Life is unpredictable, so it is not impossible to fall behind financially and get submerged with debts no matter how careful you are. But thankfully, there are many ways to help you get out of debt. According to the American Fair Credit Council (AFCC), one of the best ways to get out of your debt is through debt settlement, and according to their report, over 98% of cases, customers saw $2.34 in savings for every $1.00 fee assessed. This means if your debt were $15,000, a debt settlement would bring it down to around $9,000, saving you over $6,000.
But debt settlement comes with its own set of pros and cons, so is it the cheapest way to manage your debt? Or other alternatives like debt consolidation will serve you better? Let’s take a closer look.
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Table of Contents
What is Debt Settlement?
Debt settlement, also known as debt negotiation, involves wiping out your entire debt by paying a large portion of it in one lump sum. This sum is usually 10% – 50% of what you originally owe, but you need to agree with the creditor on what percentage, if any, to settle.
Debt settlement can bring financial comfort to borrowers while also putting them on the road to restoring their credit. Debt settlement is also beneficial for creditors as it enables them to collect at least a portion of the money they are due rather than having none at all.
Consumers may either settle their debts on their own or employ a debt settlement company to do it for them. In the latter case, you’ll pay a percentage of your enrolled debt as a fee to the business. The amount of debt you have when you enroll in the program is referred to as enrolled debt. The firm is prohibited by law from charging this fee until your debt has been cleared. Debt settlement fees often range between 20% to 25% but vary drastically between companies.
Who Qualifies for Debt Settlement?
Anyone having a substantial unsecured loan can apply for a debt settlement. There is no minimum amount, but typically the larger the loan, the greater incentive there is to apply for a debt settlement. Usually, companies settle for debts ranging from $7500 to $100,000, and this includes any credit cards, personal loans, payday loans, medical bills, business debts, and private student loan debts you may have. Debt settlements do not work for lawsuits, IRS debt, utility bills, or federal student loans. It also can’t settle auto or home loans as well as they are secured loans meaning the lender has collateral pledged for these loans.
Do You Need a Debt Settlement Lawyer?
Setting a debt is not a straightforward process as you need to convince the creditor about your circumstances, so they are willing to give up a big chunk of what you owe them. You can either choose to do it yourself, hire a debt consulting firm, or a debt settlement lawyer. They all have their pros and cons, and which one will be best for you depends on your specific situation.
If you are a people person and confident that you have a legit case that you can show to the creditor, like, having a medical emergency that restricts you from paying the debt, you can choose to represent yourself without the need of a settlement lawyer or debt settlement company. But do understand that you are on your own and a slight mistake can lose you a lot of money.
If you want to seek professional help, you can either choose a lawyer or a debt settlement company to present your case. Debt settlement companies usually charge a chunk of your savings, so it may be better economically to hire a lawyer; they also have the expertise to tackle a problem from a different direction, thus improving your chances of getting a good settlement offer. Also, if you get sued, your attorney will be there to your rescue, which you may not get by hiring a debt settlement company.
How Does Debt Settlement Affect Your Credit?
Settling a debt does not mean clearing it, so when you settle, credit card companies know that you failed to pay off all your obligations and had to pay less than you were originally entitled to. Overall, this will have a negative impact on your credit score, and you can expect the ratings to dip by 100 to 120 points.
To what extent the credit score will decrease, depends on several factors, including your current credit situation, the size of the debts being settled, whether your other debts are in good standing, the amount of debt you settled for, and several other factors.
Pros and Cons of Debt Settlement
Here is a brief overview of the advantages and disadvantages of debt settlement.
Advantages
- You might be able to settle for less than you owe: The most obvious advantage is that a creditor might agree to a lower settlement than you owe. They may also be prepared to waive fees or interest charges as well, saving you a fortune.
- Pay off your debts faster: When you settle a debt, you may pay off your entire sum at once rather than making monthly or annual installments, allowing you to reduce the burden on your budget immediately and help you start building your credit score.
- Stop receiving calls from debt collectors: The calls from collection agencies can be intimidating; you can stop them calling you if you manage to settle a debt successfully. Just bear in mind that the paperwork might take many months to complete before the calls stop completely.
- Filing for bankruptcy: Bankruptcy is the worst thing that can happen to your finances, and it will destroy your credit rating completely. Negotiating a settlement might provide you with the financial breathing room you need to avoid filing for bankruptcy. It should also deter your creditors from attempting to recuperate their losses by filing a lawsuit against you.
Disadvantages
- Creditors may be unwilling to work out a deal: A creditor’s acceptance of a settlement offer is not guaranteed. You can hire the best debt settlement company only to find the creditors not budging, which can be frustrating and a waste of time and effort.
- Fees may be required: Debt settlement companies normally charge a fee ranging from 20% to 25% of the final settlement sum. However, this is only due if the creditors approve the settlement.
- Could destroy your credit score: Resolving a debt for less than what you owe may hurt your credit score. Furthermore, many debt settlement organizations may advise you to cease making payments while they try to negotiate with your creditor, which will harm your score even more.
- Debt forgiveness may be taxable: If you agree to a settlement with a creditor, the difference between what you owe and what you pay may be taxed as income. However, if you can prove to the IRS that you are insolvent and your entire obligations surpass your total assets, you may be exempt from paying the tax.
Alternatives to Debt Settlement
If you’re drowning in debt, debt settlement may not be your only way out, as there are other less risky alternatives that you can consider.
Debt Consolidation Loan
Often confused with debt settlement, a debt consolidation loan enables you to combine multiple loans into one more manageable monthly installment. You may be eligible for a lower interest rate if your credit rating is good and taking a debt consolidation loan has no significant negative impact on your credit rating, unlike debt consolidation. But one downside though you still have to pay your full debt and not a partial one. You can learn more about debt consolidation and if it’s a good fit for you in this article.
Balance Transfer
You might be able to consolidate your debt by transferring it to a credit card with a 0% APR for an introductory term, which might last up to 18 months. You can avoid accruing interest on your loan if you pay off the sum before the 0% period expires. However, this does not immediately settle your loan but does give you time to pay off, and that too at no additional interest rates.
Nonprofit Credit Counseling
Seeking professional help like nonprofit credit counseling can be a great way to manage your finances. A credit counselor may help you develop a budget, provide debt consolidation recommendations, advise you on canceling at least part of your credit card accounts, or advise you on bankruptcy, which will stir you in the right direction.
Bottom Line
Debt settlement can be a good option, depending on your current financial position, but it’s vital to remember that the process will take time. Finding the right firm to help you through the process will be critical, but once you do manage to settle your debts, you may begin establishing a road to prosperity.
