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Debt Settlement: How 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 worked for the daily papers, MSN Money and Credit.com. Her work has been featured in The New York Times, The Washington Post, the Los Angeles Times, MarketWatch, USA Today, MSN Money and other publications. Twitter: @BeverlyOShea.
Updated on Jun 24, 2022 at 10:58AM PDT
Edited by Kathy Hinson Lead Assigning Editor Personal financial, credit scoring, financial management and debt Kathy Hinson leads the Core Personal Finance team at NerdWallet. Previously, she spent 18 years with The Oregonian in Portland in capacities such as chief of the copy desk and team director of design and editing. Prior experience includes news and copy editing at various Southern California newspapers, including the Los Angeles Times. She earned a bachelor's degree in mass communications and journalism in The University of Iowa.
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Table of Contents
Table of Contents
Debt settlement means a creditor has accepted less than the amount you have to pay as full payment. Once it accepts that deal it is no longer able to pursue you for amount and you won't have to worry about the possibility of be sued for that specific 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 time to complete -- usually between two and four years.
It isn't cheap.
If you're successful in settling your debt, it can take years to complete and you could discover you owe tax upon any unpaid debt. If you choose to use a debt settlement company and pay for fees, you'll have to pay. This is the last option.
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How do you deal with debt
The process of debt settlement is only if you have a lot of late or skipped payments and possibly collections accounts. The collector or creditor will not accept less than you owe If there's any evidence that suggests you may not have the amount have previously agreed to.
Your confidence has been destroyed and you'll be feeling hopelessly behind and your income will not be enough to meet all your obligations to creditors.
Companies that deal with creditors to lower the amount you owe for debts that are not secured, such as credit cards. This is not an option for some kinds of debts for example, a home that is foreclosed or a car that can be repossessed. The majority of companies do not settle federal student loans however you might be eligible to . If you're struggling with your student loans, an might help you.
Settlement offers work only when you don't pay at all, so you cease making payments to your debts. Instead, you create an account for savings and make the monthly installment into it. When the company that settles your account believes the account has enough for a lump-sum offer, it talks on your behalf to the creditor to accept a smaller amount.
Readers can also ask questions.
Do debt consolidation loans hurt your credit?
The debt consolidation process can improve your credit if it helps you pay on time or decreases balances on revolving accounts particularly if your credit card balances were near their limits. Your credit if you run up credit card balances again shut down all or most of your other cards or miss a payment on the credit consolidation loan.
How can I cut down my credit card debt?
Debt settlement and bankruptcy can decrease or erase credit card debt but they severely impact your credit score. The management of debt reduces interest ratesand the impact on your credit is less severe. This can lower the rate of interest as well.
How can I cut down my credit card?
Reduce your debt in three steps: 1. Determine the amount you owe. 2. Assess which payoff strategy will best suit your needs. 3. Set a goal and track your performance.
The risk of debt settlement
Some companies offering debt settlement say they can reduce credit by up to 50% and make debt-free in just 36 months.
However, the procedure isn't as simple as it seems. In our opinion, it is a last resort.
Here are the risks that come with the settlement of debt:
Your credit score will be affected If you're still not in debt on your accounts and you're not, you'll be after you divert debt payments toward the settlement account. Debts that are owed and owing off by lenders stay on your credit for seven years.
Penalties and interest will continue to accumulate: You'll most likely be hit with late charges as well as penalty fees. Interest will continue to accrue on your balance.
There's no guarantee of success: The two largest debt settlement firms are . Freedom Debt, for instance, says it has settled more than $10 billion worth of debt for more than 650,000 customers since 2002. There's no assurance that the debt settlement company will be able to settle your debt for much less, given that some creditors are not negotiating with them.
According to a study conducted by the Center for Responsible Lending, which is a non-profit research and policy institute that surveyed consumers, the majority would need to settle at least four accounts in order to get the net benefit. In addition, debt totals may rise as fees accrue and aggressive collection efforts could continue throughout the negotiation process.
