The Debt Settlement Process: What is it works and the risks you face

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Credit Settlement: How It works and the risks you face
By Bev O’Shea personal finance writer | MSN Money, Credit.com, Atlanta Journal-Constitution, Orlando Sentinel Bev O’Shea is a former NerdWallet authority on consumer credit, scams and identity theft. She holds a bachelor’s level degree of journalism at Auburn University and a master’s in education from Georgia State University. Prior to joining NerdWallet she worked for the daily papers, MSN Money and Credit.com. Her work was featured throughout the world in The New York Times, The Washington Post, the Los Angeles Times, MarketWatch, USA Today, MSN Money and elsewhere. Twitter: @BeverlyOShea.

Jun 24, 2022

Editor: Kathy Hinson Lead Assigning Editor Personal finance, credit scoring, managing money and debt Kathy Hinson leads the core personal finance team at NerdWallet. In the past, she worked for 18 years with The Oregonian in Portland in positions such as copy desk chief and team editor and designer. Her previous experience includes copy editing and news for several Southern California newspapers, including the Los Angeles Times. She earned a bachelor’s degree in mass communication and journalism at the University of Iowa.

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Table of Contents

Table of Contents

The term “debt settlement” means that a creditor has accepted less than the amount that you owe as full payment. When it has accepted that offer, the creditor can’t continue to pursue you to collect the money and you don’t have to be concerned about whether you’ll be sued for the specific amount of debt.
It may sound like a great deal However, it can be risky.
Debt settlement can destroy your credit.
Reaching a settlement can take a long time accomplish — often between two and four years.
It can be costly.

If you’re successful at debt settlement it could take years before you realize that you owe tax upon any unpaid debt. If you decide to work with a debt settlement company, you’ll pay fees. It’s a last resort.
Make sure you track your debt the simple way
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How does debt settlement work

The process of debt settlement is only when you have many late or skipped payments and perhaps collections accounts. The collector or creditor will not accept less than you owe if there’s evidence to suggest that you may have owed more than you initially agreed to.
Your will have been shredded, you will feel hopelessly behind and your income will not be enough to pay all your obligations to creditors.
Companies that negotiate with creditors to reduce the amount you owe on debts that aren’t secured like credit cards. It’s not an option for certain types of debt, like a home which can be foreclosed or a car that may be taken back. Most companies don’t settle federal student loans, but you might be eligible to . If you’re struggling with your student loans and need help, this may be a good option for you.
Settlement options are only useful if it seems you won’t make any payments, and you stop making payments on your debts. Instead, you create an account for savings and make an amount per month into it. If the settlement company is convinced that the savings account is sufficient to warrant a lump-sum payment the company will negotiate on your behalf with the creditor to agree to an amount that is less.
Readers may also have questions.
Do debt consolidation loans hurt your credit?

Debt consolidation may help your credit if it helps you make on-time payments or decreases the balances of revolving accounts, especially if your credit card balances were close to their limits. Your credit score will be affected if you rack over your credit card balances, close most or all of your other cards or miss a payment on you loan for debt consolidation. loan.

How can I cut down my credit card debt?

The bankruptcy process and debt settlement may help to reduce or completely eliminate debt from credit cards, but they severely impact your credit. Debt management reduces the rate of interest, and its effect on your credit is less significant. It can also reduce interest rates too.

How do I reduce my debt?

Reduce your debt in three steps: 1. Get a handle on what you owe. 2. Find out which payoff strategy will be most effective for your situation. 3. Make a plan and monitor your performance.

The risk of debt settlement

Some debt settlement companies say they can reduce credit by up to 50% and make debt-free in just 36 months.
However, the process isn’t as easy as it sounds. We believe that debt settlement should be a only option in the end.
Here are the risks that come with the settlement of debt:
Your credit rating will be affected: If you’re not already in debt on your accounts and you’re not, you’ll be after you transfer debt payments to your settlement accounts. Delinquent accounts and debt charged off by lenders stay on your for seven years.
Interest and penalties continue to accrue: You’ll likely be hit with late charges and penalty charges as well. The interest will continue to accumulate on your balance.
There’s no assurance of success The two largest debt settlement firms are . Freedom Debt, for instance claims to have settled more than $10 billion of debts for more than 650,000 clients since 2002. There’s no assurance that the debt settlement firm can settle your debt much less, given that some creditors do not negotiate with them.
According to a study by the Center for Responsible Lending, an independent research and policy organization the majority of consumers will need to settle at least four accounts to receive an overall gain. In addition, debt totals could increase as fees are accrued and aggressive attempts to collect may continue during negotiations.
You have to pay an amount when a debt settles according to law. companies can’t charge you charges upfront. Most of them charge a percentage of every debt they settle, based upon the debt’s balance when you enrolled into the program. Some charge a portion of the debt eliminated by the settlement.
For example, say you owe $10,000, and the agency negotiates a settlement for $6,000. The agency will charge 25 percent.
If the agency has a fee based on the amount of settled debt, you’ll pay the creditor its $6,000 and pay to the agent $2,500 for charges (25 percent of the total amount enrolled). Total: $8,500.
If the agency charges a percentage of eliminated debt, you’d have to pay the creditor $6,000 and the agency would charge you $1,000 for charges (25% of the $4,000 in eliminated debt). Total: $7,000.

