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Debt Settlement: How It Works and Risks You Face
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(image: http://image.slidesharecdn.com/samedaypaydayloans-160817065143/95/same-day-payday-loans-cater-your-money-need-exact-on-time-1-638.jpg?cb=1471416780)The Debt Settlement Process: What is It Works and Risks You Face
By Bev O'Shea personal finance writer | MSN Money, Credit.com, Atlanta Journal-Constitution, Orlando Sentinel Bev O'Shea is a former NerdWallet authority on consumer credit, scams and identity theft. She has a bachelor's degree in journalistic studies from Auburn University and a master's in education from Georgia State University. Prior to joining NerdWallet she was employed by newspaper publishers, including daily ones, MSN Money and Credit.com. Her work has appeared on The New York Times, The Washington Post, the Los Angeles Times, MarketWatch, USA Today, MSN Money and elsewhere. Twitter: @BeverlyOShea.
Updated on Jun 24, 2022 at 10:58 AM PDT
Edited by Kathy Hinson Lead Assigning Editor Personal financial, credit scoring, debt and money management Kathy Hinson leads the Core Personal Finance team at NerdWallet. Prior to joining NerdWallet, she worked for 18 years at The Oregonian in Portland in roles including copy desk chief and team editor and designer. Prior experience includes news and copy editing at several Southern California newspapers, including the Los Angeles Times. She graduated with a bachelor's in journalism and mass communications in the University of Iowa.
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Table of Contents
Table of Contents
The term "debt settlement" means that a creditor has agreed to accept less than the amount that you have to pay as full payment. If it accepts the deal and the debtor isn't able to continue to harass you to collect the money and you don't have to worry that you could be sued for that specific amount of debt.
It seems like a great deal however, debt settlement could be risky.
Debt settlement can destroy your credit.
A settlement may take a long period of time to achieve -- typically between two and four years.
It isn't cheap.
Even if you are successful at debt settlement it could take years before you discover you owe tax upon any unpaid debt. If you choose to use a company for debt settlement and pay for fees, you'll have to pay. This is the last option.
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How debt settlement works
Debt settlement comes into play only if you have a lot of payment due dates or missed payments and perhaps collections accounts. A collector or creditor will not accept less than you owe when there's a evidence that suggests you may not have the amount the amount you initially agreed to.
Your finances have been damaged and you'll be feeling hopelessly behind and your income won't be enough to keep up with all your obligations to creditors.
The companies that offer debt settlement deal with creditors to lower the amount of debt you have to pay, mainly for debts that are not secured, such as credit cards. This isn't an option for all kinds of debts like a home that is foreclosed or a car that can be taken back. Most companies don't settle federal student loans however you might be able to . If you're having trouble paying your student loans it could be possible to help you.
Settlement offers work only if it seems you won't make any payments, and you cease making payments to your debts. Instead, you establish the savings account and place an amount per month in it. If the settlement company is convinced that the account has enough to warrant a lump-sum payment, it talks on your behalf to the creditor to accept a smaller amount.
Readers also ask
Do debt consolidation loans hurt your credit?
Debt consolidation may help your credit if it helps you make on-time payments or shrinks balances on revolving accounts in particular if credit card balances were near their limit. Your credit if you run over your credit card balances, close most or all of your other cards or miss a payment on you debt consolidation loan.
How do I reduce my credit card debt?
The bankruptcy process and debt settlement may decrease or eliminate credit card debt, however, they have a significant impact on your credit. The management of debt reduces interest rates, and its impact on your credit is less than it would be. can reduce interest rates as well.
How can I lower my debt?
Reduce your debt in three steps: 1. Determine what you owe. 2. Find out which payoff strategy will best suit your needs. 3. Set a goal and keep track of your performance.
Debt settlement risks
Some debt settlement companies say they can reduce credit by up to 50% and make your debt free in only 36 months.
However, the procedure isn't as simple or as straightforward as it appears. In our opinion, it is a last resort.
Here are risks associated with the settlement of debt:
Your credit score will be affected If you're not in debt on your accounts then you will be when you redirect debt payments towards an account for settlement. Delinquent accounts and debt charged off by lenders will remain on your for seven years.
Penalties and interest continue to accrue: You'll likely be hit with late charges and penalty fees as well. The interest will keep piling up in your credit card balance.
There's no assurance of success: The two largest debt settlement companies are . Freedom Debt, for instance claims to have settled over $10 billion of debt for over 650,000 customers since the year 2002. There's no assurance that the company will be able to settle your debt for substantially less, as some creditors are not negotiating with them.
