Debt Settlement: The Good, the Bad, and the Ugly

Debt Settlement Pros and Cons

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Are you currently carrying more debt than you can handle?

If so, then it’s time to look for options to get rid of that debt faster. In the best case scenario, you can make bigger payments to try to pay your debt down. In the worst case, you could discharge your loans in bankruptcy, although you will carry that on your credit score for up to ten years, making it harder to get future loans.

Or, look to entirely different options like debt settlement to relieve your current debt burden. If you’re not sure how to get out of your present financial bind, a settlement may be the most accessible pathway towards freedom from debt. But before you get started, it’s critical to know about these debt settlement pros and cons, so you make an informed decision for your financial future.

Debt Settlement: The Basics

In the most straightforward sense, debt settlement means working with a settlement company to come up with an agreed-upon payment to settle any open accounts you have. You’re not taking out a new loan, but instead, working with the company to negotiate lower payoff amounts with each of your current creditors. When debt settlement terms are successful, you’ll pay less than you owed on your accounts in order to settle them.

It sounds easy, but is it?

Not all debt can be handled through a settlement. This process is ideal for those with high unsecured debts, like credit cards, which usually carry higher interest rates, making it harder to keep up with repayment. However, you can’t settle on loans that are secured by an asset, such as a house or a car, and you can’t use it for federal student loans.

Three people meeting around a table discussing documents.
Overwhelmed by your balances? Debt settlement may help.

The Prime Candidates For Debt Settlement

Debt settlement should be thought of as a last-resort option. If you can pay off your debt, you’re better off saving or taking out a personal loan through a company like Avant that could reduce some of your higher-interest debt.

But if you can’t qualify for a loan that has better terms than what you currently owe, it’s time to start thinking about a settlement. If you’ve missed or made late payments consistently, feel overwhelmed by collections, and have already hurt your credit score, debt settlement may be right for you.

Finally, the best candidates for debt settlement have four or more accounts. If you’re late to pay on one or two of your debts, you’re better off finding a different method.

Choosing A Debt Settlement Company

When it comes to debt settlement pros and cons, your choice of settlement company will impact your overall success. They are the ones who will ultimately negotiate your new payment, so you want to find a company that you feel supports you.

You’ll make new payments going forward directly to the debt settlement company who will then make sure your creditors are paid and will deduct their fees or any commissions owed.

Group of people sitting around a table with a laptop.
If you need help getting out from under your debt, it’s time to meet with a settlement company.

Once you sign up with a company, one of the first things they will advise you on is to cease all communication with your existing lenders or with any debt collection agencies. This can be a hard step to take as you run the risk of hurting your credit score even more than your debt may have already. However, these companies have a reason for using this method: it makes lenders and collectors sweat. When you’re not answering their calls or responding to letters, they are left wondering if they’ll ever see a penny of the debt you owe.

When a settlement company comes in on your behalf, the lenders are then more likely to take the lower payoff deal offered. They’re happy to get any of that loaned money back and so will allow you to settle your debts for a lower amount than what you owe.

How Debt Settlement Works

It’s important to work with a legitimate debt settlement company that you trust if you’re hoping to be helped more than hurt. When you stop paying your creditors, you want the people who are supporting you to be there when they say they will.

As soon as you start working with a company and they’ve advised you to ignore any payments, you’ll start contributing funds to a savings account that will cover your “new” monthly payments. Again, you’re not paying your existing creditors at this point, which means you have the money available. Once your account reaches a certain balance, the settlement company will present your creditors with an offer for a lump sum payment less than what you owe.

Woman looking at a calculator in surprise.
Surprised by those balances?

Debt Settlement Pros And Cons: Is It The Right Choice For You?

With debt settlement, you are not taking out a new loan or increasing your debt in any way. However, there are some reasons why debt settlement may not be the right choice in your situation, so it’s essential to be well-informed before making your decision.

Pros

  • The most significant advantage of debt settlement is that you will pay less money to settle your debts than you currently owe. In fact, you could potentially cut your debts down by 50% with the right settlement.
  • You’ll also get a lower monthly payment going forward that covers all of your debt, making your payments easier and more straightforward.

Cons

  • Debt settlement can hurt your credit. Therefore, if you already have poor credit due to your ongoing debt, you’re an ideal candidate for settlement.
  • The first thing debt settlement companies tell you is to stop paying your debts and ignore all calls. During this period, your lenders will keep reporting your payments as late or missed, which can further hurt your credit score.
  • Lenders and collectors will report debt settlements to the credit agencies. Rather than reporting your balances as “paid in full,” they’ll likely report your payment as a settlement for less than the agreed amount. When that happens, you’ll have this note on your credit report for seven years.
  • You can still be bombarded by collections calls, fees, and even potential lawsuits while working with a debt settlement company.
  • You’ll still accumulate interest, late payment fees, and other penalties as your balance grows on your existing accounts.
  • You’ll want to do due diligence on the settlement company you work with, so you understand how much of your payments are going to your debt, and how much is going to them for fees or commissions.
  • It can take years for debt settlements to be handled, which means extra accumulated payments to your settlement company in addition to the ongoing hits to your credit.
  • The debt that was forgiven may still be subject to federal tax, as the IRS often considers it to be income.
  • There is never a guarantee that a creditor will accept a settlement offer.

Debt Settlement Scams

Unfortunately, the debt settlement industry is ripe for corruption, and there are quite a few fraudulent companies who promise false hope. It’s crucial that you research and get to know any debt settlement companies you work with so you can avoid any scams.

Protect yourself and your financial future by taking these steps:

  • Research the company to see what others have said.
  • Don’t work with companies that contact you out of the blue, and instead, focus on those that you initiated contact with.
  • When free consultations are offered, ask the company questions like how long they’ve been in business, the background and education of their employees, and the average savings they’re able to get for customers.
  • Never pay upfront.

What Else Can You Do To Relieve Your Debt?

If debt settlement isn’t right for you, what other options do you have to help yourself get out of debt?

Get a personal loan through Payoff to help get rid of credit card debt. With rates starting as low as 8% APR, you can qualify for a loan with a lower rate than your cards, paying them off and reducing your accumulating interest.

Notebook with the words debt relief written in it.
Debt relief is possible.

You could opt for Chapter 7 bankruptcy when carrying too much unsecured debt, although you would still be dealing with a mark on your credit report for years to come.

If your debt could be under control but you have just let it get away from you, consider a nonprofit debt management or credit counselor. You won’t see the same negative impact on your credit score, and you can get help figuring out ways to make your payments easier on yourself.

You also have the option of working as your own debt settler; try getting in touch with your lenders directly to see if they have any options for directly negotiating a settlement or other repayment options.

If your debt is too much for you to handle, it’s time to get proactive in moving forward. Whether you choose debt settlement or another pathway to debt relief, remember that you can make a change, but it will take time, patience, and effort.

 

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