Everything You Need to Know About Debt Settlement
Debt settlement can be a good solution to your debt problems. If you carry more than $10,000 in unsecured debt and struggle with, or are unable to make, your monthly payments, consider debt settlement.
A negotiated settlement can significantly reduce your debt, but it will impact your credit score. It is not an easy experience for everyone. Debt settlement offers a low monthly program payment, sizable debt savings, and short time to debt freedom, but there’s no gain without some pain.
What is Debt Settlement?
Debt settlement, also called debt negotiation or debt resolution, is a process where settlements are negotiated with your unsecured creditors, where they agree to forgive a part of your balance, frequently saving you between 40% to 60% of what you owe. Results can vary widely.
After a settlement is reached, you pay the reduced, agreed-upon sum. In some cases, you will pay this settled balance in payments, over a structured period of time. More frequently you pay off the reduced balance in a lump-sum payment.
How Do I Get a Debt Settlement?
You can negotiate directly with your creditors, or you can apply for debt settlement and hire a debt settlement service to negotiate for you. Debt negotiation professionals generally are more successful at negotiating a settlement than individuals. They have the experience to know how each creditor works, what it is willing to settle for, and when a creditor will take a settlement in payments or demand a lump-sum.
The best debt settlement providers settle a large volume of debt, so they have the have bulk and scale necessary to leverage their relationships with the creditors to benefit all of their clients. They also know which creditors won’t settle debts.
No Up-front Fees
Only work with a debt settlement firm that does not charge up-front fees. Any debt settlement firm that telemarkets its services is not allowed to charge up-front fees. Lawyers and debt settlement firms that meet with clients face-to-face can charge up-front fees.
It makes no financial sense to work with any firm that charges you fees in advance, when you can find reputable, experienced settlement firms that won’t charge you a fee for any account they settle until after the settlement is finalized.
A firm that charges you for their services only after an account is settled has a higher motivation to settle your debts.
|Debt Settlement Pros & Cons|
|Significantly lowers monthly payment||Credit rating impact|
|Lowest cost to get out debt, while avoiding bankruptcy||Collection calls|
|Speeds up the time to debt freedom||Creditors can pursue legal action|
|One payment each month can resolve multiple debts||Possible tax implications|
What are the Benefits of Debt Settlement?
The biggest benefits of debt settlement are:
- Significantly reducing your total debt
- Speeding up the time it takes to become debt free
- Lowering the size of your required monthly
If your debt is so large that you can’t pay it off, you may you consider bankruptcy. Settling your debt is a much less drastic option. Although it harms your credit, the damage is much less severe than filing bankruptcy. Also, settlement is not a public record the way that bankruptcy is.
Typical settlement savings are in the range of 50% of what you owe. Your mix of creditors and the settlement provider you choose could produce very different results. These dramatic savings are based on your current account balances.
Compare your total costs in a settlement program to your total costs paying off your debts making the size payments you make currently. When you factor in all the interest you would pay your creditors, and the number of the years it would take you to pay everything off, the savings from debt settlement are even larger. Your monthly payment in a settlement program is lower, too.
What Are the Drawbacks?
The two main drawbacks to settlement are the:
- Potential for having the amount you settle considered taxable income
- Damage to your credit
Balances that are forgiven are usually considered taxable income by the IRS. However, if you meet the IRS' definition of hardship, at the time of your debt settlement, you may not have any tax obligation for the forgiven debt.
Even if you have to pay taxes on the settlement, it is far cheaper than having paid back the debt in full. Say, for example, you owe $10,000 and settle the debt for $5,000. You may have to pay taxes on the $5,000 you saved, if you aren't eligible to use the Form 982, but the taxes you could owe will be far less than paying back the full $5,000.
Settlement harms your credit because you are not making monthly minimum payments to your creditors during your settlement program. This results in delinquencies appearing on your credit report which lower your credit score. The experience can also be stressful, since you may get collections calls and could even be sued. You have to balance those concerns out against the significant savings.
Many people entering a settlement program already have damaged credit, due to late payments and carrying a lot of debt. For someone whose credit is already damaged, the benefit of saving money can be far more important than concerns about harm to an already damaged credit score.
What Kinds of Debt Can Be Settled?
Credit card debt settlement is the most common type of debt that is settled, although medical debts and other personal loans can also be settled. Mortgages, car loans, and other secured loans can’t be settled. Secured loans are backed by collateral that the creditor can repossess if payments are not made as agreed.
Federal student loans also can’t be settled due to federal law. Private student loans might be eligible. Loans made directly by a school may be eligible, so ask your debt consultant. If settlement is not an option for your student loans, contact your lenders to request consolidation, deferment, or forbearance.
- Start by evaluating your budget, so you only commit to a debt solution with a payment you can afford to make each month.
- Compare your different options, before you make a decision. Use the the free Bills.com DebtCoach tool, to evaluate your situation and find the solution best suited for you.
- Only work with a reputable debt relief company, one that does not charge any fees up-front.