According to a report by the Center for Responsible Lending, a nonprofit research and policy institute the majority of consumers will need to settle at minimum four accounts in order to get an overall benefit. Additionally, the amount of debt can increase as fees accumulate, and aggressive collection attempts might continue throughout the negotiation process.
There is the cost in the event of a debt being settled by law. firms aren't able to charge upfront fees. Most of them charge a percentage of every debt they settle, based on that debt's balance when you enrolled in the program. Some charge a percentage of the debt that is eliminated through the settlement.
For instance, let's say you owe $10,000 and the agency negotiates a settlement of $6,000. The agency will charge 25 percent.
If the agency is charged a percentage of the debt that is settled, you'd pay the creditor its $6,000 and pay to the agent $2,500 for fees (25% of the $10,000 balance that you enrolled). Total: $8,500.
If the agency has a percentage charge for eliminating debt, you'd pay the creditor $6,000 and the agency $1000 in charges (25 percent of the $4,000 in debt that was eliminated). Total: $7,000.
Additional fees will be charged in addition to the charges that are paid the debtor when the debt is settled clients may be charged additional charges, like the setup fee and the monthly cost to maintain the dedicated account set up under the program.
If you have forgiven your debt, it could be tax deductible Also, you should know that Internal Revenue Service generally regards forgiven debt as income. You might want to talk to a tax professional about other tax obligations you'll have to take upon settling your debt.
If you decide to hire a debt settlement professional Be careful. It's easy to lose your guard when you're desperate and are able to see the promises of . It's been reported that the National Consumer Law Center has declared that debt settlement companies are "almost never worth it and could get consumers into even deeper financial trouble."
The Consumer Financial Protection Bureau takes an empathetic view however, it warns consumers to be cautious about dealing with such companies is risky , and other alternatives should be considered first. There have been more than 300 complaints about debt settlement companies to the CFPB from 2014. Among the most common claims included fraud and fees that were too high.
Solutions to Debt Settlement
Michael Bovee, a debt settlement coach and often a critic of his business (he has presented evidence to the Federal Trade Commission in favor of greater regulation) He advises you to erase your debts with Chapter 7 bankruptcy and starting over, if you're given the option.
For borrowers who are overwhelmed with debts that are not secured such as credit cards, consider how your options compare with . A is almost always an option that is more beneficial. A bankruptcy can sully your credit history for a long time, but the rebuilding process can begin immediately. Consultations with a bankruptcy lawyer are typically free, though you'll be charged filing and legal fees if you choose this method.
"If you're able to eliminate your debts through bankruptcy, such as a Chapter 7 bankruptcy, that's an excellent alternative to trying to reach the settlement," says NerdWallet columnist Liz Weston, author of "Your Credit Score" and "Deal with your debt." "Only if Chapter 7 isn't an option (you decide to not declare bankruptcy, or you only be considered for the Chapter 13 repayment plan -- should you consider debt settlement."
If you're not eligible for a bankruptcy or don't want to make one happen, you might consider a offered through a nonprofit . Going that route will not typically reduce the amount you must repay, but it may reduce your monthly payments by spreading them out, or through reducing your interest rate. It's not going to have a greater effect on your credit than either bankruptcy or an agreement to settle debts.
If you decide to try settlement, you can do so.
If you think it is the most effective option or the most suitable choice for you and would like some assistance in pursuing your debt, Bovee has tips for picking a good company:
Contact the company to determine whether there's a history of complaints.
Beware of any business which offers cash in advance or guarantees that the debt will be paid.
Be sure that fees are arranged as a percentage of debt eliminated instead of debt balance at enrollment. This will give the company a reason to reduce your debt.
Beware of companies who promise that they will help you contest debts to have them declared "invalid" (a tactic that can backfire and result in more aggressive enforcement at your expense).
If you don't want to work with a company for debt settlement think about hiring a lawyer or do it yourself.
A lawyer can charge by the hour, offer an hourly fee for each creditor or take a percentage of the debt or debt eliminated.
Once you're significantly behind the payments, it's a good idea to reach out to your creditors. Some banks have hardship programs that may be able to aid. But be certain you can afford any reduced payment options the bank might offer.
If you're interested in trying , educate yourself on what's likely to happen.
You may want to gather enough cash are able to to make a lump-sum offer, whether that's working part-time or selling equipment for sale which has been sat in the basement, or taking money out of your friend. (Creditors are more likely to accept a lump sum offer as it allows them to pay quickly, instead of making a bet on the possibility of not receiving payments.) Be aware that some creditors may have a rule against settling the debt.
The author's bio: Bev O'Shea is a former credit writer at NerdWallet. Her work has been featured in the New York Times, Washington Post, MarketWatch and elsewhere.
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