How Debt Settlement Works: Is It Worth It?

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Debt settlement

You may want to know how debt settlement works and if it is worth it. If you’re looking for ways to repay your debts, you may want to learn about this method. Also known as debt relief, specific companies provide this service, but you may opt to do it yourself. 

Regardless, understand the corresponding benefits and risks and always check other alternatives to become debt-free.

How Debt Settlement Works

The debt settlement method involves negotiating with your creditors to reduce the amount you owe. It starts by requesting a debt settlement company to represent you. Then, you will discuss your financial situation with their representative, so he may assess how the company may help. 

He will then determine how much reduced debt may be acceptable to your creditors.

Once you’ve agreed to the proposed debt reduction, the debt relief company will start negotiations with your lenders. As you wait, you must allocate money into an escrow account. You refrain from paying your creditors and divert the money into escrow instead. This fund will be used to pay your debts upon successful settlement negotiation.

You might need to wait a few years before debt relief negotiations conclude. Once your lenders accept the debt settlement, you will have to accept the negotiated reduction. Your escrow account will be used to cover the remaining balance. Afterward, that will be closed and your debt relief program will be completed.

On the other hand, you may speak with your creditors on your own. They usually accept do-it-yourself debt settlement, and it may be a more affordable alternative. 

Keep in mind that DIY debt negotiation poses the same risks as settlement companies. More importantly, make sure to secure all negotiation terms and conditions in writing.

Advantages of Debt Settlement

Advantages of Debt Settlement

This method comes with its own advantages and disadvantages, much like other debt solutions. You must assess if debt settlement may truly help your financial situation. Gauge if you can weather its potential risks and if the benefits outweigh them. Check all the debt relief companies available to you, and search for alternative ways to debt freedom.

This solution is particularly favorable for those with dire financial problems. They usually have poor credit, and they are on the verge of filing for bankruptcy. If you’re in a similar situation, debt relief may just be your saving grace. 

This is one of the best advantages of debt settlement, but it offers more benefits as well.

Significantly Reduce Debts

Another great benefit of settlement is its potential to dramatically reduce your debts. You may succeed in deducting as much as 50% of the amount you owe. 

This can be a game-changer for someone crippled with insurmountable debts. Such a drastic debt reduction may truly help a person recover from disastrous debt problems.

Facilitate Debt Payoff

It can also help people pay their debts faster and easier. People who resort to debt settlement are usually overwhelmed by their numerous balances. They may find it difficult to repay their many debts as each one accumulates interest and other fees. 

Debt settlement companies manage and streamline debt payoff, so their clients may finally get relief.

Alternative For Bankruptcy

For those on the brink of bankruptcy, it offers a less drastic alternative. While debt settlement poses great risks, they aren’t as significant compared to bankruptcy. This debt solution is grueling and excruciating, and your possessions may be seized as a result. 

Debt relief still has major consequences, but they are often better than this nuclear option.

Alternatively, you may perform a do-it-yourself settlement to avoid expensive debt relief companies. These institutions may charge exorbitant amounts that some cannot afford. This may be counterintuitive for those with severe debt problems. By negotiating with your creditors by yourself, you may avoid shouldering more payments.

Disadvantages of Debt Settlement

Disadvantages of Debt Settlement

The disadvantages of debt relief are quite harsh, so it’s truly reserved for severe financial problems. It may actually sink you further into debt, and you may even be scammed by debt relief fraudsters. Similar to bankruptcy, it can heavily damage your credit report, albeit not as drastic. 

In the first place, debt settlement may fail if your creditors refuse your offer.

Adds More Payments

Debt settlement can saddle you with more payments in several ways. First, you may accumulate late fees and interest while debt relief negotiations are ongoing. You may have to stop paying your debts for three to four months before lenders allow negotiations. 

These companies don’t cover such fees, so you’ll have to contend with those after settlement.

Companies will also charge their own fees once they successfully negotiate your debts. They may also charge a percentage of the forgiven amount. Moreover, the government may also tax you in a similar fashion. If the settled debt exceeds $600, the Internal Revenue Service (IRS) will consider it as taxable income.

Your financial troubles may even worsen if your lenders refuse the settlement agreement. Prior to receiving the bad news, you would have reserved your debt payments for the settlement offer. You will have accrued tremendous sums of penalties and interest because of this. If your debt relief offer is declined, your previous debts will grow even more.

Damages Your Credit

Even if the measure does succeed, your credit score will suffer. In fact, it may take years to negotiate a settlement, so your credit rating will lower even before then. This measure will even reflect on your credit report, deducting from your score further. 

As a result, you may suffer from prolonged financial problems.

Debt Settlement Scams

You must also be wary of scammers when engaging in debt settlement. Some may offer fake debt relief services in exchange for exorbitant upfront payments. Thankfully, the Federal Trade Commission helps individuals avoid such fraudulent entities. Check their website to learn more about debt relief and how to avoid the fake ones.

Negotiating your debts yourself may be more affordable, but it shares the same risks as debt relief companies. After all, lenders may still refuse to reduce the amount you owe. You should check various debt relief companies to potentially get better options. There are even better debt solutions that may be better than debt settlement.

Alternatives To Debt Settlement

Alternatives To Debt Settlement

There are other debt reduction strategies that may better suit your financial situation. For example, you may request financial establishments for debt consolidation. You may also request the assistance of credit counseling agencies and their modified payment plans. 

In addition, you may follow other DIY techniques for debt payoff.

Debt Consolidation

You may ask your credit union or your bank to replace smaller debts with a larger, low-interest one. It will pay the full amount, and it will have a lower interest rate. The lump-sum payment may come as a debt consolidation loan or a balance transfer credit card. 

Credit card companies provide the latter to help credit card debts, but consolidation may also apply to unsecured debts.

Credit Counseling

Aside from assisting in debt payoff, credit counseling agencies will teach you better money management skills. They can potentially help your financial situation in the short-term and the long-term. 

Their debt management plans may lower your monthly payments, so you can easily complete them. Also, they’ll teach you how to avoid financial troubles in the future.

Do-It-Yourself Techniques

Finally, you may follow trusted systems for debt payoff by yourself such as debt snowball and avalanche. Both pay debts one-by-one, but they proceed in different orders. The former starts with the smallest ones first while the latter prioritizes larger balances. 

Various financial advisors rave about them as tried-and-tested methods.