Debt Settlement

Struggling with debt payments can be overwhelming and stressful. Many who have accumulated large amounts of debt and struggle to keep up with payments choose some form of debt relief to help manage what they owe.

Some choose debt settlement when other methods of debt relief have not worked. Individuals who have already undergone credit counseling and have tried to manage their debts through traditional debt relief methods, such as a debt management plan, and are still struggling might consider debt settlement as a viable option. However, it is important to note` that debt settlement comes with significant risks and may not be right for everyone. Read on to learn more about the process of settling your debt.

What is debt settlement?

Debt settlement is the process by which a debtor and creditor settle a debt for less than is owed. Unlike debt consolidation, debt settlement does not involve originating a new loan in order to pay off another. The creditor of the loan agrees to accept a partial payment of the debt as full payment when a debt is settled. These payments are typically accepted as a lump sum.

Creditors do not have to negotiate or accept an offer of debt settlement from a debtor. In many cases, however, a creditor might be willing to accept an offer if the company believes that offer might be the best chance of recovering the money that was lent. The process of settling a debt can be long, as it typically requires the debtor to communicate with the creditor on multiple occasions.

How does debt settlement work?

Debt settlement can either be done by the debtor or by a for-profit debt settlement company. These debt settlement companies aggressively negotiate the partial payment of a debt with creditors on the debtor’s behalf. Before the negotiation begins, the debt settlement service asks that the debtor make monthly deposits to an account that will be used to fund the settlement. Once the service deems the funds in the account large enough for a one-time payment, the company begins the negotiation process with creditors.

During the debt settlement process, settlement service companies will ask the debtor to stop monthly payments to the creditor if he or she has not already done so. This strategy is used to pressure creditors into accepting the terms of the settlement, as most lenders may only consider this strategy after an individual has missed several payments and is unable to pay off his or her debt. Debt settlement is often a last-resort approach to debt relief, and should be carefully thought over. Before choosing to settle debts, it is important to understand the significant risks that are involved in debt settlement.

Debt Settlement Risks

Debt settlement involves many risks and is not suitable for everyone. This debt relief method does not work for many people and in many cases only delays financial relief. Settlement negotiations do not stop accounts from incurring late fees and they do not prevent collections notices or the possibility of being sued by creditors. A successful debt settlement does not relieve the debtor from the responsibility of the taxes owed on the settled account. Using a debt settlement service will also cost a debtor money, as these companies require a fee for their services. Consulting multiple debt relief companies before deciding on any one option is wise, as each company may offer differing advice and typically do not tell clients of other options that may suit them better.

Below are some of the risks involved in debt settlement:

  • Damaged credit score – Starting the debt settlement process means letting accounts become delinquent. Accounts that are delinquent damage credit scores are recorded on an individual’s credit report for seven years.
  • Late payment fees and interest still accrue – Debt settlement negotiations do not put accounts on hold. The debt total on an account will increase, as late payment fees, interest and other penalty fees are still charged to the account.
  • Payment of additional fees – When settling a debt through a settlement company, a percentage of the debt being settled is charged. The debt percentage charged is calculated starting with either the balance of the debt upon enrollment in the program or the amount of debt eliminated by the settlement. Debt settlement companies can also charge their customers other fees, such as setup or monthly maintenance fees.
  • Taxes on forgiven debt – Being relieved of a debt does not mean that an individual is relieved of paying taxes. The Internal Revenue Service typically counts forgiven debts as a source of taxable income. Before choosing debt settlement as a debt relief option, it is best to consult with a tax professional about any taxes that may require payment if the debt is settled.
  • Settlement programs are not guaranteed – Debt settlement is never guaranteed to be successful, even when done through a debt settlement program. Some creditors are unwilling to negotiate with certain debt settlement companies. Companies that are able to settle debts may not be able to settle for much less than is owed. Debt settlement may cost a debtor more in the long run.

When is debt settlement a good idea?

Settling a debt with a creditor should always be a last resort for anyone seeking debt relief. Debt settlement is not a good option for those who are able to make monthly payments on their bills or whose debt is manageable.

Although debt settlement is usually not without significant risks and drawbacks, it may be a viable one for those who have tried other unsuccessful debt relief methods, have delinquent accounts and believe their creditor might accept a partial payment on the account balance.

Those looking to debt settlement as an option should consider settling the debt on their own instead of doing it through a debt settlement company. Although some creditors have a policy against debt settlement, some companies might be willing to accept a lump-sum offer from a debtor. To settle a debt without the help of a debt settlement program, save a reasonable amount of cash before making an offer to creditors.

Other Forms of Debt Relief

Debt settlement is a long, difficult and risky process that only few should consider. There are a few alternative options to consider before making debt settlement a final choice. Some of the other options to consider are:

  • Debt consolidation – Those who have debt in multiple accounts might find debt consolidation to be their best option for debt relief. Consolidating debt requires taking out a single new loan, often with lower interest rates, to pay off other debts.
  • Chapter 7 bankruptcy Although most believe that bankruptcy damages a credit score more than settling a debt, bankruptcy and debt settlement often lower a credit score similarly. Bankruptcy also allows those who have filed to begin rebuilding their credit sooner than debt settlement permits. Those looking to file Chapter 7 bankruptcy must complete bankruptcy counseling within 180 days before filing.
  • Credit counseling – Working with a non-profit credit counseling agency can help offer debt relief through a debt management plan. These agencies help make sense of every situation and help clients establish a plan to manage their debt without the use of debt settlement or bankruptcy.

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