If your debt has become so large that it is beyond your ability to pay it all down, one of the options available to help you is debt settlement.
In debt settlement, your creditor agrees to accept less than the full amount you owe to complete, or “charge off,” your debt obligation. When you pay off the amount to a creditor determined in a debt settlement agreement, the creditor can no longer come after you for the remaining balance, neither through a collection agency nor by suing you. Under the terms of debt settlement, as long as you are honoring your end of the agreement, creditors must also cease contacting you for repayment. Some debt settlement agencies claim they can cut your debt in half and have you free of debt in three years.
While these descriptions of debt settlement may make it sound like a no-lose situation for consumers, it also has its drawbacks. Among other concerns, debt settlement does not work for all people, according to consumer protection organizations. It could also end up costing you more in the long run than if you had never implemented a debt settlement plan to begin with. The National Consumer Law Center recommends against debt settlement in most circumstances. Likewise, the Consumer Financial Protection Bureau cites 330 complaints filed against debt settlement agencies since 2014, mostly for excessive fees and fraud. The key is to do your homework and make sure that if you do pursue debt settlement, you do it correctly.
You may consider debt settlement after you have made many late payments or missed payments towards your various debts. You may even have collection accounts open on some of those debts. Debt settlement may also be an option if you experience a permanent decrease in income. Note that if a creditor believes you have the ability to pay back the total amount owed, the creditor will not agree to less in a debt settlement arrangement.
When you hire a debt settlement company, the company will have you open a savings account into which you make monthly deposits rather than making monthly payments to your creditors. Once the balance in your account is suitable to offer your creditors as a lump sum in a negotiation, a representative from the company contacts each creditor on your behalf to make payment arrangements in exchange for a reduction in your total debt. If you fail to make your new payment arrangements as dictated by the terms of your debt settlement agreement, you will go back to owing the creditor the full debt amount and may also be responsible for fees and penalties accrued in that period.
There are certain types of debt for which debt settlement is not an option. You cannot negotiate debt settlement on a home loan, for example, as the home can be foreclosed upon. Similarly, debt settlement is not possible for a car loan because the car can be repossessed rather than the creditor accepting a reduction in the debt you owe. Debt settlement is also not available for federal student loans. You can arrange debt settlement on credit cards, however, and other forms of personal, unsecured loans.
Another option to help you manage out-of-control debt is debt consolidation. Debt settlement and debt consolidation are quite different, though. Debt consolidation takes multiple debts owed to multiple creditors and combines them into a single debt to a single creditor, typically with a lower interest rate. By contrast, debt settlement renegotiates the terms of the various debts you have. Debt consolidation helps you lower the number of creditors to whom you owe a debt, while debt settlement helps you lower the amount of debt you owe.
The fee you will pay for debt settlement services will generally be calculated in one of two ways. Either you will pay a percentage of the settled debt or a percentage of the eliminated debt. The settled debt is the amount you still owe according to the terms of the debt settlement agreement. The eliminated debt is the amount you no longer owe according to the terms of the debt settlement agreement. Depending on how much debt is forgiven in the arrangement and how much debt remains, one or the other could be considerably higher and, therefore, produce a considerable difference between the potential fee.
While debt settlement may help you reduce the total principal you owe on your debt or the size of your monthly payments, there are costs it does not reduce or eliminate. You may still accrue late fees and have to deal with collection notices while the debt settlement is being negotiated. There may be taxes you owe on certain outstanding obligations, like foreign debts. You may also still owe taxes on the forgiven portion of your debt. There is also, of course, the not-so hidden cost of the debt settlement agency’s fee for service, which is typically charged after the debt settlement arrangement is secured. You may incur fees, as well, for setting up and maintaining the bank account where your funds for settlement are being secured.
In addition to the hidden costs of debt settlement, there are certain other risks, including its impact on your credit score and the uncertainty of the results results. The impact of debt settlement on your credit can be severe. Once you begin to divert monthly payments from your creditor accounts to your debt settlement account, those creditors will report your payments as delinquent and your credit score will take a hit. Even once the debt is paid off, like the marks you accrued for keeping a delinquent account, it will remain on your credit reports for seven years.
All this assumes you actually do eventually pay off your debt. Many people who make use of debt settlement still fail to pay off the debt. Moreover, some creditors will refuse to negotiate with debt settlement agencies. One third-party organization, the Center for Responsible Lending, found you would need to settle four separate debts minimum in order to reap a net benefit from your debt settlement efforts. These are factors you should consider before you choose debt settlement.