Is Debt Settlement Right for You?

Many people are unclear about what debt settlement really is because of the different names that are used to refer to it. In reality, debt settlement is a simple process where you pay your creditors a previously agreed upon sum to clear your debts, which is usually less than the amount you owe.

Debt Settlement and Your Credit

When you opt into a debt settlement program, it will have an impact on your credit score and report. Your credit report will often have a “Paid by Settlement” entry which will tell future creditors that you didn’t fully repay your last loan, even though a substantial chunk of it was repaid. This may put you in a bit of an unfavorable situation when applying for new loans or lines of credit.

Your credit score is largely determined by your debt repayment habits and the presence of a “Paid by Settlement” in addition to any information regarding missed payments or reduced payments can severely lower your credit rating.

Debt Settlement Agency Fees

While every debt settlement agency will differ, they use three main models for charging consumers for debt settlement services. It is important to know that in addition to the fees listed below, some agencies may charge monthly fees for the terms of the negotiations till closing which can range from $19 - $89.

  1. The fee is equal to 13-20% of your total debt.
    1. If you owe $25,000 and the debt settlement agency charges a 14% fee, you will need to pay $3,500 to the agency.
  2. Some agencies, on the other hand will use a percentage fee up to 35% based on the reduction that they negotiate for you.
    1. If you owe $25,000 and they manage to get a reduction of $12,500, they may charge you a 29% fee. This would result in a fee of $3,625.
  3. The last option you may encounter is a flat fee based on the amount that you owe or the repaid amount rather than a percentage.

Benefits of Debt Settlement

  • Your debts will be repaid.
  • You will pay a lower amount than you would have in the long run.
  • You will not need to declare bankruptcy.
  • You no longer need to pay creditors directly.
  • There is one monthly payment rather than several smaller ones.
  • More flexibility of repayment.
  • You can begin with a relatively clean financial slate.

Drawbacks of Debt Settlement

  • Paid by Settlement listed on your credit report.
  • It affects your credit score.
  • You may still owe income taxes on debts that have been settled if the forgiven amount was over $600.
  • It could take months or years before an unsecured line or credit will be offered to you.
  • You have to stop paying debts for a few months while your settlement is being negotiated resulting in collection calls and late payments being reported.
  • You still need to pay the debt settlement agency’s fee.

How it Works

When you decide to opt for a debt settlement program you will need to follow these simple steps.

  1. Call a debt settlement agency and provide them with information about your situation, creditors, and outstanding debt.
  2. Receive a reduced debt estimate and information about monthly payments.
  3. Start sending payments to the debt settlement agency rather than the creditors for the duration of the negotiations and settlement period which can take anywhere from a few months to a few years.

After you have completed these steps, the debt settlement agency will deposit all your payments into an account till it reaches a predetermined amount, at which point the debt settlement agency will begin to negotiate your debt settlement with your creditors. After they have successfully negotiated, they will pay the creditor and provide you with a bill for their fees based on the criteria mentioned earlier.

Things to Consider

If you decide to engage in a debt settlement, do your due diligence and choose a company that has a good track record and uses FDIC insured deposit accounts. Double-check the company’s status and reputation with the BBB and the Attorney General’s Office. You may also want to use the assistance of a non-profit financial counselor as they may be able to recommend a reputable company or even provide these services themselves.

Before you sign any agreements, ensure that you get an agreement and estimates as well as any information regarding cancellation fees and refunds in writing. Lastly, remember that if it seems to be too good to be true, it very well may be. Don’t get pulled in by scams where companies guarantee an unbelievable percentage reduction.