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Debt Settlement: How it Does It and the Risks You Take
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Credit Settlement: How It Does It and the Risks You Take
By Bev O’Shea personal finance writer | MSN Money, Credit.com, Atlanta Journal-Constitution, Orlando Sentinel Bev O’Shea is a former NerdWallet authority on consumer credit, scams and identity theft. She has a bachelor’s degree in journalistic studies from Auburn University and a master’s in education from Georgia State University. Prior to joining NerdWallet she worked for newspaper publishers, including daily ones, MSN Money and Credit.com. Her work has appeared on The New York Times, The Washington Post, the Los Angeles Times, MarketWatch, USA Today, MSN Money and many other places. Twitter: @BeverlyOShea.
Jun 24, 2022
Edited by Kathy Hinson Lead Assigning Editor Personal finance, credit scoring, financial management and debt Kathy Hinson leads the core personal finance team at NerdWallet. Previously, she spent 18 years at The Oregonian in Portland in positions such as copy desk chief and team editor and designer. Prior experience includes news and copy editing at various Southern California newspapers, including the Los Angeles Times. She earned a bachelor’s degree in mass communications and journalism at The University of Iowa.
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Table of Contents
Table of Contents
A creditor has accepted less than what you owe in full as a payment. When it has accepted that offer and the debtor isn’t able to continue to hound you for the cash and you don’t need to worry about the possibility of be sued for that specific debt.
It may sound like a great deal However, it can be risky.
Debt settlement can destroy your credit.
Reaching a settlement can take a long time achieve — typically between two and four years.
It isn’t cheap.
Even if you succeed in settling your debt it could take years before you discover you owe tax upon any unpaid debt. And if you use a debt settlement company and pay for fees, you’ll have to pay. It is the last option.
Make sure you track your debt the simple method
Sign up with NerdWallet to view your payment schedule and breakdown of your debt all in one place.
How debt settlement works
The process of debt settlement is only when you have many late or skipped payments and possibly collections accounts. A collector or creditor is not going to accept less than you owe if there’s reason to believe it was something you originally agreed to.
Your confidence has been destroyed, you will feel overwhelmed and in debt, and your income isn’t enough to pay all your obligations to creditors.
Debt settlement companies negotiate with creditors to reduce the amount you owe for debts that are not secured, such as credit cards. It’s not an option with certain types of debt, like a home that is foreclosed or a car that can be repossessed. Most companies don’t pay federal student loans but you may be able to . If you’re having trouble paying your student loans and need help, this may be a good option for you.
Settlement offers work only if it seems you won’t pay at all, so you don’t make payments to your loans. Instead, you open an account for savings and make a monthly payment in it. Once the settlement company believes the account has enough for a lump sum offer and negotiates on your behalf with the creditor to accept a smaller amount.
Readers can also ask questions.
Do debt consolidation loans hurt your credit?
Debt consolidation can help your credit score when you make on-time payments or decreases the balances of the revolving accounts, especially when credit card balances were near their limits. Your credit if you run high on your credit card debts, close most or all of your remaining cards, or make a late payment on your credit consolidation loan.
What can I do to reduce my credit card delinquence?
Bankruptcy and debt settlement can decrease or eliminate credit card debt, however they can severely affect your credit. Debt management reduces interest rates, and its impact on your credit is less severe. It can also reduce the interest rate as well.
How do I reduce my credit card?
Reduce your debt in three steps: 1. Find out your debts. 2. Find out which payoff strategy will work for you. 3. Make a plan and monitor your performance.
Debt settlement risks
Some debt settlement companies say they can reduce credit by up to 50%, and get your debt free in only 36 months.
However, the procedure isn’t as simple or as straightforward as it appears. In our opinion, debt settlement should be a last resort.
Here are the risks that come with the settlement of debt:
Your credit will be affected If you’re still not in debt on your accounts then you will be when you redirect debt payments towards your settlement accounts. Delinquent accounts and debt charged off by lenders stay on your credit for seven years.
Penalties and interest continue to accrue: You’ll likely be slapped with late charges and penalty fees as well. Interest will continue to accrue in your credit card balance.
There’s no guarantee of success The two biggest debt settlement companies are and . Freedom Debt, for instance, says it has settled more than $10 billion worth of debts for more than 650,000 customers since the year 2002. There’s no assurance that the debt settlement company can settle your debt significantly less, considering some creditors do not negotiate with them.
According to a study conducted by the Center for Responsible Lending, a nonprofit research and policy group, most consumers would have to settle at least four accounts in order to get the net gain. In addition, debt totals could increase as fees are accrued and aggressive collection efforts could continue throughout negotiations.
