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The Debt Settlement Process: What is It Does It and the Risks You Take
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The Debt Settlement Process: What is It Does It and the Risks You Take
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 appeared on 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 positions such as copy desk chief and team editor and designer. Previous experience included news and copy editing for many Southern California newspapers, including the Los Angeles Times. She earned a bachelor's degree in mass communication and journalism at the University of Iowa.
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Table of Contents
Table of Contents
A creditor has agreed to accept less than the amount that you owe as full payment. When it has accepted that offer and the debtor isn't able to continue to harass you to collect the cash and you don't need to be concerned about whether you'll be sued for that specific debt.
It sounds like a good deal however, debt settlement could be risky.
Debt settlement can destroy your credit.
Reaching a settlement can take a long period of time to achieve -- typically between two and four years.
It can be costly.
If you're successful in debt settlement it could take years to complete and you could discover you owe tax for any debt that you have forgiven. If you choose to use a debt settlement company and pay for fees, you'll have to pay. It is a last resort.
Make sure you track your debt the simple way
Sign up with NerdWallet to view your debt breakdown and upcoming payments all in one spot.
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. The collector or creditor will not agree to pay lesser than what you owe when there's a an indication that you might not be able to pay the amount have previously agreed to.
Your will have been shredded and you'll be feeling hopelessly behind and your income will not be enough to keep up with all your obligations to creditors.
The companies that offer debt settlement deal with creditors to lower the amount you owe for debts that are not secured, such as credit cards. This isn't an option for certain types of debts, such as a house which can be foreclosed or a vehicle that could be taken back. Companies typically don't settle federal student loans however, you may be eligible to . If you're struggling with your student loans, an might help you.
Settlement options are only useful when you don't pay any more, so you don't make payments on your debts. Instead, you open a savings account and put a monthly payment there. If the settlement company is convinced that the savings account is sufficient to make a lump sum offer, it talks on your behalf to the creditor to accept a smaller amount.
Readers also ask
Do debt consolidation loans hurt your credit?
The debt consolidation process can improve your credit score if you pay on time or reduces the account balances particularly if your 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 cards or make a late payment on you credit consolidation loan.
How can I cut down my credit card debt?
Bankruptcy and debt settlement can help to reduce or completely eliminate debt from credit cards, however, they have a significant impact on your credit. Debt management can lower the rate of interest, and its impact on credit is less severe. can reduce the interest rate as well.
How can I cut down my credit card?
Reduce your debt in three steps: 1. Determine what you owe. 2. Determine which payoff strategy is going to work for you. 3. Set a goal and keep track of your performance.
Risks of debt settlement
Some companies offering debt settlement say they can reduce your debt by 50% and make debt-free in just 36 months.
But, the process is not as clear-cut or as simple as it seems. We believe that it is a only option in the end.
Here are the potential risks involved with debt settlement:
Your credit will be affected: If you're not already delinquent on your accounts and you're not, you'll be after you transfer debt payments to the settlement account. Debts that are owed and owing off by lenders stay 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 on your balance.
There's no assurance of success The two biggest debt settlement firms are . Freedom Debt, for instance claims to have resolved greater than 10 billion dollars worth of debt for more than 650,000 clients since 2002. There's no assurance that the debt settlement firm will be able to settle your debt for much less, given that certain creditors don't negotiate with them.
According to a report by the Center for Responsible Lending, an independent research and policy organization, most consumers would have to settle at least four accounts to receive the net gain. Additionally, the amount of debt can increase as fees accumulate and aggressive attempts to collect might continue throughout the negotiation process.
You must pay the cost for each debt that is settled by law. These companies can't charge you up front fees. Most of them offer a percentage on each settlement, which is based on that debt's balance at the time you signed up to it in the program. Some charge a percentage of the debt that is eliminated through the settlement.
For example, say you owe $10,000 and your agency negotiates with you a deal for $6,000. The agency is charged 25%.
If the agency charges a percentage of settled debt then you'll pay the creditor $6,000 while paying to the agent $2,500 for charges (25 percent of the total balance enrolled). Total: $8,500.
If the agency has a percentage charge for eliminating debt, you'll pay the creditor $6,000 , and the agency $1000 in fees (25 percent of the $4,000 in deleted debt). Total: $7,000.
Additional fees will be charged in addition to the charges due the debtor when the debt is settled clients may be charged additional costs, including the setup fee and the monthly cost to keep the account set up under the program.
The debt that you forgive could be tax-deductible Also, you should know that Internal Revenue Service generally regards forgiven debt as income. It is possible to speak with an expert in taxation regarding any the additional taxes you'll be liable upon settling your debt.
If you choose to hire a debt settlement professional, be careful. It's easy to let your guard down when you're feeling desperate and are able to see the promises from . The National Consumer Law Center has declared that debt settlement companies are "almost never worthwhile and can get consumers into even deeper financial troubles."
The Consumer Financial Protection Bureau takes a somewhat softer view, however, it warns consumers to be cautious, saying that dealing with these firms is risky and that other options should be explored before. There have been more than 350 complaints filed against debt settlement companies to the CFPB from 2014. Among the most common claims included fraud and fees that were too high.
Alternatives to debt settlement
Michael Bovee, a debt settlement coach, and a frequent critic of his field (he has been a witness before the Federal Trade Commission in favor of greater regulation), advises erasing your debts through Chapter 7 bankruptcy and starting from scratch, if you've got the option.
For borrowers who are overwhelmed by debt that is not secured, such as credit cards, consider how your options compare, like . A is almost always a better option. A bankruptcy can ruin your credit for years however, the process of rebuilding is able to begin right away. Consultations with a bankruptcy attorney are generally free, however you'll be charged filing and legal fees if you choose this option.
"If you're able to eliminate your debts in bankruptcy, such as a Chapter 7 bankruptcy, that's the best option over trying to reach settlements," 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 considered for an Chapter 13 repayment plan -in the event that you are considering debt settlement."
If you're not eligible for bankruptcy, or do not intend to declare one, you might consider an offer through a non-profit . Going that route will not generally reduce the amount that you'll have to repay, but it may lower your monthly payments by spreading them out, or by reducing your interest rate. It's not going to have a greater impact on your credit than bankruptcy or a debt settlement.
If you choose to go for settlement
If you feel that it is the best option or the most suitable 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 if there's a history of complaints.
Beware of any business that seeks money in advance or guarantees that the debt will be paid.
Make sure fees are structured in a proportion of debt canceled instead of debt balance at enrollment. This provides the business with a reason to reduce your debt.
Beware of companies who promise to assist you in resolving debts in order to declare them "invalid" (a strategy that could backfire, resulting in more aggressive actions at your expense).
If you don't want to work with a company for debt settlement, consider using an attorney or making it your own.
A lawyer can charge by the hour, have a flat fee per creditor or charge a percentage of the debt or debt eliminated.
Once you're significantly behind, it usually doesn't hurt to approach your creditors. Some banks have hardship programs that could aid. Be sure to pay for any payment plans that your bank might provide.
If you're interested in trying to do it, learn the likely outcomes.
It is possible to collect enough cash are able to to make a lump-sum offer, whether this means doing a part-time job, selling sports equipment that's been languishing in the basement, or getting money through your friend. (Creditors might be more likely to accept a lump-sum deal as it allows them to pay quickly, instead of risking the possibility of not receiving payments.) Be aware that certain creditors might have a policy against settling the debt.
The author's bio: 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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