If you’re drowning in debt and struggling to stay afloat, you may be considering a debt settlement program. But is it an ideal solution? It depends on your situation, so carefully consider the benefits and drawbacks of debt settlement to decide if it’s the route you should take.
How Debt Settlement Works
Debt settlement involves settling unsecured debts for less than what’s owed. You can negotiate directly with creditors or hire a debt settlement company to do the work for you.
If you hire a company to negotiate on your behalf, below is a detailed breakdown of what to expect:
- Step 1: Research debt settlement companies and select the best fit.
- Step 2: Connect with a debt consultant at the company you choose to discuss your situation and determine your eligibility for a debt settlement program.
- Step 3: If you’re a good fit, the debt consultant will develop a plan of action that complements your debt settlement goals.
- Step 4: You’ll enroll in the program and begin making the agreed-upon monthly payment to a dedicated account. The funds will be used later on down the line to cover settlement agreements as they are reached with creditors. (Note: Enrollees typically stop making payments to creditors to expedite the debt settlement process).
- Step 5: Once the balance of your dedicated account reaches a certain amount, the debt settlement company will start negotiating with your creditors.
- Step 6: Each time a settlement agreement is reached, you need to review and approve the terms.
- Step 7: Upon approval, the creditor will receive funds from the dedicated account to settle the account.
- Step 8: Continue making payments to the dedicated account until all the debts enrolled in the program go through the negotiation process.
Benefits Of Debt Settlement
Before you enroll in a debt settlement program, be mindful of the benefits they offer:
Lower Your Debt Amount
The debt settlement company you choose may have luck getting creditors to accept up to 50 percent less than what’s owed. Consequently, the constant letters and collection calls will stop, and the creditor will no longer threaten to sue you in court for the unpaid balance once they agree to the settlement and receive funds.
Pay Off Your Debt Faster
Depending on your outstanding debt balances, most debt settlement programs are designed to be completed in just 24 to 48 months. You could resolve your unsecured debt faster in some instances, but most important is that you make timely payments to your dedicated account each month. The quicker the balance grows, the sooner the debt settlement company can start working on your behalf to reach fair settlements with your creditors.
Avoid Bankruptcy
Bankruptcy is an alternative to debt settlement, but creditors frown upon it. Furthermore, it has more severe consequences for your credit health over time. For example, a Chapter 13 bankruptcy will remain on your credit report for seven years, and a Chapter 7 bankruptcy will linger for 10 years.
Disadvantages of Debt Settlement
Unfortunately, there are also drawbacks that come with debt settlement programs to consider:
Creditors May Not Agree
No concrete rule or law mandates creditors to accept debt settlement offers. Some will deny your request or avoid negotiating with debt settlement companies altogether.
It May Hurt Your Credit History
If you decide not to pay your creditors once enrolled in a debt settlement program, each new late payment could tank your credit score. And if the account is charged off, your credit score will take another hit.
Debt Settlement Fees
Debt settlement companies usually collect a fee each time they help you resolve a debt. It can range from 15 to 25 percent, which is costly if you have several debts enrolled in the program. However, the funds are taken out of your dedicated account, so you won’t have to come out of pocket.
Tax Consequences
You’ll be on the hook for federal income tax if the creditor forgives $600 or more of your outstanding debt balance. So, if your balance is $30,000 and the creditor agrees to a settlement of $15,000, the IRS requires you to add $15,000 that’s forgiven to your taxable income.
Alternatives To Debt Settlement
Not quite sold on the idea of settling your debts for a fraction of what you owe? Here are some alternatives:
Debt Consolidation
You can take out a debt consolidation loan to roll all your high-interest debts into a single loan product, preferably with a lower interest rate. But here’s the catch: you’ll need good or excellent credit to qualify for a loan with competitive terms. And even if you are approved, the payment could be too steep for your budget as the loan terms generally range from three to five years.
Bankruptcy
Bankruptcy is another option to possibly find relief from overwhelming debt. Chapter 13 requires you to make monthly payments to a court-appointed trustee for three to five years before getting a clean slate. Chapter 7 takes three to six months, but your income must not exceed a certain amount to be eligible. Either way, both mean bad news for your credit health and could have lasting financial consequences. Therefore, you should only file bankruptcy after you’ve exhausted all other options.
DIY Debt Settlement Vs. Hiring A Debt Settlement Company
While debt settlement could mean bad news for your credit score, you could also get much-needed relief from overwhelming debt balances in just a few years. Plus, you won’t have to file for bankruptcy, and your credit score will start to improve over time as you resolve debts and take the proper actions to begin rebuilding your credit health.
You can take the DIY approach to settle your debts, but your creditors may not be inclined to work with you. A better option: hire a team of dedicated professionals who can effectively negotiate with creditors to get results.
