Table Of Contents
- Debt settlement is a debt relief option that can help you get out of debt faster and for less money than you owe.
- You can negotiate directly with creditors or work with a debt settlement company; both have risks and advantages.
- You can arrange a lump sum or term settlement with recurring payments.
- There are fees to consider when working with a debt settlement company and forgiven debt is taxable by the IRS.
- This process can negatively impact your credit score by as much as 100 points for up to 7 years.
- If debt settlement is not right for you, alternatives like consolidation and credit counseling can help.
What Is Debt Settlement?
Debt settlement is a negotiation process that involves working with your creditors to settle your debts for less than the full amount owed.
This process can be done independently or through a debt settlement company.
There are two types of debt settlement:
- Lump sum settlements: you or the firm representing you will pay one large payment to the creditor based on the agreed-upon terms.
- Term settlements: you or the firm representing you will make recurring payments over a set period until the agreed-upon settlement balance is paid in full.
How To Start The Debt Settlement Process
You can find and contact a debt settlement company or negotiate with your creditors directly to sign up for debt settlement. A debt settlement company will work with creditors on your behalf to negotiate a settlement.
In either case, confirm everything in writing before making settlement payments or assuming you’re clear. It is also wise not to agree to terms you can’t afford to maintain just because they sound good on paper.
Finding A Debt Settlement Company
To find a legitimate debt settlement company, it is important to do thorough research. Look for companies accredited by the Better Business Bureau and with positive reviews from past clients.
What to look out for, according to the CFPB:
- Makes promises that seem too good to be true
- Guarantees specific results before negotiating with your creditor
- Demands payment before settling any of your debt
- Advises that you stop paying or communicating with creditors before agreeing in writing
- Contradicts the guidance of other reputable sources
We’ve done some research for you in our guide to the best debt settlement companies out there.
Do-It-Yourself Debt Settlement
This process can be as simple as a phone call to your credit card or loan company or may involve follow-up conversations and forms like proof of income.
Call them, explain your circumstances, and express that you would like to know your options for settling your debt in a way that everyone agrees to.
The Cost Of Debt Settlement
Debt settlement companies typically charge fees for their services. The fees vary but are usually a percentage of the total settled debt.
On average, these firms can charge between 15 and 25% of the debt total, and many require up-front payments to start.
Settling your debt directly with a creditor will not involve additional fees, only the agreed-upon settlement amount.
Working With A Company Vs. Doing It Yourself
The National Foundation for Credit Counseling, The Federal Trade Commission, Consumer Financial Protection Bureau, and other consumer advocates do not recommend working with a debt settlement company over “Do-It-Yourself” Debt Settlement.
Your situation and the terms of available settlement solutions are the real determining factors here. You may even consider starting with the DIY approach and pursuing outside help if your efforts aren’t as satisfactory as you’d like.
How Debt Settlement Can Affect Your Finances
If you enroll in a debt settlement program, you’ll stop paying your creditors and pay the debt settlement company instead. They will use the funds to negotiate with your creditors.
Consider the following factors when planning your debt settlement:
- Compare the short and long-term effects of the options available to you. Could you keep up with a higher monthly payment? Will your income change in the future?
- How would a lower credit score or derogatory marks on your credit report affect future life decisions? Seven years can be a long time to have a lower chance of approval for an apartment rental or car loan.
- Since the IRS considers forgiven debt taxable, how would this affect your tax filing? Could you owe on your taxes next year?
Credit Impacts Of Debt Settlement
When you settle a debt for less than the full amount owed, it will appear on your credit report as a “settled” account for up to 7 years. This can lower your credit score by as much as 100 points and make it harder to get approved for credit lines in the future.
The exact time and impact on your score will depend on the specifics of your situation.
Alternatives To Debt Settlement
If debt settlement isn’t right for you, you may consider the following options instead:
- Balance Transfers
- Credit Card Forbearance Programs
- Credit Counseling
- Debt Consolidation or Refinancing Loans
- Debt Management Programs
Frequently Asked Questions (FAQs)
What Debts Can Be Settled Through Debt Settlement?
Debt settlement can be used for unsecured debts. This includes credit cards, personal loans, and medical bills.
Secured debts like home and car loans or secured credit cards do not apply.
How Much Can You Save With Debt Settlement?
The amount you can save with debt settlement will depend on your situation. However, it is possible to settle debts for 50% or less of the original amount owed.
How Long Does Debt Settlement Take?
The time it takes to negotiate your debts will depend on several factors, including the amount of debt you have and whether you’re working with multiple creditors.
The timeline for completely paying off your debt depends on the structure of your settlement, be it a term agreement or a lump sum.
Can You Settle Your Debts On Your Own?
Negotiating directly with a debt settlement company may take longer and require a bit more effort on your part.
The tradeoff is that this approach can be less expensive overall and avoids the risks associated with less reputable debt settlement companies.
Is Debt Settlement The Same As Debt Consolidation?
No, debt settlement and debt consolidation are two different debt relief options. Debt consolidation involves taking out a new loan to pay off existing debts.
In contrast, debt settlement involves negotiating with creditors to settle your debts for less than the full amount owed.
Considering debt consolidation? We’ve rounded up the best debt consolidation loans available.
Is Debt Settlement Better For Your Credit Than Bankruptcy?
Debt settlement is often better for your credit than bankruptcy. While both options can negatively impact your credit score, debt settlement is typically less severe and can be resolved more quickly.
If you are struggling with debt repayment, you may consider debt consolidation instead.
Will Debt Settlement Stop Collection Calls?
Debt settlement can help reduce the number of collection calls you receive, especially when you are represented by a company. However, there is no guarantee that this will happen. Some creditors may continue to contact you until you’ve paid the debt in full.
Until your creditor has agreed to terms with you or your representative, you are still responsible for making payments on pending due dates. These companies can come after you in the meantime, and skipping payments while negotiating can hurt your chances of settlement.
Do You Report Forgiven Debt On Your Taxes?
Any debt over $600 forgiven as part of the settlement process will likely be considered taxable income, so be prepared to pay taxes on your settlement.
A creditor that cancels over $600 of your debt will issue a 1099-C form prior to the following tax season.
You can consult a tax professional or IRS guidelines to determine the specifics based on your circumstances.
Is Debt Settlement Right For Everyone?
Debt settlement is not necessarily the right option for everyone. It is best for people struggling with unsecured debts who cannot make their minimum monthly payments and for whom other solutions are not ideal.
Take time to weigh the pros and cons of debt settlement before deciding if it is the right option for you.
Is Settlement The Solution?
Between 2007 and 2019, 18 million consumers settled debt across 34 million unsecured credit accounts — one in thirteen consumers, according to the Consumer Financial Protection Bureau.
If you’re struggling with credit cards or overdue loan payments, know you’re not alone. Many options are available, including our guide to paying off credit card debt.
Debt settlement can be a good option for people struggling with debt, helping to get out of debt faster and for less money. However, it is important to understand the impact of debt settlement on your credit score and the risks associated with this process, whether working with a company or negotiating independently.