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The Debt Settlement Process: What is it Does It and the Risks You Take
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Credit Settlement: How 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 the daily papers, MSN Money and Credit.com. Her work was featured throughout the world in The New York Times, The Washington Post, the Los Angeles Times, MarketWatch, USA Today, MSN Money and other publications. Twitter: @BeverlyOShea.
Updated Jun 24, 2022 10:58AM PDT
Editor: Kathy Hinson Lead Assigning Editor Personal finance, 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 for various Southern California newspapers, including the Los Angeles Times. She graduated with a bachelor's in mass communication and journalism in Iowa's University of Iowa.
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Table of Contents
Table of Contents
A creditor has agreed to accept less than the amount you owe as full payment. Once it accepts that deal, the creditor can't continue to pursue you for cash and you don't need to worry that you could get sued over that particular debt.
It sounds like a good deal However, it can be risky.
Debt settlement can destroy your credit.
The process of settling a dispute can take a long time to achieve -- typically between two to four years.
It could be expensive.
Even if you succeed at debt settlement it may take years and you may realize that you owe tax upon any unpaid debt. If you choose to use a company for debt settlement, you'll pay fees. This is the last option.
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How debt settlement works
Debt settlement comes into play only when you have many payment due dates or missed payments and possibly collections accounts. The collector or creditor will not accept less than you owe when there's a evidence that suggests you may not have the amount that you originally agreed to.
Your finances have been damaged and you'll be feeling overwhelmed and bewildered, and your income isn't enough to keep up with the debts you owe.
Companies that deal with creditors to lower what you owe, mostly for debts that are not secured, such as credit cards. This isn't an option for all types of debt like a home that is foreclosed or a vehicle that could be repossessed. The majority of companies do not deal with federal student loans, but you might be able to . If you're having trouble paying your student loans, an might help you.
Settlement offers only work when you don't pay at all, so you stop making payments to your debts. Instead, you establish the savings account and place a monthly payment into it. Once the settlement company believes the savings account is sufficient for a lump-sum offer, it negotiates on your behalf with the lender to accept a smaller amount.
Readers can also ask questions.
Do debt consolidation loans hurt your credit?
Debt consolidation may help your credit if it helps you pay on time or shrinks account balances particularly if your credit card balances were exceeding their limit. Credit is affected if you run up credit card balances again shut down all or most of your cards or fail to pay you loan for debt consolidation. loan.
What can I do to reduce my credit card credit card
Bankruptcy and debt settlement can reduce or completely eliminate debt from credit cards, however, they have a significant impact on your credit score. Debt management can lower interest ratesand the impact on your credit is less than it would be. can reduce interest rates as well.
How can I lower my debt?
(image: https://objects-us-east-1.dream.io/fsrn-archive/uploads/2016/06/Payday-loans-Stallio.jpg?is-pending-load=1)Reduce your debt in three steps: 1. Find out your debts. 2. Assess which payoff strategy will best suit your needs. 3. Set a goal and keep track of your progress.
The risk of debt settlement
Some companies offering debt settlement say they can reduce your debt by 50% and get you debt-free within 36 months.
However, the process isn't as simple or as easy as it sounds. Again, we believe debt settlement should be the last resort.
Here are the risks that come with debt settlement:
Your credit score will take a hit If you're not delinquent on your accounts, you will be once you redirect debt payments towards your settlement accounts. Delinquent accounts and debt charged off by lenders will remain on your for seven years.
Penalties and interest will continue to accrue: You'll probably be slapped with late charges as well as penalty fees. Interest will continue to accrue in your credit card balance.
There's no guarantee of success: The two largest companies for debt settlement are . Freedom Debt, for instance claims to have resolved more than $10 billion in debt for over 650,000 customers since the year 2002. However, there's no guarantee that the debt settlement firm will be able to settle your debt for much less, given that some creditors do not negotiate with them.
According to a study conducted by the Center for Responsible Lending, a nonprofit research and policy group the majority of consumers will need to settle at minimum four accounts before receiving the net benefit. In addition, debt totals may rise as fees accrue and aggressive attempts to collect might continue throughout negotiations.
You have to pay an amount when a debt settles: By law, these companies can't charge you upfront fees. They typically charge a percentage of every debt they settle, based upon the debt's balance when you enrolled into the program. Some charge an amount of the debt that is eliminated through the settlement.
