If you are in debt and you are struggling to make ends meet month to month, you need to find a way to make your finances work. Apart from tightening your budget, you should also look into other methods to reduce your debt and get your money in order.
In this article, we will examine debt settlement as a possible solution to debt that is spiraling out of control, taking into account the pros and cons, what the program entails and any other options you could consider. If you would like to see a comparison of debt settlement companies, Click Here To View Our Top 10 Debt Consolidation List.
What is a Debt Settlement Program?
A debt settlement program is usually offered by a for-profit company who will negotiate a settlement on your debt on your behalf. This can be a good idea for people who are failing to manage their debt, feel overwhelmed by their financial situation or are accruing further debts month over month.
Rather than paying off multiple creditors, a debt settlement program seeks to consolidate your debt and to reach a reduced settlement rather than pay off the entire debt. A settlement is a lump sum that is paid to resolve the debt. Usually, the debt settlement company will set up a separate account for you to deposit a single monthly payment and will then start negotiating a settlement based on these savings.
Though a debt settlement program can save you around 40% on your debts, you must keep in mind that these companies are for-profit and will also take a fee, usually 15-20% of your original debt. Factor this fee in before you agree to the terms of a debt settlement company so that you are not surprised later on.
How Does Debt Settlement Work?
When you enter a debt settlement program, you agree that the debt settlement company will negotiate your debt for you with the aim of reducing the amount you owe by offering a lump sum payment. As part of the agreement, you will stop making regular payments to your creditors. Instead you will set up a 3rd party account in escrow and make a single monthly payment to this account. You must stop making payments to your creditors because debt settlement companies only deal with delinquent debt.
What are the Pros and Cons of Debt Settlement?
Before you choose to enter a debt settlement program, you must consider the pros and cons of doing so. Here are some factors to consider.
- Debt settlement can lower the amount you owe your creditors which may be quite considerable if you have amassed large debts.
- Your monthly payments may be reduced which is beneficial if you are consistently overextending yourself each month.
- You will have access to an advisor who will be able to negotiate on your behalf, taking the strain off you.
- Your credit rating will be impacted as your debts must go delinquent in order to settle. This will appear on your credit report for up to 7 years and after settling, your creditor will mark the debt as settled. Your credit score may drop by as much as 150 points, depending on your initial score.
- Your forgiven debt is considered additional income by the government and is taxable at your normal tax rate. You will receive a 1099-C cancellation of debt tax notice after any settlement.
- There is a chance that your debt settlement company will not be able to negotiate a settlement for you on all of your debts as your creditors are under no obligation to agree to a settlement.
- Discontinuing payments to your creditors in favor of the escrow account can be risky as you may accrue late fees and penalties that will push you further into debt.
What do You Need to Do Before You Enroll?
Before you enroll in a debt settlement program, it is important that you do some research.
Researching Debt Settlement Companies
To start the process, you first need to research the various debt settlement companies who operate in your state. The debt settlement industry is, unfortunately, abused by some scammers who offer deals that are too good to be true to people who are becoming desperate.
Searching a company online with ‘complaints’ is often a good way to see if there is anything to be concerned about. You can ask your state attorney general for advice about the legitimacy of a debt settlement company and check that they are able to operate in your state. You can also ask a local consumer protection agency.
There are some common statements made by scammers to tempt you in.
- Guarantees that your debt will all go away
- Suggestions that there is a new government scheme to bail you out
- Charging fees before any debt is settled
- Unrealistic settlements for pennies on the dollar
- Suggestions it can prevent any lawsuits or debt collection calls
- Requires that you don’t communicate with creditors without explaining consequences
A good debt settlement company will always explain the consequences of your signing up, give a realistic expectation of what you can achieve and give you time to consider what you want to do. They will never pressure you into making a fast decision and they cannot legally charge any fees before the settlement of any debt.
There are four debt settlement companies recommended towards the end of this article.
Do The Math
Debt settlement will often save you money, but you still need to consider whether this is the best route for you. Paying off debt with debt settlements takes around 2 – 4 years, so you need to be sure that you will be able to make the single monthly payment to your escrow account for the duration of this period.
