The process of negotiating with a creditor to reduce the amount you owe in exchange for a one time payment in full of an agreed upon amount is called debt settlement. You may often see it referred to as debt negotiation as well.
Seeking a settlement agreement can be an effective debt resolution approach—under the right circumstances. This is particularly true in instances in which payments are in considerable arrears, or a balance is so high paying it off will be extremely difficult.
However, there are some pros and cons of debt settlement to consider.
How Debt Settlement Works
First of all, it’s important to note you can do everything a professional debt settlement firm can do on your own. On the other hand, it’s equally important to note that negotiating a debt settlement plan with a creditor is an arduous and time consuming process, with no guarantee of success.
Once you reach the person who has the authority to agree to a settlement proposal, you’ll try to get the total amount you owe reduced, along with waivers of accumulated fees and interest. You’ll offer a one-time payment in full of the agreed upon settlement amount, in exchange for these concessions. Be mindful though, you must be in a position to make the payment in full when the agreement is reached. Otherwise, it could be rescinded.
Working with a debt settlement firm, you’ll be enrolled in a type of savings plan in which the monies you’d normally forward to your creditors is deposited until the account’s balance is high enough to fund a settlement agreement. Payment will be made to the creditor settle the debt from that account and the process will continue until all of your debtors are satisfied.
Debt Settlement Alternatives
Generally speaking, debt settlement should be one of the last debt relief options of which you avail yourself.
While debt settlement is not as destructive to your credit history as bankruptcy, credit counseling, debt management and debt consolidation are less damaging and should be investigated before attempting a settlement.
In fact, given a choice of credit counseling vs debt settlement, going with counseling first could resolve your problem with far less collateral damage.
Debt Settlement Pros
The most obvious benefit of debt settlement is it enables you to resolve credit accounts for less than you owe. Settlement will also put an end to collection calls and restore your peace of mind.
Most debt settlement programs eradicate debt within 48 months. That is, assuming you have the wherewithal to set the cash aside to fund your payoff agreements. The time frame is also dependent upon the amount of debt with which you’re burdened.
Debt settlement can help you avoid filing for bankruptcy protection and enduring the consequences of that action. A bankruptcy filing will stay on your credit report for seven to 10 years, depending upon the nature of your filing. A debt settlement program will usually allow you to start rebuilding your credit history in a much shorter amount of time.
Debt Settlement Cons
Creditors don’t always agree to accept settlements. In other words, there are no guarantees that debt settlement will work. And, over the time you spend trying to get a settlement, your debt will be increasing, owing to fees and ever increasing compounded interest payments.
Working with a debt settlement company will also entail fees, generally in the range of 15% to 25% of the amount you owe. The good news is they can’t bill you until they’ve reached a settlement agreement to which you and your creditor agree—and it is paid. But you will owe that money when the settlement is funded.
While not as bad as the fallout from a bankruptcy filing, there are negative credit score and credit report consequences to debt settlement just the same. Accounts will be listed as “settled” rather than “paid in full”. This could give potential creditors pause when reviewing your post-settlement credit applications.
Some creditors report settled debt to the IRS, which will then look upon the forgiven amount as earned income. In other words, you could have to pay taxes on forgiven debt.
In Conclusion
It’s important to consider these pros and cons before embarking upon a debt settlement plan. It’s also a good idea to consider the alternatives first. Yes, a debt settlement program might be less costly in terms of the cash you’ll pay, but there are benefits to looking at debt consolidation, counseling and management first.