You have to pay a fee for each debt that is settled: By law, these companies can’t charge you up front fees. Most of them charge a percentage of each debt they settle, based on that debt’s balance at the time you signed up to into the program. Some charge an amount of the debts that are eliminated through the settlement.
For example, say you owe $10,000 and your agency negotiates with you a settlement of $6,000. The agency charges 25%.
If the agency has a fee based on the amount of settled debt, you’d pay the creditor $6,000 and pay to the agent $2,500 for charges (25 percent of the total amount enrolled). Total: $8,500.
If the agency is charged a percentage of the eliminated debt, you’d be charged by the creditor $6,000 , and the agency $1000 in charges (25 percent of the $4,000 debt that was eliminated). Total: $7,000.
Additional fees will be charged In addition to the fees that are that are paid after the debt is paid off, customers can face other charges, like the setup fee and the monthly cost to maintain the special account that is set up in the program.
Forgiven debt may be taxable: You should also know that Internal Revenue Service generally regards forgiven debt as income. It is possible to speak with tax professionals about any additional tax obligations you’ll have to take when you settle your debt.
If you choose to hire a debt settlement professional, be careful. It’s easy to let your guard down when you’re in a state of desperation and you see promises made by . It’s been reported that the National Consumer Law Center has said debt settlement companies are “almost never worth it and could get consumers into even deeper financial trouble.”
The Consumer Financial Protection Bureau takes a somewhat softer view, however, it warns consumers to be cautious about dealing with such companies is risky and that other alternatives should be considered first. There have been over 350 complaints filed against firms that offer debt settlement to the CFPB since 2014. Most of the complaints were fraud and excessive fees.
Solutions to Debt Settlement
Michael Bovee, a debt settlement coach, and often a critic of his field (he has presented evidence to the Federal Trade Commission in favor of greater regulation) recommends eliminating your debts through Chapter 7 bankruptcy and starting again, if you have the option.
For those who are burdened with debts that are not secured like credit cards, think about how your options compare, like . It is usually an option that is more beneficial. Yes, bankruptcy can affect your credit score for a long time however the process of rebuilding is able to begin right away. Consultations with a bankruptcy lawyer are generally free, however you’ll have to pay filing and legal fees if you choose this option.
“If you are able to erase your debts with the form of a Chapter 7 bankruptcy, that’s a much better option than trying to reach the settlement,” says NerdWallet columnist Liz Weston, author of “Your Credit Score” and “Deal With Your debt.” “Only if Chapter 7 isn’t an option or you choose not to file for bankruptcy, or you can only be considered for the Chapter 13 repayment plan -If you’re considering the possibility of settling your debt.”
If you don’t qualify for a bankruptcy or don’t intend to file one, consider the possibility of a donation through a nonprofit . Going that route will not typically reduce the amount you must repay, but it may reduce your monthly payments by spreading them out, or through lowering your interest rate. It’s not going to have a greater effect on your credit than bankruptcy or a debt settlement.
If you decide to pursue settlement
If you believe that it is the best or most appropriate choice for you and would like some help in the process of pursuing your debt, Bovee has tips for choosing a company wisely:
Check with the to see the complaint history.
Beware of any company who offers money in advance or promises that your debt will be paid.
Be sure that fees are arranged as a percentage of debt eliminated rather than of debt balance at enrollment; that gives the company an incentive to reduce your debt.
Do not trust companies that claim to help you challenge debts in order to declare them “invalid” (a tactic which could backfire and result in more aggressive action taken against you).
If you don’t want to work with a company for debt settlement think about hiring an attorney or doing it yourself.
A lawyer may bill by the hour, have a flat fee per creditor or be charged a percentage of debt or debt that is eliminated.
If you’re seriously behind the payments, it’s a good idea to reach out to your creditors. Some banks have hardship programs that may be able to aid. But be certain you can manage any lower payment options your bank may offer.
If you’re considering trying learn about the likely outcomes.
It is possible to collect enough cash are able to to make a lump-sum offer, whether that’s working part-time, selling sports equipment that’s been languishing in the basement or getting money through your cousin. (Creditors might be more likely to accept a lump sum offer that allows them to receive money immediate, rather than risking payment dates that may not be forthcoming.) Also be aware that some creditors may have a rule against settling debts.
Author bio Bev O’Shea worked as a writer for credit at NerdWallet. Her work has appeared in publications such as the New York Times, Washington Post, MarketWatch and elsewhere.
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