Debt can be stressful to manage. Many residents with a large accumulation of debts who have a difficult time making timely and consistent payments can benefit from some kind of debt relief.
One method is debt settlement. However, this option should only be attempted if other options have not worked. This may be a good option for those who have met with a credit counselor and attempted a debt management plan.
Debt settlement is risky and comes with numerous drawbacks, thus it may not be a viable option for certain debtors. Read the sections below to learn about the debt settlement process and determine if it is a good option for your financial circumstances.
How to Define Debt Settlement
The debt settlement process involves a creditor and debtor working together to settle on a new debt that is less than the originally owed amount. This process differs from debt consolidation in that a new loan is not created. Rather, the loan amount is reduced.
Creditors accept a partial payment of the loan the full amount. This payment usually must be paid in full.
Creditors are not required to accept any debt settlement offers from debtors or even negotiate. However, many creditors are likely to accept an offer especially if they believe that it is the best chance of a debtor paying his or her debts. This process can be lengthy and involve multiple conversations between creditors and debtors.
How Debt Settlement Works
The debt settlement process can be accomplished by a debt settlement company or the debtor. Hiring a debt settlement company may be the best option for many as these businesses are aggressive with their negotiations with creditors.
They also provide instructions for debtors on the process. They inform the residents in debt that they will have to begin making monthly deposits to a settlement accounts and stop making payments to their creditors.
This fund will be used to make a one-time payment to the creditors. The settlement company will begin making negotiations with creditors once there are sufficient funds in the account.
Residents must stop making payments to creditors because lenders will often not accept a debt settlement offer until the debtor has missed several payments. Because this comes with financial risks, debt settlement should be considered as a last resort.
The Risks of Settling Debts
There are a number of risks involved with debt settlement. It is not a good option for everyone and can even cause more problems for some residents. Debtors will continue to incur late fees and collection notices during negotiations.
Some may even be at risk of being sued by their creditors. In addition, debtors will be required to pay their debt settlement company for their services. Residents are encouraged to consult with multiple settlement companies before deciding on one.
Below are some of the risks that debtors should be aware of before they choose this option:
- There is no guarantee on settlement – Unfortunately, there is no guarantee that a debt settlement will be successful. Certain creditors will not want to negotiate a settlement while others do not want to settle for the amount that the debtor wants.
- Damage to credit score – The debt settlement process begins by allowing certain accounts become delinquent. Thus, as debts, late fees and interest accrues, debtors will see the resulting damage reflected in their credit scores.
- Additional fees and payments – Debt settlement companies often charge a fee for their services. Many charge by a certain percentage of either the debt balance or on the amount eliminated. Additionally, some charge monthly or startup fees.
- Additional taxes – The IRS considers relieved debts as a source of taxable income. Thus, reducing debt does not always remove payment responsibility in other areas of a resident’s finances.
- Late fees and interest – As debtors pay fund their settlement accounts, they will be accruing penalty fees in their debt accounts that they will be required to pay.
When is Debt Settlement a Good Idea?
Seeking debt settlement as a solution to large amounts of debt should be residents’ last option. Those who are able to make monthly payments and can manage most of their debts should not consider debt settlement.
Debtors who have been unsuccessful with other methods of debt management or have been delinquent in their debt payments may want to consider settlement as an option.
Furthermore, residents considering debt settlement may want to begin the process on their own instead of hiring a settlement company. Debtors should also be aware of which creditors will not accept debt settlements offers and which ones are more open.
Residents are encouraged to save a certain amount of money if they are planning on settling without the help of a company.
Learn About Other Debt Relief Options
Because debt settlement is a lengthy and risky process, debtors are advised to consider other options before deciding to settle. One option is debt consolidation.
This process allows residents to combine their multiple debts into one account. Consolidated debts plans often have lower interest rates which can benefit many debtors. Another option is to working with a credit counseling agencies.
There are many that offer free help and can assist residents in creating an effective debt management plan. Credit counseling agencies provide debtors with all the information and resources they need to manage their debt with few risks.
Last, debtors can file a chapter 7 bankruptcy. Contrary to popular belief, bankruptcy will not damage a credit score more than debt settlement would. Moreover, filing this type of bankruptcy allows residents to begin rebuilding their credit sooner than a debt settlement.
However, debtors are required to complete bankruptcy counseling at most 180 after filing.