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The Debt Settlement Process: What is It works and the risks you face
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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 of journalism at Auburn University and a master's in education from Georgia State University. Prior to joining NerdWallet, she worked for daily newspapers, MSN Money and Credit.com. Her work has appeared throughout the world in 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 10:58AM PDT
Editor: 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 capacities such as chief of the copy desk and team editor and designer. Prior experience includes copy and news editing for various Southern California newspapers, including the Los Angeles Times. She graduated with a bachelor's in mass communications and journalism at The University of Iowa.
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Table of Contents
Table of Contents
The term "debt settlement" means that a creditor has accepted less than the amount that you owe as full payment. Once it accepts that deal it is no longer able to pursue you for cash and you don't need to worry about the possibility of be sued for that specific obligation.
It sounds like a good deal, but debt settlement can be risky:
Debt settlement can destroy your credit.
The process of settling a dispute can take a long time to complete -- usually between two to four years.
It could be expensive.
Even if you are successful at debt settlement it could take years and you may realize that you owe tax on any forgiven debt. And , if you work with a debt settlement company and pay for fees, you'll have to pay. This is not a last resort.
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How debt settlement works
Debt settlement can be used only if you have a lot of missed or late payments, and perhaps collections accounts. A creditor or collector will not agree to pay lesser than what you owe if there's reason to believe you could that you originally agreed to.
Your will have been shredded, you will feel lost and your earnings will not be enough to pay all your obligations to creditors.
The companies that offer debt settlement work with creditors to cut down the amount of debt you have to pay, mainly on debt that is not secured like credit cards. It's not an option for certain kinds of debts, such as a house which can be foreclosed or a car that can be taken back. Most companies don't deal with federal student loans, but you might be eligible to . If you're struggling with your student loans, an might help you.
Settlement offers work only if it seems you won't make any payments, and you stop making payments on your debts. Instead, you establish an account for savings and make an amount per month there. When the company that settles your account believes the savings account is sufficient to warrant a lump-sum payment and will negotiate on your behalf with the creditor to accept an amount that is less.
Readers can also ask questions.
Do debt consolidation loans hurt your credit?
Debt consolidation can help your credit score if to make timely payments or shrinks account balances, especially if the balances on your credit cards were close to their limits. Your credit if you run up credit card balances again and close all or the majority of your other cards or make a late payment on your loan for debt consolidation. loan.
What can I do to reduce my credit card credit card
Debt settlement and bankruptcy can decrease or eliminate credit card debt, however, they have a significant impact on your credit score. The management of debt reduces interest ratesand the impact on credit is less severe. can reduce the interest rate as well.
How can I cut down my debt?
Reduce your debt by three steps. Find out what you owe. 2. Assess which payoff strategy will work for you. 3. Set a goal and track your progress.
Risks of debt settlement
Some debt settlement companies say they can reduce the amount of debt you owe by 50 percent, and get you debt-free within 36 months.
However, the procedure is not as clear-cut or as easy as it sounds. We believe that debt settlement should be a last resort.
Here are the risks that come with the settlement of debt:
Your credit score will be affected If you're not in debt and you're not, you'll be after you divert debt payments toward an account for settlement. Debts that are owed and owing off by lenders remain on your credit for a period of seven years.
Interest and penalties continue to accrue: You'll likely be slapped with late charges and penalty fees as well. Interest will continue to accrue in your credit card balance.
There's no assurance of success The two biggest debt settlement companies are and . Freedom Debt, for instance claims it has resolved greater than 10 billion dollars in debts for more than 650,000 clients since 2002. But there's no guarantee that the company can settle your debt substantially less, as some creditors are not negotiating with them.
According to a study by the Center for Responsible Lending, an independent research and policy institute, most consumers would have to settle at minimum four accounts in order to get a net gain. In addition, debt totals may rise as fees accrue, and aggressive collection attempts could continue throughout negotiations.
You must pay the cost for each debt that is settled: By law, these companies can't charge you upfront fees. Most of them charge a percentage of each amount they pay, depending on that amount of debt at the time you joined it in the program. Some charge an amount of the debt eliminated by the settlement.
