You could save money and pay down debt quicker
A debt settlement program is the best way to get out of debt if you’re in serious debt. This conclusion might be drawn from the American Fair Credit Council (AFCC), an association of companies in the debt settlement business who have adhered to a strict code.
The 2020 report reveals that debt settlement resulted in an average of $2.64 in consumer savings per $1.00 fee. Nearly all settlements offered, which were over 98.9%, in a client’s debt decreasing that was greater than the associated fees.
“Debt Settlement can save consumers money because they allow them to resolve their debts for a lower amount than the full balance,” states Gerri detweiler. He also says: “It could be a way to get out of debt for those individuals who cannot afford to repay the entire amount.”
Is debt settlement still the best way of getting out of debt? Let’s take a closer glance.
KEY TAKEAWAYS
- In debt settlement, you offer a lump sum payment to a creditor in return for a portion your debt being forgiven.
- It is essential to stop making minimum monthly payments for debt in order to negotiate a debt settlement. This will cause late fees, interest, and credit damage.
- The typical debt settlement offer is between 10% and 50% of your owed amount.
- You are at greater risk of being sued if you leave debt unpaid for too long.
- Even if you work with a reputable company for debt settlement, creditors are not under any obligation to reduce your debt.
What is Debt Settlement?
Debt settlement is also known as ” debt relief” and “debt adjustment”. It involves resolving your delinquent debt by promising to pay a large lump-sum payment to the lender. The amount of debt settlement offered will vary depending on your situation. 3 Creditors must decide whether to accept any offer.
Consumers have two options: they can either settle their debts themselves or hire a firm that will do it for them. The fee you pay to the firm is a percentage of your enrolled credit. The amount of debt that you have at the time you join the program is called your enrolled debt. The company cannot charge this fee unless it has paid all of your debt. 4 Fees range from 20% to 25%.
Tax costs may be associated with debt settlement. Forgiven debt is considered taxable income by the Internal Revenue Service (IRS). However, if you can prove to the IRS that your debt is not taxable income, you won’t have to pay any tax. If your total liabilities exceed your assets, the IRS will consider you insolvent. 5 A certified public accountant can help you determine if you are eligible for insolvency status.
Freedom Debt Relief, one the most well-known debt negotiators in the country, has compiled data from AFCC to show that debt settlement is far less expensive than credit counseling and making minimum monthly payments.
However, the details of your case will determine if debt settlement is the best option.
Strategies for Debt Settlement and the Risks
Ironically, those consumers who sign up for a debt settlement program to manage their debts but have been making payments, even irregularly, have less negotiation power than those who have not made any payments. Their first step should be to stop paying. According to Sean Fox, co-president at Freedom Debt relief, credit scores can be affected by the debt settlement process. Credit scores will usually recover as the consumer makes payments on settled debt.
Being in default on debt or settling the debt for less can have a serious impact on your credit score, likely sending it to the mid-500s which is considered poor. The greater your score is before you fall behind, then the more it will drop. Late payments can remain on your credit score for up 7 years. 7
Non-payments can also lead to interest and late fees that will increase your balance. This can make it more difficult to settle your debt. After becoming delinquent, consumers can expect to receive harassing phone calls from debt collectors. Consumers with debts exceeding $5,000 may be sued by creditors. This could lead to wage garnishment. The sooner you can settle the debt, the more money you have. Detweiler states that the more time your debt remains unpaid, the higher the chance of you being sued.
There is no guarantee that the lender will settle your debt after you have suffered the damage. Chase, for instance, won’t work with debt settlement companies. It will only work with consumers, or with licensed credit counseling agencies that are nonprofits. The Consumer Financial Protection Bureau warns you that any savings achieved by a debt settlement company could be lost if the fees and penalties accrue on unpaid debts.
Bankruptcy vs. Debt Settlement
If the process goes according to plan, everyone can benefit from debt settlement. The consumer is able to get out of debt, save money, and the debt settlement companies make money by providing a valuable service. Creditors receive more than if they stopped paying or filed chapter 7. Chapter 7 bankruptcy is the process of liquidating non-exempt assets to repay creditors.
Detweiler said that chapter 7 bankruptcy is a quicker option than debt settlement. This legal process can end collection calls and lawsuits. He says that debt settlement does not offer these guarantees. However, he points out that there may be many reasons chapter 7 might not be the best option. Consumers may be required to give up property that they feel they should keep. They may also not wish their financial problems to be public. Consumers might find that their job options are limited if they declare bankrupt. Some professions assess workers’ credit histories.
