What Is Debt Settlement and Is It Worth It?

FT Contributor  | 

Debt settlement is a service offered by third-party companies to help you get out of overwhelming debt. If you qualify for debt settlement, the company negotiates what you owe your creditors into one lump sum, generally less than the balance you owe. You’re responsible for paying this lump-sum to satisfy the settlement, as well as a fee to the company. With this deal, you’ll generally owe less money to settle the debt and debt collection agencies are no longer involved. You can also avoid getting sued over debt by a creditor.

It sounds like the perfect solution, doesn’t it? Keep in mind, however, that there can be drawbacks to these debt resolutions. A debt settlement negatively affects your credit report for seven years. Depending on the terms of the specific settlement, you may not save much money in the long run. It’s important to analyze your situation, as well as the pros and cons of the debt settlement negotiation, when determining if this solution is right for you.

How Debt Settlement Works

You can contact debt settlement companies after you’ve missed a significant number of payments. In most cases, a resolution can only be reached if it seems you will not attempt to pay back the debt at all. Debt settlements are also usually only used for credit card settlements or medical bills and not for loans, such as home mortgages.

The company you hire to assist with debt settlement contacts the credit card company on your behalf to negotiate the balance you owe. Once a settlement is agreed upon, you are responsible for completing the payment and paying the settlement company any fees you owe.

You can also choose to go at it alone and negotiate reduced credit card payments and forgiveness with the credit card company directly. However, the credit card company may not take you seriously or be willing to offer a helpful negotiation without professional assistance.

Debt Settlement Companies

If you want help settling your debt, a debt settlement company can complete the negotiations for you. However, it’s important to conduct thorough research before trusting a third-party company. There are many debt settlement companies, some of which may be fronts for scams, and some of which may charge hefty fees that will make it impossible to get out of debt.

It’s typical for these companies to charge you a fee or a percentage of the money saved in the settlement. However, it’s your job to ensure this deal will still help to better your financial situation. Therefore, before you agree to hire a specific company, calculate the money you’ll owe for the service and ensure it makes sense financially for you.

Debt Settlement Scams

If you’re desperate for a debt settlement, you may be an easy target for an illegitimate third-party company. When identifying the best debt settlement companies for your situation, it’s important to analyze the specific terms of the agreement. If a company sets unrealistic expectations, such as a promise it can reduce your debt by at least 50 %, consider it a red flag. If the company ploys aggressive marketing tactics or hounds you for personal information right away, you should also be leery that it’s a potential scam and not looking out for your best interests.

A legitimate debt settlement company won’t make any firm promises upfront and will provide you with a detailed outline of the fees you will owe for the settlement. A trustworthy company is accredited and will also have past customer reviews and good ratings available for you to look over.

If you haven’t yet missed a payment but are struggling to continue paying your debt, a debt resolution company may be right for your situation. Debt resolution companies employ the assistance of an attorney to complete negotiations with the credit card company. The attorney may be able to negotiate a lump-sum payment or payment plan with your credit card company for less than the amount you owe.

Expenses associated with debt resolution may be higher than a settlement company since you’re hiring an attorney to represent you. However, since you haven’t skipped any payments, you won’t have to worry about credit card charge-offs or collection agencies. Therefore, you may experience fewer negative effects on your credit score and history.

Debt Settlement Pros and Cons

While a settlement may seem like the easy way out from under a pile of mounting debt, it’s important to understand that it’s not the perfect solution. There are pros and cons to choosing this route, and you should be aware of these before attempting to resolve your debt in this manner.

Pros

  • You can avoid declaring bankruptcy.
  • Debt collection agencies can no longer contact you.
  • Large debts may become more manageable, including credit card or medical bills.
  • You can lower the debt amount you owe.
  • You may be able to repay your debts in less time.

Cons

  • Your interest charges will increase from skipping payments.
  • It can take years to complete a debt settlement.
  • You’ll experience a growing negative account balance.
  • Debt settlement will negatively impact your credit score and remain on your credit report for seven years.
  • The IRS will tax your settlement as “forgiven income.”
  • You’ll owe a percentage fee of the settled debt amount to the debt settlement company.
  • There is no guarantee your creditor will agree to a settlement, which will leave you with a larger debt than before.

Alternatives to Debt Settlement Programs

Since there are many risks associated with a debt settlement, it should only be used as a last-resort solution. Before you stop making credit card payments and decide to rely solely on a company to settle debt, consider alternative options, including:

  • Debt counseling. Consumer credit counseling teaches you important skills in personal finance management so you can learn how to get and stay out of debt.
  • Debt consolidation. Consolidate several debts into one and use home equity loans, personal loans, or credit card balance transfers to manage your current debt.
  • Debt management plans. Using a debt counselor as a resource, you can create a plan and account with a counseling agency to help you become debt-free.

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This post was updated August 12, 2019. It was originally published August 13, 2019.