Additional fees will be charged: Besides the fees that are paid when a debt settles, customers can face other costs, including the setup fee and the monthly cost to keep the account set up under the program.
The debt that you forgive could be tax-deductible: You should also know that Internal Revenue Service generally regards forgiven debt as income. You might want to talk to tax professionals about any additional tax obligations you’ll have to take upon settling your debt.
If you choose to enlist the services of the debt settlement expert, be careful. It’s easy to lose your guard when you’re desperate and you see promises made by . A study by the National Consumer Law Center has stated that debt settlement firms are “almost never worthwhile and can cause consumers to be in more financial difficulties.”
The Consumer Financial Protection Bureau takes a somewhat softer view, but still cautions consumers strongly, saying that dealing with these companies can be risky and that alternative options should be explored first. There have been over 300 complaints about debt settlement firms to the CFPB from 2014. Most of the complaints included excessive fees and fraud.
Other options to settle debt

Michael Bovee, a debt settlement coach and frequently criticizes his business (he has testified before the Federal Trade Commission in favor more regulation) recommends eliminating your debts through Chapter 7 bankruptcy and starting over, if you’re given the option.
For borrowers who are overwhelmed by unsecured debt such as credit cards think about how your options compare, like . A bankruptcy is generally the better choice. A bankruptcy can sully your credit history for years however, the process of rebuilding can begin as soon as. Consultations with a bankruptcy attorney are usually free, but you’ll have to pay filing and legal costs if you opt for this option.
“If you can erase your debts in the form of a Chapter 7 bankruptcy, that’s an excellent alternative to trying to negotiate settlements,” says NerdWallet columnist Liz Weston, author of “Your Credit Score” and “Deal With the debt.” “Only when Chapter 7 isn’t an option — you refuse to file for bankruptcy or you are unable to qualify for an Chapter 13 repayment plan -or if you are considering the possibility of settling your debt.”
If you’re not eligible to file a bankruptcy or intend to make one happen, you might consider the possibility of a donation through a nonprofit . The option you choose to take won’t typically reduce the amount you have to pay but it can decrease your monthly payment by spreading them out or through lowering your interest rate. It’s less likely to have an impact on your credit score than bankruptcy or a debt settlement.
If you decide to pursue settlement, you can do so.

If you think it is the best option for you, and you’d like some help in the process of pursuing your debt, Bovee has tips for picking a good company:
Contact the company to determine if there’s a record of complaints.
Beware of any company which offers cash in advance or guarantees that your debt will be paid.
Be sure that fees are arranged in a proportion of debt reduced instead of the debt balance at enrollment which gives the business the incentive to cut down on your debt.
Avoid companies that promise that they will help you contest debts in order to declare them “invalid” (a method that can backfire and result in more aggressive actions against you).

If you don’t want to engage a debt-settlement firm you might want to consult a lawyer or doing it yourself.
A lawyer may bill by the hour, have a flat fee per creditor or be charged a percentage of debt or debts that are eliminated.
If you’re seriously behind, it usually doesn’t hurt to reach out to your creditors. Certain banks offer hardship programs that may be able to assist. Be sure to pay for any payment plans that your bank may provide.
If you want to try , educate yourself on what’s likely to happen.
It is possible to collect as much cash as you can to make a lump-sum offer, whether that’s doing a part-time job or selling equipment for sale which has been sat in the basement, or taking money out of your friend. (Creditors might be more likely to take a lump-sum offer that allows them to receive money immediate, rather than taking a chance on the possibility of not receiving payments.) Be aware that certain creditors may have a policy against settling the debt.

Author bio Bev O’Shea worked as a writer for credit at NerdWallet. Her work has appeared in the New York Times, Washington Post, MarketWatch and elsewhere.

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