Debt settlement is the process of negotiating with your creditors to try to agree on a reduced payoff amount. You can do this yourself, or you can hire a third-party company to do it for you. There are some potential benefits to doing this, but there are also some risks involved. One big risk is that your credit score will almost certainly take a hit.
How does debt settlement work? 6 things to watch out for
What is debt settlement?
Debt settlement is an agreement between you and your creditor to pay off your debts for less than the full amount owed.
There are many ways to get out of debt, but not all of them are good for your financial health. One option is known as “debt settlement” or “debt adjustment,” which is when you work with a third-party company to lower your payments. However, not all lenders accept this method, and it can actually do more harm than good in some cases.
What is a debt settlement company?
Debt settlement companies offer services to help reduce or eliminate debt. They act as intermediaries between borrowers and lenders, negotiating on behalf of the borrower to try and get more favorable terms. This can be helpful for people who are struggling with debt and need assistance dealing with creditors.
There are a few things to keep in mind before you work with a debt settlement company. First, make sure you understand the process and terms offered by different companies. It’s important to do your research and read reviews to find a reputable company that fits your needs.
Debt settlement: how does it work?
Are your bills starting to pile up? Are creditors calling day and night? There’s no need to panic. While it may not be easy, it is possible to settle your debt on your own. The first step is to reach out to your creditors and explain your financial situation. It will take time and persistence, but with a little effort, it may be possible to lower the amount owed, change the interest rate, or come to some other form of agreement.
There are pros and cons to using a third-party company or lawyer to help you settle your debt. On the one hand, you will have to pay for their services either as a flat fee or as a percentage of your savings. On the other hand, this could save you money in the long run by helping you get a lower settlement from your creditors.
The debt settlement companies typically require you to stop making payments to your creditors and instead make deposits into a savings account. This account is then used by the company to pay off your debt or collect fees that you owe. However, stopping payments to creditors can cause you to fall further behind on your payments, and your credit score could drop as a result.
The new terms need to be agreed upon for settlement to be reached – whether that be a lump-sum reduced amount, lower monthly payments, or debt discharge. However, agreement to any terms is not required and is entirely up to the individual. Depending on how the debt was settled, payments might need to be made to the company handling the debt until the outstanding balance is paid in full.
The risks associated with debt settlement
When you’re in over your head with debts, it can be tempting to look for a quick fix like debt settlement. But before you sign up for any services, it’s important to understand the risks involved. For starters, finding a legitimate company can be tricky. There are plenty of scammers out there who will take your money without ever delivering on their promises. Even with a reputable company, you may have to wait years for them to negotiate all your debts.
You could face hefty fees
There is no set fee for debt settlement services as it varies depending on local and state laws. However, it is not uncommon for a third-party debt settlement professional to charge a percentage of 15 to 25 of resolved debt. This means that, for example, seeking to settle a $50,000 debt could result in a fee based on that amount–not taking into account any final repayment amount that may be negotiated.
There are many companies that claim they can help you negotiate your debt and get you a lower payment. But before you sign up with any of them, it’s important to know how they operate and what fees they’re allowed to charge. The Federal Trade Commission has rules in place that say debt negotiation companies can only charge fees after they’ve helped you settle your debt. So, be wary of any company or attorney that tries to charge you upfront before the work is done.
It could hurt your credit score
First, it’s important to know that this approach will likely have a negative effect on your credit score. This is because many debt settlement companies will ask you to stop making payments on your credit card while negotiations are taking place. Lenders and creditors are usually more willing to negotiate with consumers who are still able to make monthly payments on their bills. So, by not paying your bills, you’re essentially damaging your credit.
Most creditors will require that an account is in a delinquent state before they will agree to settle. This means that during the negotiation process, an individual’s credit score is likely to take a hit. Additionally, there is always the possibility that you may be sued.
It’s not just that having “settled” accounts on your credit report can lower your score. It can also make it harder to get approved for new lines of credit.
The debt settlement process isn’t as fast as you think
The process of debt settlement can be a long one, sometimes taking up to four years. Your attorney or debt settlement company will work with your creditors to try and reach an agreement. The more creditors you have, the longer the process may take. In addition, you will need to save up money in order to pay off your debts in a lump sum.
Whether you’re working on your own or with a third party, it’s important to be patient and understand that it may take years to see results. However, there are other alternatives to consider if you need immediate relief from your debts.
