Is Debt Settlement Right For You?
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You’ve been putting more on your credit cards, trying to keep up. Now, it feels like there isn’t a way out. Credit cards can be helpful but come with high interest rates, making them tough to pay back. This is evidenced by the fact that credit card balances rose to $1.03 trillion in Q2 of 2023, according to the Quarterly Report on Household Debt and Credit. If you’re looking for ways to get out of debt and become debt-free, debt settlement is an option. But what is debt settlement exactly and is it the best option? Find out more in this debt settlement guide.
What is Debt Settlement?
Debt settlement is a service offered by some companies where they work with your creditors to settle your debt, so you pay less than you currently owe.
These for-profit entities typically work with consumers with a lot of credit card debt for a fee. The company works on your behalf to help negotiate a lower amount so you can “settle” the debt. Typically, this means paying a lump sum amount.
While debt settlement can sound like an attractive option for consumers who want to be debt-free and pay less, there are risks involved.
What to be Aware of When Considering Debt Settlement
Paying less than you owe, sounds great right? If you’re feeling the burden of debt, this can seem like a no-brainer. However, the debt settlement process can have a long-term, negative impact on your credit and finances. On top of that, some debt settlement companies promise you “debt relief” or “debt forgiveness,” and don’t deliver on their promise and may not be legitimate.
Even if the companies are legitimate and vetted, there are no guarantees that your creditors will end up agreeing on a settlement.
Don’t Miss Out: The IRS writes off millions in tax debts.
How the Debt Settlement Process Works
Debt settlement companies typically suggest that you stop making payments on your credit card balances. Creditors are less likely to agree to a settlement if you can currently afford to pay your debt. Depending on your circumstances, you may already be delinquent on your credit card debt and unable to make payments.
Your debt settlement company will tell you to put funds aside each month in an account. The funds in that account are used to make a lump sum payment when a settlement is reached — which could take several years.
During the waiting period to see if you can settle or not (because it’s not guaranteed), your credit score can take a significant hit since you’re not making payments on your credit cards. Expect these delinquent payments to stay on your credit report for seven years. That may end up hurting you if you’re looking to rent an apartment, obtain a mortgage, or an auto loan.
There might also be late fees, interest, and the possibility of a lawsuit as well. Compare these costs with what you have to gain from debt settlement.
If the debt settlement company is able to reach a settlement amount, it may be up to 50% less than what you owe. Only then is the company able to take their fee, which is generally about 15% to 25% of what you originally owed or based on the settlement amount. Even if you do make payments and end up settling your debt, it can negatively impact your credit score and show up on your credit report.
Additionally, any amount that is forgiven through a debt settlement may be considered taxable in the eyes of the IRS. So if you owe $20,000 and settle with a lump sum payment of $15,000, the $5,000 is discharged and considered taxable income. However, if your financial situation is dire and you can prove you’re insolvent, the IRS may not hold you responsible for the taxes.
Help With Your Debt
Pros and Cons of Debt Settlement
Debt settlement isn’t something to consider lightly. It may be beneficial for some consumers, but it comes with a level of risk and some potential long-term consequences. Here are the pros and cons of debt settlement to consider before making any moves.
Pros:
- Pay less than you owe.
- The company works on your behalf.
- Have an action plan to be debt-free.
Cons:
- Interest, fees, etc. may reduce your savings.
- No guarantee that a settlement will be accepted by creditors.
- Adversely affects credit score.
- Stays on credit report for seven years.
- May have to pay taxes on the forgiven amount.
Other Options to Consider
If you feel like your debt has become unmanageable and it’s causing a lot of anxiety, you want help and support. Debt settlement is one option, but there are debt settlement alternatives to consider as well.
Work with a Non-Profit Credit Counseling Agency
There are non-profit credit counseling agencies that can offer guidance and support. You can get a free consultation and come up with a plan. The company may put you on a debt management plan, which can help you pay off debt and comes with a low fee.
The agency works with your creditors to minimize fees and reduce monthly payments. You then pay the agency who pays the creditor. Unlike debt settlement, a debt management plan should not affect your credit. Review the National Foundation for Credit Counseling (NFCC) for more information and options.
Take Control: Find out if you qualify for debt relief.
DIY Settlement
Instead of working with a company that will take a cut to settle your debt, you can also try to do it yourself. Call up your creditors and discuss your situation. Let them know the amount you can pay in full and see if they’ll accept a lower amount.
Bankruptcy
Though it’s not ideal and can also adversely affect your credit, you can consider bankruptcy. Chapter 7 bankruptcy is an option for consumers who no longer can make payments on their debt. This option may help discharge debt and be faster than debt settlement, as it can take months instead of years.
A Chapter 7 bankruptcy will also come with some costs and negatively impact your credit, staying on your credit report for 10 years.
Consider All Options
If you’re anxious about your credit card debt and want a solution, it’s easy to rush into something that you think will fix the problem. Debt settlement can be a gamble and all the players on the market may not have your best interest at heart. Research companies, customer reviews, and information on the Better Business Bureau (BBB). Compare all of your options so you can make the best move for your situation, without any surprises, and sign up to be a Consumer INsider today!
