Are you bending over backwards to pay off an enormous amount of debt? If this is true of you, it’s going to be tempting to reach out to a debt settlement company in hopes of reducing the amount you owe.
Debt settlement is a service offered by third-party firms that may attempt to cut back your debt by negotiating settlements with your creditors or debt collectors. Some debt settlement firms will be successful at reducing your debt, however their services and programs additionally include risks that might leave you deeper in debt. Debt settlement may even end up damaging your credit.
When considering debt settlement programs, “It’s necessary to do your due diligence to avoid debt relief scams,” says Leslie Tayne, founder and head attorney at Tayne Law Group, that specializes in debt relief. “If you’re wanting to eliminate the burden of debt, the very last thing you want to be addressing is a scam from a company that promises to help.”
Here’s some key info you should understand about how debt settlement works, its pros and cons, and the way it may have an effect on your credit.
How Debt Settlement Works
Debt settlement firms can also be called “debt relief” or “debt adjusting” firms. The businesses usually offer to contact your creditors on your behalf, so that they can discuss an improved payment arrangement or settle or cut back your debt. They usually charge a fee, typically a share of the amount you’d save on the settled debt.
The company might attempt to negotiate with your creditor for a lump-sum payment that’s less than the amount that you owe. While they’re negotiating, they’ll need you to make regular deposits into an account that’s under your control but is run by an independent third-party. You utilize this account to save cash towards that lump payment.
While they negotiate, the debt settlement company can also advise you to stop paying your creditors until a debt settlement agreement is reached.
Once the debt settlement company and your creditors reach an agreement — at a minimum, changing the terms of at least one of your debts — you need to conform to the agreement and make a minimum of one payment to the creditor or debt collector for the settled amount. Then the debt settlement company will begin charging you fees for its services.
Tayne considers a victorious settlement to be one that “allows a consumer to walk away without having to pay their full debt amount.”
Keep in mind that there’s no guarantee the company will be able to reach a debt settlement agreement for all of your debts.
Debt Settlement Pros And Cons
There can be some pros to debt settlement, however you must rigorously contemplate the potential risks of debt settlement as well.
Settling a debt through a debt settlement company may …
- Lower your debt amount
- Help you avoid bankruptcy
- Get creditors and collectors off your back
But the risks might outweigh the advantages.
1. Your creditors might not agree to negotiate
Not only is there no guarantee that the debt settlement company will be able to successfully reach a settlement for all of your debts, some creditors won’t negotiate with debt settlement firms in any respect.
2. You’ll find yourself with additional debt
If you stop making payments on a debt, you can end up paying late fees or interest. You’ll even face collection efforts or a lawsuit filed by a creditor or debt collector. Also, if the company negotiates a successful debt settlement, the portion of your debt that’s forgiven might be considered taxable income on your federal income taxes — which means you’ll need to pay taxes on it.
3. You’ll be charged fees, even if your entire debt wasn’t settled
Debt settlement firms can’t collect a fee till they’ve reached a settlement agreement, you’ve agreed to the settlement, and you’ve made at least one payment to the creditor or debt collector as a result of the agreement. However you could still find yourself paying some of the debt settlement company’s full fees on the remainder of your unsettled debts, says Bruce McClary, vice president of public relations and communications at the National Federation for Credit Counseling.
“If you have five or six creditors and the company settles one of those debts, they can start charging a fee as soon as they receive a result,” McClary says.
And if a debt relief company settled a “portion” of your total debt enrolled with its program, it will charge you that very same portion of its total fee. As an example, if your total debts came to $10,000, and a debt relief company settled $5,000 of the full amount, it’s allowed to charge 50% of the full agreed-upon fee.
4. It may negatively impact your credit
A debt settlement company might encourage you to stop sending payments on your debts while you save cash for a lump-sum payment. However at this point, your creditors may not have agreed to something, which means all those payments you’re missing will land up as delinquent accounts on your credit reports.
Your credit scores may take a hit as a result of any delinquent payments, and the creditor may also send your account to collections or sue you over the debt.
Alternatives To Debt Settlement
1. Negotiate your own settlement
Try negotiating settlements with creditors on your own. Offer an amount that you will pay straightaway, even if it’s less than what you owe.
2. Transfer balances
If you have got credit card debt, think about a balance transfer. A balance transfer is when you move debt from one credit card to another, typically to take advantage of an introductory zero interest offer on the new card.
Balance transfer cards usually have one of these zero intro APR offers for a specified amount of time and may charge a fixed fee or a percentage of the amount you transfer.
To figure out if a balance transfer is a smart plan for you, check whether or not you’ll pay more cash on the interest payments on your current card than the cost of any balance transfer fees. And you must also attempt to pay the balance off before the card’s promotional period expires to avoid paying interest on your balance.
3. Look for nonprofit credit counseling
Nonprofit organizations might offer credit counseling services that offer free or low-cost advice on budgeting and debt management. Credit counseling organizations don’t usually negotiate to reduce debt. What they will do is work with creditors on payment plans or to prevent late fees or collection efforts.
Debt settlement firms may be able to cut back your debt amount with creditors, however there aren’t any guarantees.
Before you enroll in any debt settlement program, the Consumer Financial Protection Bureau recommends contacting your state attorney general and local consumer protection agency to check whether there are any complaints on file. The state attorney general’s office can also check if the company is required to be licensed and whether it meets your state’s requirements.