The forgiven debt is taxable
Although it may feel like a weight has been lifted off your shoulders to settle your debt, you may now be facing taxes from the IRS. Any forgiven debt that is more than $600 is taxable. So, for example, if a debt settlement company can negotiate $10,000 worth of debt down to $7,000, you would owe taxes on the $3,000 forgiven by your creditor.
You should make sure that the money you pay your debt settlement company is enough to cover any applicable taxes. However, it’s important to check the details of any agreement you sign. Otherwise, you may be responsible for paying off the rest of the debt, plus the fees charged by the settlement company and any taxes owed.
There’s a chance you’ll owe more than when you started
Debt settlement can be a daunting process, but with the help of a debt attorney or third-party company, it can be manageable. One of the first things you may be advised to do is to stop making payments on your debt.
Ignoring your debt can have some pretty severe consequences. Not only will your creditors begin to tack on late fees and other charges, but eventually the amount owed could balloon to more than the original debt. This can complicate any settlement negotiations and leave you with less relief from your debt than expected.
You may not be able to settle
Settling your outstanding debt is not always possible with every company. Some companies also refuse to work with debt settlement agencies. This can make it more difficult to come to an arrangement with your creditor, especially if you have fallen behind on payments according to the terms set by the debt settlement company. Additionally, your creditor may take legal action against you which would damage your credit even further.
Alternatives to debt settlement
There are other options available to you besides debt settlement, in case it doesn’t work out for your particular situation.
Bankruptcy may not be the first thing that comes to mind when you think of debt relief options, but depending on your circumstances, it could be a more attractive option than you realize.
Filing for Chapter 7 bankruptcy can eliminate most types of unsecured debt, like credit cards and medical bills. However, it won’t get rid of back taxes, student loan debt, or child support payments. The process usually takes a few months to complete, as opposed to a few years with debt settlement. Neither option is great for your credit score, but getting rid of debt sooner is always better than later. So, if you’re wanting a quicker solution, bankruptcy might be the way to go.
Debt consolidation can be a great way to get your finances under control. By combining all your debts into one new loan, you can reduce the amount of interest you owe and make one manageable payment per month. There are two ways to achieve this: through a nonprofit credit counseling agency or by taking out a consolidation loan on your own. Whichever route you choose, getting your debts consolidated can help you regain control of your finances.
Another option is to seek assistance from a nonprofit credit counseling agency. These agencies can help you create a debt management plan that works best for your financial situation. In some cases, credit counseling agencies operate in similar ways to debt settlement companies. Some companies have little to no cost for you, but you’ll make payments to them rather than to your creditors. With this option, you would typically close all outstanding accounts—such as credit cards—until your debt is paid off.
Moving your credit card debt to another card that has 0% APR for 12-24 months can help you save on monthly interest payments. This type of balance transfer can be beneficial as long as you are able to pay off the full balance before the zero percent interest term expires. Once the promotional period ends, any unpaid balance will begin to accrue interest at the standard rate.
There are a few things to consider when shopping for a balance transfer credit card. Most importantly, you want to find a card that won’t charge a fee to transfer your outstanding balance. Secondly, keep in mind that not all balance transfer credit cards will transfer your full outstanding balance. This could mean that you’re responsible for paying off your new balance and any leftover debt from your old card.
Don’t fall for debt settlement scams
There are many companies that claim to be able to help you settle your debts, but not all of them are legitimate. To avoid being scammed, you should:
- Avoiding businesses that make false promises: Don’t be fooled by companies that claim they can make your debt disappear. While it’s true that some creditors may be willing to negotiate a settlement, there’s no guarantee that this will happen. And even if you are able to reach a settlement, you’ll still need to pay off the debt.
- Not paying fees before debt settlement: When considering a debt settlement company, be wary of any that require payment upfront. Carefully read the terms of any such payments, and make sure you understand what they will be used for.
- Keeping up with communications: Your debt settlement company should make sure that you understand the consequences of not making payments to your creditors, as well as the risks of using their services. Otherwise, you may end up in a worse financial situation than you were in before.
The bottom line
Debt settlement might not be the best option for tackling your debt. Creditors and debt collection agencies may not work with debt settlement companies, and some may not do settlements at all. Even settlements that are reached could take years. Imagine waiting to pay multiple types of debt and the damage it could do to your credit during that time.
There are a lot of options available to help with debt, and it can be tough to decide which one is right for your situation. Debt consolidation, debt management plans, credit card balance transfers, and even bankruptcy all have their own benefits and drawbacks.