Debt settlement involves clearing out debt by repaying a percentage of it in a single payment to a creditor. This amount is usually less than what you primarily owe. While debt settlement may offer slight relief to borrowers, a settled status on your credit report still hurts your score.
So, if you are looking to get out of debt, debt settlement may work for you.
Here’s how debt settlement works and how to see if it’s right for you.
How It Works
There are several ways to attain debt settlement, but a lawyer or a third-party company typically does it. You will have to fund their services, either as a portion of your savings or a flat fee.
Meaning, even if you settled your debt for much less than what you originally owed, you still have to pay for these costs other than your debt. However, you can also take a DIY approach where you negotiate your settlement.
Debt settlement handled by a third-party company has a different process compared to the DIY approach. Here’s what it looks like:
- Research companies: You can find many authorized debt settlement firms in the United States. Legitimate debt settlement companies follow regulations and policies made to protect consumers and their money.
- Stay alert: Proceed carefully if a company guarantees specific results. For instance, a debt settlement company can’t promise that a creditor will automatically agree to a debt settlement. Check each company through the Better Business Bureau (BBB) website and search consumer complaints through your state attorney general’s office website.
- Know the costs: Once you’ve listed some companies, ask about debt settlement costs. If the company avoids your questions, it’s a telltale sign that it is a shady business.
- Evaluate your finances: Often, debt settlement companies require you to deposit money into a separate savings account for at least 24 months before your debt is entirely settled. These running costs go toward the lump-sum settlement of what you owe.
Sometimes, you might find it challenging to keep tabs on these payments. Because of this, you may give up on the agreement before some or all of your debt is settled. To avoid this pitfall, make sure to double-check your budget to know if you can afford debt payments for at least 24 months.
- Ask about the timetable: When you enter into a debt settlement agreement with a creditor, you will start making payments to the company and stop paying the collectors. And depending on the interest rate and how much debt you have, it can take several years to settle your debt. Some creditors can get you debt-free within 2-4 years. Throughout this period, you may accrue fees and interest charged by the creditor on top of the fees charged by the company.
- Choose a company: If you are completely acquainted with the possible pitfalls and geared to move ahead, it is time to choose a debt settlement company based on what you’ve researched.
Here’s a brief guide to the things you must do if you take a DIY approach:
- Evaluate your situation: Make a list of your outstanding debt accounts. Include the names of the lenders, how much you owe, and how behind you were on payments. This list will serve as the basis for your plan.
- Research creditors: Most creditors might have different regulations for how much they will accept and when they’ll collect a settlement.
- Open a separate bank account: So that you don’t get tempted to use your money elsewhere, open a new bank account for your settlement fund. Regularly deposit money into this account to boost your fund to the point where you can make a competitive settlement offer.
- Make an offer: If you have an offer in mind, let your creditor know. In some cases, the creditor might have already offered you a settlement amount. You can either respond with a lower offer or accept it.
- Pay the settlement amount: Once you have reviewed and accepted the agreement, pay the settlement amount.
Benefits And Risks
There are a few pros and cons to debt settlement:
The Risks
- It could adversely affect your credit if you stop making debt payments.
- Even if your debt is not entirely settled, you might be charged with fees and interests.
- You could end up with more debt or face a lawsuit filed by a debt collector if you stop making payments.
- Some creditors may not agree with debt settlement.
The Benefits
- Help you steer clear from bankruptcy.
- Lower your total debt.
- Get collectors and creditors off your back.
Alternatives
Various debt settlement alternatives incur less risk. Here are some of them:
- Balance transfer
- Debt consolidation loan
- Nonprofit credit counseling
- Debt management program
The Bottom Line
Debt settlement done through a third-party company or by yourself comes with substantial risks. It is crucial to completely understand how debt settlement works and its pros and cons before choosing it. Talk to a bankruptcy attorney, a debt settlement expert, or a credit counseling agency to make an informed decision.