For example, say you owe $10,000, and the agency negotiates a deal for $6,000. The agency will charge 25 percent.
If the agency is charged a percentage of the settled debt, you'd pay the creditor its $6,000 while paying the agency $2,500 in fees (25 percent of the $10,000 balance enrolled). Total: $8,500.
If the agency is charged a percentage of the eliminated debt, you'd pay the lender $6,000 and the agency would charge you $1,000 for fees (25 percent of the $4,000 in eliminated debt). Total: $7,000.
There are additional charges to pay in addition to the charges paid to when a debt settles the customer may also be subject to other costs, including the setup fee and the monthly cost to keep the account created under the program.
If you have forgiven your debt, it could be tax deductible Also, you should be aware that the Internal Revenue Service generally regards forgiven debt as income. You may want to consult an expert in taxation regarding any other tax obligations you'll be taking on if you settle your debt.
If you do decide to engage the services of an expert in debt settlement Be cautious. It's easy to fall into a state of panic when you're desperate and you see promises made by . The National Consumer Law Center has declared that debt settlement companies are "almost never worth it and could cause consumers to be in deeper financial troubles."
The Consumer Financial Protection Bureau takes a somewhat softer view, however, it warns consumers to be cautious in advising that dealing with these firms is risky , and other alternatives should be considered first. Over 300 complaints about debt settlement companies to the CFPB from 2014. Most of the complaints were fraud and excessive fees.
Other options to settle debt
Michael Bovee, a debt settlement coach who is often a critic of his business (he has presented evidence to the Federal Trade Commission in favor of greater regulation), advises erasing your debts with Chapter 7 bankruptcy and starting from scratch, if you've got the option.
For those who are burdened by debt that is not secured, like credit cards, consider how your options compare to . A bankruptcy is generally the better choice. Yes, a bankruptcy will sully your credit history for many years however the process of rebuilding is able to begin right away. Consultations with a bankruptcy attorney are usually free, but you'll be charged filing and legal costs if you opt for this route.
"If you can erase your debts in 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 refuse to file for bankruptcy, or if you only be eligible for a Chapter 13 repayment plan -in the event that you are considering the option of debt settlement."
If you aren't eligible for bankruptcy, or do not want to make one happen, you might consider a offered through a nonprofit . This option won't generally reduce the amount that you have to pay however it could decrease your monthly payment by spreading them out, or by reducing your interest rate. It will have less impact on your credit than either bankruptcy or a debt settlement.
If you choose to go for settlement
If you feel that you're in the right or most appropriate choice for you, and you'd like assistance with the debt resolution option, Bovee has tips for choosing a company wisely:
Check with the to see if there's a record of complaints.
Stay away from any company which offers cash in advance or promises your debt will be paid.
It is important to structure fees as a percentage of debt eliminated rather than of debt balance at enrollment; that will give the company a reason to reduce your debt.
Do not trust companies that claim that they will help you contest the validity of your debts and declare them "invalid" (a method that could backfire, resulting in more aggressive enforcement at your expense).
If you're not planning to engage a debt-settlement firm think about hiring an attorney or making it your own.
A lawyer can charge by the hour, have a flat fee per creditor, or be charged an amount of debt, or debts that are eliminated.
If you're seriously behind, it usually doesn't hurt to reach out to your creditors. Some banks have hardship programs that may be able to help. Be sure to manage any lower payment options the bank might offer.
If you want to try , educate yourself on what's likely to happen.
You may want to gather as much cash as you can to make a lump-sum offer, whether that's taking a part-time job, selling sports equipment that's been sitting in the basement, or taking money out of your cousin. (Creditors might be more likely to accept a lump sum offer that allows them to receive money quickly, instead of taking a chance on the possibility of not receiving payments.) Be aware that certain creditors may have a rule against settlement of debts.
Author bio Bev O'Shea was a credit reporter at NerdWallet. Her work has appeared in the New York Times, Washington Post, MarketWatch and elsewhere.
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