The first thing you need to understand about Debt Settlement is that it is not a loan. That’s right. It’s not a loan at all. Many Debt Settlement companies market Debt Consolidation and then pitch you Debt Settlement, because Debt Consolidation is what consumers know. The truth is that Debt Settlement is the process of hiring a company to represent you and negotiate your unsecured debts with your creditors. Unsecured debts are: credit cards, personal loans, and medical debt. A Debt Settlement company will negotiate terms for a settlement and use your money to pay off that agreed amount.
When Debt Settlement is a smart move?
Debt Settlement is a good option for some people, but isn’t for everyone. In order to qualify for Debt Settlement a consumer (you) would need to be able to claim that you had a hardship of some sort. What do you mean by hardship you ask? A hardship can be one of a variety of things—from job loss, divorce, medical issues, income reduction, or even just financial mismanagement. Debt Settlement is also a good solution if you can’t qualify for a Debt Consolidation Loan, so if you have a good credit score and enough income to qualify for a loan, then you are probably better off doing that. If you don’t have a stellar credit score but do have steady income, then Debt Settlement could be just what you need.
How does debt settlement work?
When a consumer joins a Debt Settlement program that person agrees to stop paying their monthly credit card payments—if they still are—and the debt settlement firm will contact each creditor explaining that they are representing the consumer and that the consumer is having a hardship.
As part of the program—the firm creates a type of savings account where the client (you) would put money into each month. After 4-8 months, depending on your accounts and debt amounts, the firm will have enough money to settle one of the clients debts. After settling that account, the account is closed and the client doesn’t owe that creditor anymore. The debt settlement firm would also collect a fee as part of settling that account. At this point the process repeats itself until all of the accounts are settled and the client has no more debts.
Federal law requires that Debt Settlement firms only charge a fee when they have actually helped someone, and that fee is usually 15%-20% of the debt you are trying to resolve. Debt Settlement firms can often get creditors to write-off 40%-60% (on average) of your total debt. So for example—a $10,000 credit card balance can be negotiated down to $5,000, plus a $2,000 fee (20% of $10k)—consumers end up paying 70 cents on the dollar and have that debt resolved in 2-4 years as opposed to paying it down over several years, if ever. People usually enroll multiple accounts with totals ranging from $7,500 to $100,000+ in unsecured debt.
Who should consider Debt Settlement?
Anyone that has experienced a financial hardship that has caused them to accumulate a substantial amount of unsecured debt (credit card, medical debt, or personal loans) should speak to a Debt Settlement firm to see if they qualify. If you have a lot of this type of debt and don’t have any income, you may consider looking into bankruptcy. A Debt Settlement program requires a consumer to be able to contribute funds monthly in order to have money to negotiate with.
The benefits of Debt Settlement
The major benefits to doing Debt Settlement are three fold:
1 - Time to zero debt - Debt Settlement programs can take 2-4 years, but at the end the debt is gone. Paying off debt by paying monthly minimum payments could take several years.
2 - Affordability - The consumer isn’t making monthly payments on high interest credit cards or medical loans, but instead making a single affordable payment into a Debt Settlement program.
3 - Over all savings - Your debt is being negotiated down and usually by a good margin, so in the end you have paid far less interest and fees.
When Debt Settlement isn’t worth it?
If a consumer has the cash-flow and discipline to pay down their balances, then that’s the first thing they should do. There are strategies for paying off debt by yourself and it may be the right approach in the right situation.
If you have a solid 660+ credit score and decent income, then you should not do Debt Settlement but get a Debt Consolidation Loan with one lower interest payment instead. If you have equity in a home and can qualify for a Home Equity Line of Credit, then you should do that before getting a Debt Consolidation loan.
Debt Settlement will have a negative impact on your credit score because you are essentially defaulting on your accounts, so if you need your credit score to make a big purchase then it might not be for you. The negative impact to your credit score is typically reversed by the time you have paid off all your debts and are finishing a Debt Settlement program, and once you are finished and maintain responsible borrowing habits your credit score should continue to climb over time.
Answers to debt settlement questions
Is debt settlement a scam?
There are several reputable debt settlement companies out there that have thousands of clients and have been in business for several years. The industry does have a scammy past because it was unregulated for many years, but in 2010 Congress passed the Debt Settlement Consumer Protection Act that put into place strict consumer protections and cleaned up the industry almost overnight. Though, you should always be judicious when evaluating any financial company by doing your research, reading reviews, and testimonials. You can also check a company's Better Business Bureau rating.
Will debt settlement hurt my credit score?
Going through a debt settlement program will definitely impact your credit in a negative way. I would also mention that if you are a good candidate for debt settlement then you probably have a subprime credit score (580-669) already and wouldn’t be able to qualify for credit, otherwise you would have gotten a debt consolidation loan instead. The worst thing you could do is to start a debt settlement program and then not follow through with it.
How long does debt settlement take?
Most debt settlement programs take two to four years, but it all depends on how much debt you are trying to settle and how much you can contribute to the program each month. The faster the settlement company has the money they need to negotiate your debts, the faster they can settle them and move on to the next debt account.
What types of debt can be settled?
Debt settlement can only resolve unsecured debts like credit cards, personal loans, medical debt, and some types of student loans. Mortgages, car loans, and most student loans do not qualify for a debt settlement program.