What to Consider with Debt Settlement
Advertiser Disclosure: Our first priority is to provide valuable information to help our readers gain insight into financial topics. Although we receive compensation from some of the brands listed on our site, we only highlight companies we believe can benefit our readers and their financial situations.
From 2022 to 2023, the average American’s credit card debt grew 16.6%. The good news is if you’re struggling with credit card debt, there may be an option beyond simply paying it off slowly: debt settlement.
Debt settlement means settling your debt for less than you owe, thereby saving money. Sounds great, right? I mean, who doesn’t like paying less.
But, debt settlement is a complicated topic and it can result in some unexpected hurdles you should be aware of. Read below to learn all about how debt settlement works – and if it’s worth it.
What is Debt Settlement?
Many companies and organizations use the words “debt relief” and “debt settlement” interchangeably. No matter what you call it, here’s how the process works.
Let’s say you took out a loan a couple of years ago. Recently, you lost your job and couldn’t afford to keep making payments. Now, the loan has been sold to a collection agency that is trying to get you to pay them.
You are desperate for a way to resolve this so you contact a debt relief or debt settlement company. They promise they can settle the loan so you won’t have to make any more payments.
Debt settlement entails paying a negotiated percentage of the loan instead of the full amount owed. The lender agrees to this plan because they’d rather be paid something instead of nothing, and it can be a good deal for the borrower because they don’t have to pay 100%.
Research has found that about 98% of consumers who go through debt settlement save money. On average, a typical consumer can save $2.64 for each $1 they pay in fees. For example, if you pay $5,000, you could save $13,200.
However, there’s no guarantee that the lender will agree to a debt settlement plan. Not all lenders will be open to it, so you shouldn’t always count on it, even if it’s worked before.
How Does Debt Settlement Work?
Most individuals find it easier to hire a company to handle the debt settlement process for you, since they’re used to negotiating with the credit companies.
Most people who settle their debts end up paying between 10% and 50% of the total amount owed. Remember, this is a negotiation, so always start low.
Help With Your Debt
What are the Factors to Consider in Debt Settlement?
When you sign up with a debt settlement company, they may require that you stop making payments on that loan or credit card. This will provide more leverage when they make their settlement offer to the lender.
However, your on-time payment history is one of the most important aspects in your credit score. Even missing one payment could cause a 100-point drop in your score. If you miss several payments, your credit score will likely tumble dramatically.
Recovering from a debt settlement can take time. If you’re planning on buying a house in the next year or so, that might have to wait. Your credit score might be considered “bad” for a while before it improves.
But fixing your credit score is always possible – it will just take more time.
Alternatives
Debt settlement can have a negative impact on your credit score, so you can explore other options if you need your high credit score in the near future.
Contact the Creditor
Before you start the process of settling your debts, you should reach out to the lender directly. It’s best to do this before you miss a payment, while you’re still in good standing.
Ask them if they have any options and mention how much you’re struggling. If there are any extenuating circumstances, like if you lost your job or your child had to visit the hospital, you should mention that as well.
Do this for every credit card and loan you have. Your creditors may be able to put you on a temporary forbearance program that lets you defer your bills. If you owe medical bills, they can often put you on a 0% interest payment plan.
Also, some credit card issuers can provide a lower interest rate if you call and ask them.
Balance Transfer
If your credit is still in good shape, then you can apply for a credit card with 0% APR on balance transfers. This can help you pay down your balance substantially while avoiding interest fees.
Balance transfers do come with a fee though, often 3% or 5% of the amount being transferred. Also, the length of the promotional 0% APR period depends on the card. It can last as little as six months or as long as 21 months. Try to apply for a card with the longest interest-free period.
If you cannot transfer your entire credit card balance onto the new card, focus on the debt with the current highest interest rate. This will help you minimize interest paid. Remember, every dollar that doesn’t go toward interest can be used to pay down the principal.
Contact Social Services
If your income has dropped significantly, you may be eligible for social service programs that can save you money. For example, many utility companies have special deals for low-income residents.
Now is not the time to have pride. When you’re talking to a company, be specific about your circumstances. If you can show you’re eligible for special programs, you could get some extra relief from a lender or bill provider.