Many people struggle with debt because they accrue debt month over month as their finances won’t stretch to their needs. If you can’t afford to make your monthly payment towards settlement, it is likely that your situation will either get worse, or you will have to drop out of the program.
If you can stretch your budget and you are determined to work your way out of debt, debt settlement companies will try to settle for a lump sum of around 40% original enrolled debt amount. Debt settlement companies usually charge a fee of between 15-20% of the original enrolled debt amount which is taken once the debt settlement is secured. Some states have caps on this percentage fee, so be aware of the cap before you agree.
Altogether, debt settlement usually saves consumers around 25-35% of their original enrolled debt amount.
The Debt Settlement Process
Once you have chosen a company and you feel confident that you will succeed in paying off your debts, you can start the debt settlement process. This process can be long and difficult but it works step by step until your debt is all paid off.
- Consultation. To start with, you will see an IAPDA debt specialist who will go over all your debts to ascertain how much you owe, how many creditors you are indebted to and how much you pay each month.
- Enrollment. Your advisor will then evaluate your finances and look at how much you can contribute to the program each month. They will then enroll you on their debt settlement program.
- Payments. Once your monthly contributions are set, you will stop making payments to your creditors and start paying into the escrow account set up for you instead.
- Negotiations. Usually after around 6 months, your settlement company will start negotiating settlements with the money that has accrued in your escrow account. If a settlement is reached with a creditor, they will notify you.
- Settlement. When a settlement is agreed, you will transfer the money from your escrow account to your creditor and pay your settlement company their percentage fee.
Which Debt Settlement Companies Should You Consider?
Once you feel that you are fully informed about the risks and benefits of debt settlement, you have done the math and you are confident about the process, you can start to consider which company is best for you.
Freedom Debt Relief (OUR PARTNER)
With a decade of negotiating experience and around 42,417 accounts settled each month, Freedom Debt Relief are another well recommended company. They are ranked #2 on out Top 10 List. They are easy to get in touch with and will offer plenty of advice to help you back to financial stability. Your success is their success so they will agree a suitable monthly payment with you on their customized plan. You can visit Freedom’s website by clicking here.
What are the Other Debt Relief Options?
Debt settlement is not the only debt relief option available to you and it may be that there are better ways for you to manage your debt.
If you do not meet the minimum requirements for a debt settlement program, it is likely that you will be referred to a credit counseling agency. This is a process where you are advised on how to budget and you may be enrolled in a debt management plan. Though a debt management plan will take much longer – around 5-7 years, your credit counselor will also negotiate with your creditors to try to reduce interest rates and fees. Your credit score will also be affected.
Many debt settlement companies will also offer credit counseling services, but you can also find non-profit services too. Credit card providers must include a toll-free number on their statements to help you find a non-profit counseling organization. The U.S Trustee Program also provides a list of government approved counseling organizations.
Debt Consolidation Loan
A debt consolidation loan is a single loan that you can take out to pay off multiple creditors. The benefit is that you will only have to make a single monthly payment, rather than keep track of multiple debts. This lender is usually a bank or a credit union but some debt settlement companies also offer this service.
While debt consolidation can be easier to manage, you must also consider the interest rates and whether you will need to provide collateral to be eligible. There may also be other requirements to meet such as debt-to-income ratio or a certain level of income.
A final option for people struggling with debt is bankruptcy. There are two types of bankruptcy and neither should be taken lightly as both will reduce your credit score by up to 200 points and will remain on your credit report for up to 10 years.
A Chapter 7 Bankruptcy process will liquidate all your debts, using the sale of some of your assets to pay for it. This could include property such as a mortgaged house or a car.
A Chapter 13 Bankruptcy process will allow you to keep your assets and a court will approve a plan for you to repay your remaining debts over a 3-5 year period. For this type of bankruptcy you will need to pay a lawyer and get credit counseling for up to 6 months before you file for bankruptcy.