What You Need to Know About Debt Settlement
The economy has been crazy recently. Schools are closing. Conferences, concerts, and other events have are getting canceled. Companies are asking employees to work from home. What this will do to our pocketbooks is anyone’s guess.
But, if people can’t work and have struggled already to make ends meet, things are only going to get worse. If debt is involved, it could be even more stressful. Those who fall far behind in their debt payments and can see no way out might need to look at a debt settlement.
What is a debt settlement?
Debt settlement is a debt relief option where you (or a debt relief company) negotiate a settlement for less than you owe.
How does debt settlement work
You have to be behind in your debt payments, usually three months or more. If you are current on your payments, there is no incentive for your creditor to grant you relief from your debts. A borrower is usually around five or six months behind when seeking a debt settlement.
When you begin this process, you will stop making payments and start putting the money in a savings account. This will allow you to build up a sufficient amount to make a lump-sum payment to eventually pay off the settlement.
Debt settlement agreements, if they are successful, work best with unsecured debt, like credit cards and personal loans. With mortgages and auto loans, those debts are “secured” by the property that was financed (your home or your vehicle).
I recommend you negotiate your own debt settlement and save thousands of dollars. If you decide to follow this path, you will need to contact your creditors, let them know what is happening, and ask if they will settle for less than what you owe.
Is debt settlement a good idea
Debt settlement can be the fastest, cheapest way to get out of debt without declaring bankruptcy. However, you will have to decide if it is the best option for you and your family. Everyone’s situation is different.
If a creditor were to accept your debt settlement request, your credit report would show you paid less than you owed to resolve a debt. This can have an impact on how future lenders view your ability to pay back a debt.
If you do decide to seek a debt settlement, then you should understand there are some risks involved.
Debt settlement pros and cons
Consider these pros and cons of debt settlement, and it might help you decide if you should start the process of debt relief.
Pros
- Lowers your debt amount
- Keeps you out of bankruptcy
- Should slow down calls from creditors
- It can provide some peace of mind because you have a plan in place to erase the debt
Cons
- Debt settlements are not guaranteed to work
- Your credit score will be negatively impacted
- It can be a lengthy process, three years or more
- You could end up owing more due to late fees and interest
- It can be costly (especially if you use a debt settlement company
- You might owe taxes on the amount of credit that was forgiven
Debt settlement vs. bankruptcy
There are some similarities between debt settlement and bankruptcy. Both can get you out of debt quicker; it will likely damage your credit score and can result in paying less than owed.
The main difference is you can negotiate your own debt settlement; however, you will need to go through the courts to file for bankruptcy.
People can file for two types of bankruptcy: Chapter 7 or Chapter 13.
Chapter 7 is faster because it involves selling just about all your assets and the money going to settle your debts. It can take four to seven months.
With a Chapter 13 bankruptcy, you will set up a debt repayment plan and pay back a percentage of what you owe your creditors. Courts will decide the terms of the agreement; they will not be negotiated as they are in a debt settlement. With a Chapter 13 filing, you might be able to save your home. It can take three to five years to resolve, including the payback period.
Debt settlement vs. debt consolidation
When you seek debt consolidation you, it’s kind of like repackaging your debt. It differs from debt settlement because you are still paying off everything you owe. With consolidation, you take out a loan or a credit card and transfer all the debt to it.
The goal of debt consolidation is to make affordable monthly payments at a lower interest rate. You will pay off your other debts and just have the one, new loan (or a balance transfer credit card) to pay.
For debt consolidation to work, you cannot increase your debt and start making purchases on the credit cards you just consolidated.
How long does debt settlement stay on your credit report
When you enter into a debt settlement agreement, it can remain on your credit report for seven years, and your credit score could drop 60 to 100 points. A Chapter 7 bankruptcy will stay on your credit report for ten years. A Chapter 13 filing will remain on your report for seven years. Both bankruptcies will decrease your credit score by 100 to 200 points, or even more.
Should I consider debt settlement companies
Some people advise only using reputable, professional debt settlement companies. However, using a debt settlement company can be risky.
The Federal Trade Commission says you should avoid doing business with any company that promises to settle your debt if the company:
- Charges any fees before it settles your debts
- Touts a “new government program” to bail out personal credit card debt
- Guarantees it can make your unsecured debt go away
- Tells you to stop communicating with your creditors, but doesn’t explain the serious consequences
- Tells you it can stop all debt collection calls and lawsuits
- Guarantees that your unsecured debts can be paid off for pennies on the dollar
Just as I recommend negotiating lower bills on their own, I say negotiating your debt settlement on your own (with some guidance from The Budget Mom).
