Never be late on your payments Do not miss any payments Always pay a little bit more than the monthly payment amount The bottom line Knowing and understanding the different types of debt can help you manage your finances better in the long run. You have a choice: either you let your money control you, or you take charge of your financial situation and manage it effectively. The main distinction you have to figure out is which debt suits you best. You should always do research and have a plan to handle the debt before you sign the dotted line. Lyle Solomon has extensive legal experience as well as in-depth knowledge and experience in consumer finance and writing. He has been a member of the California State Bar since 2003. He graduated from the University of the Pacific's McGeorge School of Law in Sacramento, California, in 1998, and currently works for the Oak View Law Group in California as a principal attorney.
Guest Post by Orlando Rodríguez DISCLAIMER: The information provided in this article does not, and is not intended to be, legal, financial or credit advice; instead, it is for general informational purposes only. Debt settlement is when creditors or collection companies agree to clear a debt for less than you owe. It sounds simple in principle — and very convenient — but is it a money-saving tactic or a credit trap? What are the risks of debt settlement, and what are the alternatives? If you’re confused by debt settlement, you’re in the right place. In this brief guide, we’ll explore what the term means, and how it can affect your credit. What is debt settlement? When you settle a debt, you pay your creditor or a collection agency less than you owe, including existing interest and fees. Debt settlements are usually lump-sum payments, though some organizations allow consumers to set up payment plans instead. Debt settlement pros include: Reduced pressure from creditors A fresh financial start The chance to avoid bankruptcy The risks of debt settlement include: Serious credit damage Unexpected tax bills Extra fees and penalties Before you negotiate with a creditor or collection agency, think seriously about your options. Don’t make any decisions until you know what you’re up against. What are the advantages of debt settlement? We touched on the advantages of debt settlement briefly above. Now, let’s look at each plus point in a little more detail. Reduced financial pressure Debt can feel like a crushing weight. Constant calls from creditors and collection agencies cause anxiety, and the guilt associated with outstanding debt can lead to mental health issues. Perhaps unsurprisingly, getting rid of a debt can bring emotional relief. A fresh start If you currently pay a lot of money toward your debts every month, opting for debt settlement could help you find financial balance in the long term. Debt settlement offers don’t appear by magic — it takes a while before creditors begin to negotiate — but they’re a quicker route to a debt-free status than minimum payments. After you eliminate your debts, you can start again. That’s perhaps the biggest debt settlement plus. No bankruptcy Debt settlement can help you avoid bankruptcy. If you have assets you’d rather not part with, or you’re worried about the impact personal insolvency might have on your small business, you could be better off settling your debts than filing for Chapter 7 bankruptcy. If you’re hovering between bankruptcy and debt settlement, consult with a financial professional to find the best option for you. What are the negative effects of debt settlement? It’s wonderful to imagine a fresh start—an end to overwhelming monthly payments and the shame associated with unmanageable debt. There are downsides to debt settlement, however. Serious credit damage When you settle a debt for less than you owe, it makes a negative impact on your credit report. When you negotiate settlement terms and your original contract with the lender is modified, you’ll damage your payment history and your credit score will go down. Unless you’re able to negotiate to have them removed, delinquent payments and collection accounts will stay on your report for seven years—even if you settle. The impact on your credit score depends on the terms of the settlement and how it’s reported on your account. Unexpected tax implications Many people are surprised by the tax implications of debt settlement. When you settle a debt for less than you owe, part of it is written off—and the IRS sometimes considers the forgiven portion taxable income. On the face of it, that doesn’t seem fair—after all, you didn’t physically receive the forgiven portion of your debt. Nevertheless, you may need to report that amount to the IRS and if applicable, pay taxes on it. The tax-related rules that apply to debt forgiveness are pretty complex. To find out where you stand, ask an accountant or a financial advisor before settling debt. Extra fees and penalties Debt settlement strategies