There is an amount in the event of a debt being settled: By law, these businesses are not able to charge you up front fees. They typically charge a percentage of every settlement, which is based on that amount of debt at the time you joined in the program. Some charge a portion of the debt eliminated by the settlement.
For instance, let's say you owe $10,000 to the agency and an agency agrees to negotiate a settlement of $6,000. The agency will charge 25%.
If the agency charges a percentage of debt that is settled then you'll pay the creditor $6,000 while paying an agency $2500 in charges (25 percent of the total balance enrolled). Total: $8,500.
If the agency charges a percentage of eliminated debt, you'd pay the lender $6,000 and the agency $1,000 in charges (25% of the $4,000 debt that was eliminated). Total: $7,000.
You'll pay additional fees In addition to the fees that are paid to when a debt settles the customer may also be subject to other fees, such as the setup fee and the monthly cost to maintain the dedicated account set up under the program.
Forgiven debt may be taxable Also, you should know that Internal Revenue Service generally regards forgiven debt as income. You might want to talk to an accountant about any 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 cautious. It's easy to fall into a state of panic when you're feeling desperate and are able to see the promises from . It's been reported that the National Consumer Law Center has said debt settlement companies are "almost never worthwhile and can lead consumers into deeper financial troubles."
The Consumer Financial Protection Bureau takes a somewhat softer view, however, it warns consumers to be cautious, saying that dealing with such companies is risky and that other options should be explored before. There have been over 350 complaints filed against companies that deal in debt to the CFPB in the last year. The most frequent complaints included fraud and fees that were too high.
Other options to settle debt
Michael Bovee, a debt settlement coach and a frequent critic of his field (he has testified before the Federal Trade Commission in favor of greater regulation), advises erasing your debts with Chapter 7 bankruptcy and starting over, if you're given the option.
For those who are burdened with debts that are not secured like credit cards consider how your options compare, like . A is almost always a better option. A bankruptcy can ruin your credit for a long time however, the process of rebuilding is able to begin right away. Consultations with bankruptcy attorneys are typically free, though you'll pay legal and filing fees if you decide to go this route.
"If you can erase your debts in bankruptcy, such as a Chapter 7 bankruptcy, that's a much better option than trying to settle agreements," 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 you can only be eligible for a Chapter 13 repayment plan -or if you're considering debt settlement."
If you're not eligible to file a bankruptcy, or don't want to make one happen, you might consider an offer through a non-profit . Going that route will not generally reduce the amount that you must repay but it can decrease your monthly payment by stretching them out or by reducing your interest rate. It will have less impact on your credit than either bankruptcy or an agreement to settle debts.
If you decide to pursue settlement, you can do so.
If you think it is the best or most appropriate choice for you and would like some help in the process of pursuing the debt resolution option, Bovee has tips for choosing a company wisely:
Check with the to see the complaint history.
Avoid any business who offers money in advance or promises your debt can be settled.
It is important to structure fees in a proportion of debt canceled instead of debt balance at enrollment. This provides the business with a reason to cut down on your debt.
Beware of companies who promise to help you challenge debts in order to declare them "invalid" (a tactic that can backfire and result in more aggressive actions against you).
If you're not planning to engage a debt-settlement firm think about hiring a lawyer or making it your own.
Lawyers can bill by the hour, offer one flat fee per creditor, or be charged a percentage of debt or debt that is eliminated.
If you're seriously behind, it usually doesn't hurt to reach out to your creditors. Some banks have hardship programs which could be able to assist. But be certain you can manage any lower payment options the bank might offer.
If you want to try , educate yourself on what's likely to happen.
It is possible to collect as much cash as you can in order to make a lump sum offer, which could mean working part-time, selling sports equipment which has been sat in the basement, or borrowing money from your friend. (Creditors might be more likely to accept a lump-sum deal as it allows them to pay quickly, instead of risking payments that might not come.) Be aware that certain creditors might have a policy against settlement of 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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