Have you been having trouble making the minimum payments on your credit cards or loans? Would you like to eliminate your debts quickly while saving money on interest? If so, you’ve probably heard of debt settlements.
Debt Settlement: What Is It?
You work with a debt settlement agency to settle your debts for a fraction of their value. You start by telling them what obligations you want to pay. Each month, you’ll send them a certain amount of money, and they’ll put it in a special account. The agency will make a payment plan for you.
If you’re working with a debt settlement agency, you don’t pay your creditors. When you’ve got enough money in your settlement account, the company will start negotiating with your creditors one by one. When they come to an agreement with your lender, you’ll pay the amount due.
This process continues until all of your debts have been repaid and you have graduated from the program.
The problem with debt settlement companies is that they can be scams and end up making your financial situation even worse. Some states have even had to pass laws regulating their practices to prevent them from making things worse.
The Pros Of Debt Settlement
The pros of debt settlement include the following:
- You can save a lot of money by settling your debts.
- The structure is one of the benefits of debt settlement.
- By settling your debts, you will be able to avoid bankruptcy in the future.
Let’s take a closer look at each debt settlement benefit in more detail now.
Certainly, one of the main benefits of debt settlement is the ability to save money by reducing your interest and fees from your creditor as well as the total value of your outstanding debt.
Suppose you have a $1,000 balance with a creditor. In that case, your debt settlement agency may be able to arrange for you to pay off 60% of what is due, or $600, and you’ll save $400 plus any future interest charges from the lender as a result of accepting the settlement offer.
If you work with a debt settlement agency, you are transferring the responsibility of dealing with your creditors to the agency. They will handle the negotiation process, and you will only need to provide your approval or disapproval of each settlement offer. Neither you nor your creditors will need to contact you again.
The best thing about debt settlement is that it gives you a structure to pay off old debt. The debt settlement agency will hold your money for you and use it to pay off your obligations. You won’t need to worry about saving the money on your own when it can be tempting to withdraw the funds for other purposes. You will have no worries about saving money.
It is also beneficial for individuals who are seeking to avoid bankruptcy. Bankruptcy can have a devastating effect on a person’s credit report for up to ten years. While debt settlement is unlikely to raise your credit score, it will not have the same adverse effects as bankruptcy would.
Please see the example below for a better understanding.
As an example, Shelby is being sued by a debt collection agency for a debt of $2,000 due on her credit card. After reviewing her finances carefully, Shelby sends the debt collectors an offer of $1,200 as a settlement. In the end, Shelby is able to save some money and avoid committing further debt, as she has been able to reach a debt settlement of $1,500 (only 75% of the original debt amount).
The Cons Of Debt Settlement
There are some cons associated with debt settlement, including:
- It can be very expensive to settle a debt.
- If you settle your debts, you will not be protected from a lawsuit for your debts.
- Your credit score can be negatively affected by debt settlement.
- It is important to note that debt settlements are taxable income.
We will examine each of these disadvantages of debt settlement in more detail below.
In general, debt settlement agencies can be expensive. Their services aren’t free. Typically, an agency will charge you a fee of up to 25% of the total amount of your debt, taking away from the savings you could have achieved through debt settlement.
If a creditor decides to sue you while your account is with a debt settlement company, you will need to deal with the lawsuit on your own. A debt settlement agency cannot protect you from a potential lawsuit. Even if a debt settlement agency manages your debts for you, you remain entirely responsible for them.
A debt settlement can also negatively impact your credit score since if you don’t pay off your debt in full, your creditor will report the fact that you have settled your debt for less. This can hurt your credit score, thus making it harder for you to get new credit later on.
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As a last note, if you are able to settle your debts for a fraction of what they were originally worth, you will likely owe additional taxes for the amount that was forgiven. The IRS considers forgiven debt to be income unless you file for bankruptcy. You may also be required to pay state taxes depending on where you are located.
Let’s take a look at another example as well.
The following example illustrates how Steven owes several debts. He enrolls in a debt settlement program to try to alleviate the stress of these debts. Upon combining all his debts, he finds out that he owes about $15,000 overall. Steven ends up paying thousands of dollars in fees to the settlement company at the end of the settlement process and owing the IRS additional taxes on the forgiven debt by the end of the settlement process. It would have been easier for him if he had just attempted to deal with the debts on his own, saving himself money and stress in the process.
Is It Possible To Settle A Debt On Your Own?
There is no need to use the help of a debt settlement company in order to settle your debt on your own.
As a first step, you should figure out how much you can afford to pay toward the debt. Individuals are recommended to start with at least 60% of the debt’s value. For example, if you owe $3,000 to a creditor, you would propose to repay $1,800 in exchange for wiping your financial slate clean.
The next step is to submit your initial settlement offer to the creditor or debt collector. This offer might look something like this:
“I, [your full name], am offering you a lump-sum payment of $___ to settle my account number ___. You can accept or counteroffer. If you accept, respond to this message with only “Accept.” If you want to counteroffer, respond with your new offer amount. Please do not contact me in any other way than by responding to this email. This offer expires in 6 days on MM/DD/YY. I will pay the agreed amount within 90 days of the settlement date.”
You may have to go through several negotiation rounds before you are able to reach an agreement with the creditor or debt collector once they receive your offer. The creditor or debt collector will decide whether to accept or counter with an offer of their own.
Prior to sending any money to the creditor, make sure that you get a copy of the contract in writing. Your contract is your protection in the event that the creditor decides to pursue you for the remainder of the debt.
No matter what your situation is, you’ll want to develop better financial habits in the future.