take time to come to fruition. While you wait for an opportunity to negotiate, your unpaid debts will accrue interest and fees. Sometimes, collection agencies charge additional recovery fees, which they apply when they agree to a settlement. If you agree to the settlement amount, if part of your agreement, you’ll also need to pay those fees. What are some alternatives to debt settlement? Not sure debt settlement is right for you? In that case, consider these alternatives: Renegotiation — Ask your creditors for an interest rate reduction, or talk to them about reducing monthly payments. Debt consolidation — Consolidating your credit cards and loans into one single lower monthly payment can greatly reduce the amount you spend on debt every month. Credit counseling — If you have trouble creating a workable budget and need help figuring out your finances, speak to a credit counselor or financial advisor. A debt management plan — Under the terms of a DMP, you make payments to reduce the amount you owe to all your creditors at once. Chapter 13 bankruptcy —Your finances get reorganized and you make court-mandated payments for a set amount of time after you file for Chapter 13 bankruptcy. Chapter 7 bankruptcy — Chapter 7 bankruptcy wipes the slate clean—but it’ll be difficult to obtain credit for a while, and the bankruptcy will stay on your record for 10 years. Bankruptcy is arguably the most extreme solution to debt. Consumers who opt for Chapter 7 bankruptcies have to liquidate many of their assets before they’re deemed debt free. Under the terms of Chapter 13 bankruptcies, people are allowed to keep some of their assets. Chapter 13 is safer if you own your own home or have valuable possessions you want to pass on. Speak to an experienced financial advisor and consult with a bankruptcy lawyer before choosing voluntary insolvency. How do you settle a debt? If you decide to proceed with a debt settlement strategy, you can take a DIY approach or work with a debt settlement company. Let’s review both options. The DIY route Creditors are unlikely to negotiate with you if they believe you can continue to make monthly payments or that you can pay the debt in full. To move into debt settlement territory, it’s best if your accounts are already delinquent by at least 90 days. If you want to continue missing payments while negotiating, know that there are serious credit-related ramifications associated with terminating payment in this way. So, consider keeping up with payments while at the same time building a lump sum to pay off the debt. Before you quit paying, talk to your creditors about reducing monthly payments. If you do stop paying your loan or credit card bill, late charges and fees will accrue and your credit score will drop. So, if you go the DIY route, know what you can and can’t afford to do, and find an agreement with the creditor that works best for your situation. Note: Remember, your credit score will drop dramatically if you stop paying your debts, so you’ll find it very difficult to obtain a loan or a credit card—possibly for years. A settlement company If you have a lot of debts to settle and haven’t been able to negotiate with your creditors independently, a settlement company can help take the pressure off. Settlement companies negotiate with your creditors on your behalf, reducing the amount of direct contact you have with the companies you owe money to. Settlement companies usually charge fees. So, it’s important to factor those into your payment estimates. On the flip side, they can help you recover a sense of financial stability and may also provide budgeting advice. Note: It’s hard to define what percentage of a debt is typically accepted in a settlement. Some companies won’t take less than 70 percent of what you owe, while others will go as low as 30 percent. Is debt settlement really worth it? In short, debt settlement is sometimes worth it if you can’t afford to pay off what you owe in full. If the risks of bankruptcy outweigh the benefits for you, and if you feel trapped under a mountain of debt, a settlement offer might bring peace of mind. If you decide to settle one or more of your debts, seek advice from a qualified tax professional about tax implications. Draft a savings plan to ensure you have the money to pay any taxes you owe at the end of the year, and create a solid budget to keep your finances on the level in the future. Finally, check out credit repair options, some of which could help you rebuild a solid credit profile. Orlando Rodríguez is a writer and content specialist for the Credit.com team dedicated to creating helpful, informative and eye-catching content. He completed his undergraduate work at the University of Utah focusing on Film and Media Arts. He’s written blogs and journalistic content for many different industries, and narrowed down his niche to the financial industry. In his off time, Orlando puts effort into crafting creative content around the arts.