For example, say you owe $10,000 and an agency agrees to negotiate a settlement for $6,000. The agency is charged 25 percent.
If the agency is charged a percentage of the settled debt that is, you'd pay the creditor its $6,000, and to the agent $2,500 for charges (25 percent of the total balance enrolled). Total: $8,500.
If the agency charges a percentage of eliminated debt, you'd pay the creditor $6,000 and the agency would charge you $1,000 for fees (25% of the $4,000 eliminated debt). Total: $7,000.
You'll pay additional fees in addition to the charges paid to after the debt is paid off, customers can face other costs, including the setup fee and the monthly cost to keep the account that is set up in the program.
The debt that you forgive could be tax-deductible: You should also be aware that the Internal Revenue Service generally regards forgiven debt as income. You may want to consult an accountant about any the additional tax obligations you'll be taking on if you settle your debt.
If you decide to enlist the services of the debt settlement expert, be careful. It's easy to let your guard down when you're desperate and you see promises of . A study by the National Consumer Law Center has stated that debt settlement firms are "almost never worth it and could cause consumers to be in deeper financial troubles."
The Consumer Financial Protection Bureau takes more of a softer approach, but still cautions consumers strongly in advising that dealing with these firms is risky , and other options should be explored before. Over 350 complaints filed against firms that offer debt settlement to the CFPB in the last year. The most frequent complaints included fraud and fees that were too high.
Solutions to Debt Settlement
Michael Bovee, a debt settlement coach and frequently criticizes his field (he has presented evidence to the Federal Trade Commission in favor of more regulation), advises erasing your debts through Chapter 7 bankruptcy and starting again, if you have the option.
If you are a borrower who is overwhelmed by debt that is not secured, such as credit cards, think about how your options compare, like . It is usually a better option. Yes, bankruptcy will affect your credit score for years however, the process of rebuilding is able to begin right away. Consultations with a bankruptcy attorney are typically free, though you'll have to pay filing and legal fees if you decide to go this route.
"If you are able to erase your debts in a Chapter 7 bankruptcy, that's the best option over trying to settle agreements," says NerdWallet columnist Liz Weston, author of "Your Credit Score" and "Deal With Your Debt." "Only in the event that Chapter 7 isn't an option (you decide to not declare bankruptcy, or you can only qualify for a Chapter 13 repayment plan -or if you're considering the possibility of settling your debt."
If you're not eligible to file a bankruptcy, or don't want to make one happen, consider a offered through a nonprofit . This option won't generally reduce the amount that you must repay but it can reduce your monthly payments by spreading them out or through reducing your interest rate. It's not going to have a greater impact on your credit than bankruptcy or the debt settlement.
If you decide to try settlement
If you believe that it is the best option for you and you want assistance with the debt resolution option, Bovee has tips for picking a good company:
Check with the to see whether there's a complaint history.
Stay away from any company which offers cash in advance or guarantees that your debt will be paid.
Make sure fees are structured as a percentage of debt eliminated instead of the debt balance at enrollment. This provides the business with a reason to trim more of your debt.
Avoid companies that promise to help you challenge debts to have them declared "invalid" (a method which could backfire and result in more aggressive enforcement towards you).
If you're not sure whether you want to engage a debt-settlement firm, consider using a lawyer or doing it yourself.
A lawyer may bill by the hour, offer a flat fee per creditor, or take a percentage of the debt or debt eliminated.
If you're seriously behind, it usually doesn't hurt to reach out to your creditors. Certain banks offer hardship programs which could be able to aid. But be certain you can pay for any payment plans that your bank might provide.
If you're interested in trying to do it, learn what's likely to happen.
You might want to gather as much cash as you can in order to make a lump sum offer, whether that's doing a part-time job selling the sports equipment that's been languishing in the basement, or taking money out of your cousin. (Creditors may be likelier to accept a lump sum offer as it allows them to pay immediately, rather than making a bet on payment dates that may not be forthcoming.) Be aware that certain creditors may have a rule against settling the debt.
About the author: Bev O'Shea is a former credit writer at NerdWallet. Her work has appeared on the New York Times, Washington Post, MarketWatch and elsewhere.
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