A major problem for many consumers in debt is their inability to pay for a bankruptcy attorney. Fox states that many consumers are not eligible for bankruptcy protection. Fox says that debt settlement is only available to anyone who can show financial hardship (e.g. job loss, reduced hours worked, medical expense, death in the family, divorce) and who is unable to pay down their debts.
Chapter 7 bankruptcy can be completed in three to six months. This is compared to years of debt settlement. This can be less stressful than traditional debt settlement and may help your credit score recover quicker. However, bankruptcy will remain on credit reports for 10 years.
Comparison of Debt Settlement and. Minimum Monthly Payments
Consumers who are looking to save money should not make minimum monthly payments on high interest debt. It could take years, or even decades depending on how much debt you have and the interest rate. You will make very little progress each month paying down your balance because interest is compounding every day.
You might be able to make your creditors very happy by paying the minimum monthly payment and not having to pay a lot of interest. A solid payment history can also help your credit score. We don’t recommend spending more on interest to improve your credit score. Your retirement will not be paid for by a good credit rating. However, money in the bank will.
Additionally, if your available credit is greater than your credit line, it can negatively impact your credit score, and possibly negate the benefits of regular, timely payments. According to the AFCC report, “the average client decreased their total debt by approximately $30,000 to $35,000 at settlement time.” This figure includes deducting fees.
Credit Counseling vs. Debt Settlement
Credit counseling is a service that nonprofits and government agencies offer for free or at a low cost. These services are often partially funded by credit card companies. You may be eligible for a reduction in your interest rate and waiver of penalties by enrolling in a credit counseling agency .
These concessions may or not be enough to make your debt pay off faster. You may also not be able or able to afford the monthly payments. You may not be eligible for a reduction in interest rates, even if your financial situation is severe.
Fortunately, you don’t have to default on any of your debts so your credit score might suffer less. Credit counseling can offer additional financial help that may help you avoid similar problems in future. This includes budget development and counseling as well as referrals to low-cost assistance programs and services to reduce expenses.
How do you choose which company to go with if you don’t want to file bankruptcy? It is better to seek credit counseling before you consider contacting a debt settlement firm. Credit counselors can help determine the best course, which could include debt settlement. However, this should be done in a way that benefits both you as a client and not necessarily a company that is more interested in your credit score than in your credit health.
For consumers who are less financially stressed than those in financial difficulty, credit counseling and consolidation loans may be a good option. However, bankruptcy and debt settlement can be helpful for those with more severe financial problems. It all depends on the individual.
The Federal Trade Commission website provides helpful information on how to choose a credit counselor. 12 Another good resource is the National Foundation for Credit Counseling.
What percentage of a debt is considered in a settlement?
A report by the Center for Responsible Lending found that debts are typically settled at 48% of outstanding balance. The report found that debts are settled at 48% of the outstanding balance on average. 13
How can you negotiate a credit card debt settlement yourself?
You can negotiate a credit card debt settlement by calling your lenders. Ask them to put you on a plan to pay off your debts. Depending on your circumstances, some creditors may work with you. 4
How do you find a good debt settlement company?
You can ask your family and friends for recommendations on good debt resolution companies. Ask your financial advisor or search online for reviews
What is a Debt Settlement Scam and How Can I Avoid It?
Scams involving debt settlement are common. Scams may include for-profit companies that claim to “eliminate” your debt for a large fee. These scammers will often ask for a large amount of money, but they do very little or nothing. They may claim that they can “fix” your credit report or remove it from your record, but this is impossible. A debt settlement scam could also lead to you falling deeper into debt if they claim to have reached out to your creditors. Before you sign up for a debt settlement company, make sure to check the Better Business Bureau and your state’s attorney-general’s office.
How can you repair your credit after debt settlement?
The debt settlement remains on your credit report for seven year, beginning on the date you became delinquent. Repairing your credit following a settlement is possible if you don’t exceed your credit limit, pay all your bills on time and maintain a balanced debt-to-credit ratio.
The bottom line
For many people, debt settlement is the most cost-effective way to get rid of debt. It all depends on how much debt you have. There are also other factors that you should consider such as the time required and how stressful it might be compared to other options. Before you make a decision about debt settlement, it is important to understand all the pros and cons.
It is best to explore all three options. Detweiler says that if you’re struggling with debt, you should talk to a credit counseling agency and a debt settlement expert. This will help you understand all options and make informed decisions.
