When you’re struggling with overdue debt, you may wonder whether debt settlement is the right way to take care of it. It may be a workable option, depending on which approach you take: relying on a third-party debt settlement company or settling the debt on your own.
Experts warn that using a debt settlement company can be a costly, risky alternative. Meanwhile, a DIY settlement plan may work, but it can be tough to carry out.
Read on to learn about the ins and outs of working with a debt settlement company.
Accredited Debt Relief
Fee for Settlement
15% to 25%
Founded
2011
BBB Rating
A+
15% to 25%
2011
A+
The Basics of Debt Settlement
Debt settlement, also known as debt negotiation, involves wiping out debt by paying a portion of it in one lump sum. This sum typically is much less than what you originally owed.
For the borrower, debt settlement can provide financial relief and put them on the path toward rebuilding their credit. For the creditor, debt settlement enables them to receive at least some of the money they’re owed rather than no money at all. Furthermore, it may mean the borrower can avoid filing for bankruptcy. Although, according to some experts, filing for bankruptcy may be the better alternative in some cases.
Normally, debt settlement involves money you owe to credit card issuers, rather than other types of debt. But you may be able to settle other unsecured debt as well.
How Debt Settlement Works
Debt settlement handled by a debt settlement company differs from taking a DIY approach. Here’s what the process looks like when hiring a debt settlement company.
1. Research debt settlement companies. A number of legitimate debt settlement companies operate in the U.S. Most states require that they be licensed. Debt settlement companies are supposed to follow industry regulations that are designed to protect consumers and their money.
2. Be cautious. If a debt settlement company promises certain results, proceed carefully. For example, they can’t guarantee that a creditor will even agree to a debt settlement. In the course of your research, check the websites of your Better Business Bureau, your state attorney general’s office and consumer protection agencies like the federal Consumer Financial Protection Bureau (CFPB).
3. Ask about costs. Once you’ve zeroed in on a debt settlement company, inquire about how much it charges for debt settlement. If the company skirts your questions about costs, this may signal that it’s a shady operation. Debt settlement companies typically charge a 15% to 25% fee to tackle your debt; this could be a percentage of the original amount of your debt or a percentage of the amount you’ve agreed to pay. Let’s say you have $10,000 in debt and settle for 50%, or $5,000. On top of the $5,000, you could be required to pay another $750 to $1,250 in fees to the debt settlement company.
4. Review your finances. Debt settlement companies frequently require you to put money into a special savings account for 24 months or longer before the debt is completely settled. These payments go toward the lump-sum settlement of your debt. In some cases, you may find it hard to keep up with these payments. Therefore, you might give up on the settlement agreement before all or some of your debt is cleared. To avoid this scenario, go over your budget to see whether you’d be able to afford debt payments for 24 months or more.
5. Inquire about the timetable. It often takes two to four years to complete the debt settlement process. Over that time, you may accumulate interest and fees charged by the creditor, in addition to the fees charged by the debt settlement company. Why might you be hit with interest and fees by a creditor? Because debt settlement companies often suggest that you stop making payments to your creditor while you’re working with a settlement company and, instead, shift that money to a special savings account. Be aware that if you’ve halted payments to your creditor, you may be contacted by debt collectors or may even be sued.
6. Select a debt settlement company. If you’re fully aware of the potential pitfalls and ready to move ahead with debt settlement, it’s time to pick a debt settlement company based on your research.
7. Nail down the details. Before doing business with any debt settlement company, make sure you’re clear about the timetable and the fees. Also, ask how many of your initial payments will go toward the company’s fees, and how much money you’ll end up paying over time.
8. Know the tax consequences. The IRS views any forgiven debt as taxable income if it exceeds $600. So, if you settle a $10,000 debt for $5,000, the $5,000 that was forgiven likely will be taxed.
Accredited Debt Relief
Fee for Settlement
15% to 25%
Founded
2011
BBB Rating
A+
15% to 25%
2011
A+
The Risks of Debt Settlement
Debt settlement may be good or bad, depending on your situation. Here are some potential risks associated with debt settlement.
Negotiation Problems
The hard truth is that the creditor may reject the settlement offer. Therefore, you and the debt settlement company may need to submit a counteroffer. You might also be forced to reach out to the original creditor to see whether you can work out a payment plan. In the worst-case scenario, you may owe more than you did initially, and a rejected settlement offer may push you toward bankruptcy.
Increased Debt
Fees paid to a debt settlement company or fees and interest charged by an original creditor could add hundreds or even thousands of dollars to your debt.
Negative Impact on Credit Score
Because creditors are motivated to settle a debt only when they think it’s the only way they’ll get paid, your accounts may already be past due, or will become past due as you make payments to the debt settlement company. A debt settlement will cause your credit score to drop—perhaps by more than 100 points—and the damage could last for a while: A debt settlement remains on your credit report for at least seven years.
Alternatives to Debt Settlement
If you find yourself weighed down by debt, you’ve got several options that incur less risk than debt settlement—whether that means working with a debt settlement company or conducting DIY debt settlement negotiations. Here are four alternatives to debt settlement.
Balance Transfer
You may be able to shift your debt through a balance transfer to a credit card that offers a 0% APR for an introductory period, for perhaps as long as 18 months. If you pay off the balance before the 0% period expires, you can avoid racking up interest on the debt.
Debt Consolidation Loan
A debt consolidation loan may enable you to combine several debts into one manageable monthly payment at an interest rate that’s lower than what you’re paying now.
Nonprofit Credit Counseling
Visiting with a counselor at a nonprofit credit counseling agency can help you get back on your financial feet. Among other things, a credit counselor can help you create a budget, make recommendations about debt consolidation, advise you about closing at least some of your credit card accounts or counsel you regarding bankruptcy.
Debt Management Program
One of the tools at the disposal of a nonprofit credit counselor is a debt management plan, or debt management program (DMP). If you’re enrolled in a DMP, the counselor will consult with your creditors to come up with a debt repayment plan that combines your debts into one monthly payment—a payment that may be lower than the total of all the payments you’re making now.
Next Steps If You Want to Go Ahead With Debt Settlement
If you want to proceed with debt settlement, be sure to consider the impact this will have on your credit. For instance, how low might your credit score go, and how long will the debt settlement linger on your credit report? And how much will the debt settlement company charge for negotiating with your creditors?
Bottom Line
Debt settlement done through a company comes with significant risks. Therefore, it’s important to weigh the potential alternatives, such as debt consolidation or nonprofit credit counseling, before committing to a relationship with a debt settlement company.
Frequently Asked Questions
What percentage of a debt is typically accepted in a settlement?
Generally, you can expect a creditor to agree to repayment of around 50% of the total debt owed. In settling your debt, the creditor is agreeing that it is better to receive a partial payment than to risk receiving no payment.
How does debt settlement affect your credit?
Debt settlement can cause your credit score to fall by more than 100 points, and it stays on your credit report for seven years. If your creditors close accounts as part of the settlement process, this can cause your credit utilization to increase, which also negatively affects your credit score.
Can you negotiate debt settlement yourself?
Yes, you can negotiate debt settlement yourself, although it may take a decent amount of time and patience to make it happen. You’ll need to have the cash resources on hand to make any required payments. And remember that your creditors are not required to accept a debt settlement.
