Debt Settlement Companies…The Good, The Bad and The Ugly

You have consumer debt and you know you are in over your head. You are not sure what to do next. Then you hear an ad on the radio that tells you can be out of debt for pennies and there is a little-known secret about credit card debt…you don’t have to pay it all.

Most of the time when you hear an advertisement with these claims, they are referring to settling your debts. Debt settlement companies have become more common in recent years, but is debt settlement something that will work for you?

What Is Debt Settlement?

Debt settlement is when a creditor agrees to accept a lesser amount than what is owed on a debt forgiving a portion of the full amount of the loan. For example, maybe $30,000 is owed and the lender agrees to take $12,000. After the $12,000 is paid, the collection of the loan stops.

This is a very simple explanation of how it all works. Additionally, debt settlement applies to unsecured debt (credit cards, store cards, medical bills). Mortgages, student loans and car loans cannot be settled.

Why Debt Settlement?

The biggest reason a person would choose debt settlement is to avoid bankruptcy. It is important to realize that lenders are not required to negotiate a settlement on what you know. If you decide debt settlement is the route you want to go, keep in mind that you may not be able to negotiate a settlement with all of your lenders.

What About Debt Settlement Companies?

There are a lot of debt management companies that offer debt settlement as part of their financial services. Debt settlement companies often require you to stop making payments to your creditors and start making payments to the debt settlement company. The company negotiates with your lenders.

Once a settlement amount has been agreed upon by the lender, the debt settlement company pays the agreed upon amount to the lender out of the payments you have made to them. This process is followed until all settable debts have been paid. Debt settlement companies have fees and they can be steep. In most cases, they will begin collecting these fees, before they will begin working towards settling your accounts.

Can I Settle My Debts On My Own?

Sure, nothing keeps you from calling you lenders and asking them if you can settle what you owe on an account. It has been my experience that most lenders will not be willing to settle unless it has been many months since you have made a payment.

If your accounts are current and you can make the payments, credit counseling could be a better option for you. But, if you want to settle with a company, it does not hurt call them and talk about it.

If you have accounts that have been charged off and they are still on your credit report, the creditor is often willing to settle the debt. The settled debt is marked on the credit report as “settled for a lesser amount”.

It does stay on your credit report for several years. If you are trying to qualify for a mortgage, these outstanding balances must be satisfied either through settlement or payment in full.

Will Debt Settlement Negatively Impact My Credit Score?

The quick and easy answer to this question is “yes”. Debt settlement can often be as devastating to your credit score as filing bankruptcy. Before someone wants to settle a debt it often involves months and months of late payments or no payments at all resulting in a decrease in your credit score.

No matter how bad a credit score is, it is recoverable. A bankruptcy stays on your credit report for 10 years. Some forms (job applications, credit applications, etc.) will ask the question “have you ever filed for bankruptcy protection”?

Not disclosing the bankruptcy is fraudulent. Despite having to disclose that you have filed bankruptcy, this clean start may still be what is best for you.

Is Debt Settlement for You?

This is a question only you can answer. Here are my thoughts on debt settlement. Having looked into debt settlement once, I did not feel the amount of money it would have saved me was worth taking the long-time hit to my credit.

It would not have saved me that many months in payments either (probably most likely do to fees charged by debt settlement companies). Personally, I don’t think I would ever use a debt settlement company. I can easily pick up the phone and ask a lender, if I can settle a debt.

Here some things to consider if you are considering debt settlement:

The Good:

1. It can help you avoid bankruptcy
2. It is a good way of getting rid of old debts that have to be eliminated in order to qualify for a mortgage (these debts have already done their damage to your credit).

The Bad:

1. Creditors do not have to settle with you.
2. Many creditors will not settle if your account is current. They may only agree to a settlement if the account has gone 6+ months without a payment and they feel that a settlement is the only way they will get any money at all.
3. If a company agrees to settle a debt for a lesser amount than owed, the forgiven amount is taxable income. For example, if you have a $30,000 debt, the company agrees to settle for $12,000, the other $18,000 will be taxable income for the year the settlement is paid.

The Ugly:

1. Using debt settlement as a form of debt relief, will severely impact your credit score. Settling debts may be the best choice for old or charged off debts, but settling debts that are current, will just make things worse.
2. If you stop making your credit card payments in the hopes of saving money to settle in the future, there is the potential you could be sued by your creditor.
3. If you are considering debt settlement for several credit card accounts, you may have to make the very difficult decision to opt for filing bankruptcy.

Final Thoughts

If you are overwhelmed with debt and cannot see any way out, consult a non-profit consumer credit counseling agency. Keep in mind the word “non-profit” does not necessarily mean no-fees. A debt management company can help you decide what debt relief option will work best for you.

They will even tell you if bankruptcy is your only way out. Credit counseling agencies also have a lot of free resources that can help you manage your money and financially prepare you for the future.

My number one tip from all this is…DON’T WAIT. Things will not get better without making changes. If you are struggling with high interest rates and barely making minimum payments, it will be a long uphill battle if you delay getting help.

I used a debt management company to pay off all my consumer debt and I am not sure I would have been able to pay the debt off without the assistance provided by the consumer credit counseling company. Consolidating unsecured debts so that you only have to make one payment monthly and reducing interest rates significantly goes a long way to becoming debt free quickly.