A debt settlement is an agreement between borrowers and lenders to make a lump-sum payment instead of the full amount owed. It is one of the most aggressive and effective debt resolution methods available. However, it is not a debt relief method you should take on lightly. It is a last-ditch resort that forces lenders to decide between giving you a break on part of your debt or getting nothing at all.
Debt settlement doesn’t always work. The U.S. Consumer Financial Bureau specifically warns that dealing with debt settlement companies can be risky and that some over-promise. The agency says you should consider all of your options, including working with a nonprofit credit counselor.
Here’s a comprehensive look at debt settlement so you can decide whether this form of debt relief makes sense to you.
How does debt settlement work?
The threat of bankruptcy is what brings many creditors to the table. Lenders know that personal bankruptcy can discharge unsecured debt and prefer to get something than to be left standing with worthless promissory notes. If you can convince your lenders you cannot afford to pay your debt in full, they may agree to a discounted payment instead. How much of a discount are lenders willing to give? It all depends on your negotiating skills and your financial situation. You should also be aware some of your creditors may refuse to work with the debt settlement company that you choose.
Remember credit card companies and lenders don’t mind extending the terms of loans as long as you continue paying the interest on your debt. Credit card companies, for instance, love clients who just pay the minimum amount on their account for years if not decades. For it to work, you typically have to stop making payments on your unsecured loans for months or even years.
Not paying your bills is not something you should consider lightly. It will seriously damage your credit history. Eventually, you will also have to deal with debt collectors, which nobody likes. Professional debt settlement firms can help limit the activity of debt collectors, but nobody can guarantee you won’t be bothered with collection calls or home visits.
Who should consider debt settlement?
As we explain below, a debt settlement is not the only option available to borrowers. There are serious consequences to debt settlements that should, at the very least, give you pause. However, under certain circumstances, negotiating with your creditors is the smart option.
A debt settlement is the best choice for people who:
- Have overwhelming debt they can’t afford to pay
- Have poor credit or don’t care about getting bad credit
- Don’t qualify for Chapter 7 bankruptcy
To decide whether a debt settlement is a good option for you, consider these questions:
How much do you owe?
If you only owe a few thousand dollars, you may have less damaging options to consider. For instance, you could:
- Reduce your monthly expenses and follow a payment plan that systematically repays your debt.
- Consider selling stuff you don’t need. The average home has a couple thousand dollars worth of things to sell.
- Cash out on your savings or investments.
- Ask friends or family for help.
What is your credit score?
Hurting your credit score is the only real leverage lenders of unsecured loans have on you. If your credit is already bad, lenders are more likely to consider a debt settlement plan.
Also, if you have good to excellent credit (700 to 850), you may qualify for a reasonable debt consolidation loan. Debt consolidation loans don’t reduce your debt, but they don’t hurt your credit history either. However, be careful about using your home as collateral for your debt consolidation loan. It is rarely a good idea to tie your home to a loan that isn’t a mortgage. You can’t lose your home over unsecured debt, such as credit card debt or personal loans, but you can lose your home if you put it as a security for a consolidation loan. Even if you do qualify for a debt consolidation loan, your current income may make it impractical to even attempt to pay the entire debt. Talk to a debt relief specialist and ask what your best options are.
Do you qualify for a Chapter 7 bankruptcy?
Bankruptcy is another extreme debt relief option that has serious financial consequences. For instance, bankruptcy stays on your credit history longer than the missed payments of a debt settlement and it could disqualify you for certain jobs in the financial industry. A Chapter 7 bankruptcy forces you to liquidate most of your assets to pay as many of your creditors as possible. If you own a home, cars or other valuable property you want to keep, you want to avoid a bankruptcy.
Do you need a debt settlement firm to negotiate with creditors?
No, you don’t. You can do it all yourself. You need to assess what is best for your particular situation.
Benefits of doing it yourself or hiring a debt settlement firm
The biggest benefit of negotiating directly with lenders is you don’t have to pay the debt settlement firm fees. Debt settlement firms are for-profit companies staffed by debt relief experts who expect payment for their services. If you negotiate your own debt settlement, you can skip the fees. If your debt is less than $5,000 and you decide debt settlement is your best debt relief option, it may be a good idea to try doing it yourself. The debt settlement company’s fees might outweigh the savings when you are dealing with smaller debt amounts.
With large debt amounts, the benefits of hiring a debt settlement company increase. These include:
- Creditor policies. Certain creditors will not settle directly with consumers.
- Settlement terms. Consumers may face less advantageous settlement rates on their own, as opposed to debt settlement companies that have relationships with creditors and can often package bulk settlements.
- Poor lines of communication. Consumers may struggle to get hold of decision makers or endure long delays in any negotiations or paperwork processing with the creditors.
- Experience. Every creditor has different processes and procedures in how they determine settlement offers and terms. Not knowing those can leave a consumer in the dark.
- Lack of support. Settlement companies have a customer service department to assist consumers with any questions or difficulties that arise during their program. This support can be particularly valuable, especially in cases in which creditors become aggressive. If an account were to escalate to legal status, a consumer settling on their own would need to seek out a third party for help.
- The fine print. Unfamiliarity of the settlement process can be intimidating, and mistakes can be made. You will need to beware of fine print and carefully review any correspondence, proposed settlement or agreement with a creditor.
- Legalese/lack of familiarity. Settlement agreements should be reviewed very carefully, perhaps by a third party, to make all the terms are those that are agreed upon.
- Emotional toll. Settling your debts on your own can be an emotionally draining and painful process.
How to choose a debt settlement company?
Hiring a debt settlement company is like choosing a lawyer or a car repair shop: you would prefer not to need their services, and it’s not always easy to spot the good guys for the companies that give the industry a bad name. SuperMoney has surveyed the debt settlement industry and identified the reputable companies over those you are best avoiding. By following debt relief best practices, we have helped thousands of people settle over $5 billion in debt.
Here are some of the factors we consider when vetting and rating debt settlement firms:
- Guarantee: We prefer companies that provide customer satisfaction guarantees.
- Financial strength: We only recommend firms that are financially sound and well funded.
- Expert staff: Only firms that hire certified debt relief experts are considered.
- Accreditation: Companies are members of the American Fair Credit Council, the largest trade association serving the debt settlement industry.
- Experience: Debt settlement firms need to have considerable experience.
- Payment options: We seek out affordable companies that offer several payment options.
Questions to ask
Before hiring a debt settlement company:
- Are you fully accredited, licensed and compliant with best practice standards?
- Are all your debt specialists certified by the International Association of Professional Debt Arbitrators?
- How long have you been in business and how much debt have you settled for your clients?
After giving a summary of your financial situation:
- Will you help me with all of my debts? If not, which ones can’t you deal with?
- Can you still help me if I cannot afford the minimum monthly payment some months?
- What kind of security measures do you take to protect my personal information?
- Am I able to get regular, updates on the status of my account and settlements?
- Is there a money-back guarantee if the program doesn’t work for me or I decide to quit?
- When will my accounts be settled?
Debt settlement is a powerful debt relief tool. It’s not for everyone, but in the right circumstances, it can be the best route toward debt reduction.
To contact a debt relief specialist, click the button below. You can get a free debt analysis and an idea of what your debt relief options are.