The Pros And Cons Of Debt Settleme
Having a mountain of debt that just doesn’t seem possible to repay can be a distressing situation for any borrower - and debt settlement is often touted as a solution.
If you’re struggling to make your monthly repayments - especially in the current lockdown economy - you may want to consider a settlement. Still, it’s crucial to know how the process works and what your chances of success are.
In this article, we’ll cover the basics of debt settlement and give you the information needed to make the best possible decision.
What Is Debt Settlement?
Debt settlement involves offering your creditor a lump sum payment that’s significantly smaller than the total amount you owe.
- Most debt settlements involve amounts equal to 10% - 50% of the original amount.
- Creditors may be willing to accept these smaller amounts rather than run the risk of you not paying the debt at all. This makes debt settlement especially popular among people who have accounts in arrears.
How Does Debt Settlement Work?
When you sign up for debt settlement, you’ll typically do so at a credit counseling agency. These organizations specialize in negotiating settlement packages with creditors.
- Your debt settlement representative will negotiate with the creditor on your behalf. You’ll need to provide them with detailed information about your debts as well as your monthly finances.
- Settling your debt is easier if your account is in arrears. This is because your creditors are more likely to accept a lump sum payment if it looks like you’re about to default on your debt altogether.
- Most debt settlement representatives charge a percentage of the total debt you arrive with prior to the negotiation (your enrolled debt). Some may also charge a percentage of the amount they manage to reduce your debt by.
Who Is Eligible For Debt Settlement?
In principle, any consumer who’s unable to pay their debts can approach their creditor to request a settlement. This process is best handled by a competent professional like a credit counselor.
However, being eligible for settlement doesn’t mean that this approach is the best option for you.
- A settlement may benefit borrowers with over $10,000 in debt that’s either in default or at risk of slipping into arrears.
- You’ll need to have a lump sum in cash available to pay your creditors if they agree to the terms offered to them by your credit counselor.
What Are The Pros of Debt Settlement?
There are several advantages to pursuing a settlement:
- A successful negotiation could save you thousands of dollars in debt and make your monthly payments manageable.
- Your credit card debt - which can’t be forgiven even after death - could be substantially reduced and won’t be a burden to your dependents or estate.
- Settlement may be quicker than a credit counseling repayment plan or making minimum monthly payments.
What Are The Cons of Debt Settlement?
Settlements come with their share of disadvantages. Here are some things to consider before you proceed.
- Your counselor may recommend that you stop making payments to entice your creditor to accept the settlement. This could result in late payment penalties and interest being added to your total debt.
- Despite your representative’s best efforts, there’s no guarantee that your creditor will accept the settlement offer. You may be liable for the total debt amount plus late payment fees and interest.
- It’s important to note that settled debt is regarded as income by the IRS. You could save money on your repayments, but end up receiving a large tax bill the following year. If you’ve declared insolvency you may be able to avoid paying taxes on your settlement.
How Does Debt Settlement Impact Credit Scores?
One of the realities surrounding the settlement approach is that it can have a negative effect on your credit score.
- A settlement will stay on your credit record for seven years. It could also cause your credit score to fall into the 500s - and this could make it difficult to apply for other forms of credit for a while.
- The higher your FICO score is before the settlement the more it’ll fall - but your numbers will start to rise again as you make regular payments on your other debts.
Debt settlement is a process of negotiation between you and your creditor - usually through a credit counselor. You’ll offer to pay them a lump sum in exchange for a substantial discount on the amount you owe them.
Offering to settle a debt can be beneficial if you owe more than $10,000 and are aware that there’s a risk of having your offer rejected. You’ll want to work with a representative who’s upfront about their fees and has a solid track record of success in the industry.