Everything You Need to Know About Debt Settlement
Debt settlement is viewed by heavily indebted borrowers as a way of permanently escaping bills and creditors - but is it the best approach?
Debt settlement companies often offer to save indebted borrowers up to 50% of their outstanding balance be it from credit card, loans, or other type of unsecured credit. They typically try to do this by negotiating with your creditors on your behalf. While it may work in some cases, it’s by no means guaranteed.
Take a closer look at the process to help determine if it’s the right for settling your outstanding balances.
What is Debt Settlement?
It is a process of negotiation between the company and the issuer of whatever debt you’re trying to reduce.
- The end goal in this matter is for your credit issuer to agree to settle your outstanding debt in a single lump payment that’s lower than your total outstanding amount.
- Even though the credit issuer will make a loss in this scenario, it’s still better than a total default. You could say that debt settlement works based on the idea that “something is better than nothing”.
- In exchange for negotiating this type of settlement, the company will typically charge you a percentage of either the total outstanding amount or the amount they save you.
How Does It Work?
The first step towards proceeding with debt settlement is picking the appropriate company based on your needs. The chosen company you appoint will contact your credit issuer and try to negotiate a lump sum settlement with them. They may ask you to stop making payments on the debt and pay the funds into a special savings account instead - this is supposed to help you save up the total payment that they will offer your credit provider.
- For example, if you have a maxed-out credit card that’s right on the $10,000 limit, a debt settlement company may offer the card issuer $6,000 as a final agreement.
The company will probably ask you to stop making payments so that the account goes into temporary default, thus adding motivation for the card company to settle.
- The card firm may be more likely agree for a lower amount rather than have you default altogether.
- If they agree to the $6000 settlement, you’ll need to pay them in either one total or a few smaller payments.
- The debt settlement company will then charge you a fee, usually a percentage of the total debt or the amount they saved you.
- This amount will be due after you’ve made your first payment to the creditor.
Pros and Cons
Debt Settlement is a tricky process that is accompanied by its fair share of pros and cons. Weigh them up to determine if pursuing it, is an appropriate outcome given your current financial circumstances.
- You won’t need to negotiate with creditors - a debt settlement company may have more negotiating experience than you.
- Saving on a lower lump sum - this could amount to several thousand dollars, depending on how large your debt is.
- You’ll be free of debt collectors.
It’s important to remember that these advantages only apply if and only if your firm succeeds in negotiating a total settlement.
- If the negotiations fail, you’ll be back where you started - and you could end up owing more than before.
- You may be charged late payment fees and penalties by your credit issuer.
- Your credit score could drop significantly.
- The credit issuer involved may refuse to negotiate with your debt settlement company.
- You’ll need to pay a substantial fee - some companies charge a percentage of the total debt, regardless of how much they save you.
- Any amount you save in debt payments could be counted as taxable income.
Going back to our earlier example, if your company manages to secure a $6,000 lump sum payment on the $10,000 balance that you owe, you could save $4000. However, you’ll also need to pay the company a commission, which could come to $1000-$2500, depending on your agreement.
Additionally, you may also be liable for fees charged by your card company - not to mention the effect the settlement process could have on your credit score.
This could cause your APR on future credit to rise, costing you thousands of dollars in the long term.
Debt Settlement Companies
Debt settlement is a complicated process since there’s no guarantee of a successful outcome. Therefore, you may be wondering what makes a good company and how to choose one. These are some of the highest-ranked offerings in the industry.
Each of these companies are run in a way that maximizes the benefit they offer their customers thanks to transparent fees and program lengths. Each of these services also covers a wide range of debt types. Most companies specialize in a particular type of debt, while some are good at dealing with general debt settlements.
For example, Accredited Debt Relief is one of the best overall negotiators, while DMB Financial specializes in high interest credit card debt.
Keep these questions in mind when choosing from amongst the range of companies:
- Are their fees transparent? You’ll need to know how much you will be paying in fees, especially the percentage of your debt that you’ll be charged as a commission.
- How long will the debt settlement take? This timeline varies between companies, but it’s usually somewhere between 12 and 60 months.
- What total amounts will they take on? Again, this varies. Most companies require a minimum debt of $7,500-$10,000 before they’ll sign on a new client.
Make sure that you’ve weighed up the pros of dealing with debt settlement companies against the fees and commissions you’ll be required to pay, as well as other potential drawbacks before you make your final decision.
Alternatives to Debt settlement
There’s absolutely no question that debt settlement can be a hit-and-miss process. If you’d rather avoid the risk of an unsuccessful negotiation, there are other options you can explore. It’s not recommended that you go straight for debt settlement. In fact, it’s really a last resort option in most cases. Here are some other ways of getting your debt under control before taking the settlement route:
- A consolidation loan - This will let you pay off multiple debts at a lower APR, and you won’t be tempted to use the accounts while you’re paying them off.
- A balance transfer credit card - This will allow you to shift your debt from a high APR card to a new card with a promotional interest-free period, usually 6 months. Make sure you can repay the debt in this time, before interest charges are added from month 7 onward.
- Filing Chapter 7 bankruptcy - Only designed for very specific and special circumstances, you’ll want to consult a lawyer and financial planner before taking this more extreme route.
Debt settlement is a service that offers you the possibility of paying off large unsecured debts while saving money in the process. Still, it is worth remembering that the outcome of negotiations can never be guaranteed.
It may be a good last resort if you’ve exhausted all of your other debt management options. Always carefully weigh up the pros and cons before you pursue this strategy to ensure it’s the right fit for your financial circumstances.