A debt settlement program is a debt resolution strategy that allows debtors to reduce the amount they owe in exchange for a lump-sum payment. Tired of paying endless minimum payments that barely cover the interest on the loan? A debt settlement can completely remove your debt account for a fraction of what you owe. Although a debt settlement program is one of the most effective methods to reduce debt on unsecured loans, there are serious consequences you should understand before you join one. For instance, it will hurt your credit score and it may not stop all collection calls.
How does a debt settlement program work?
Debt settlement programs follow four steps:
- Debtors must stop making payments on their unsecured loans. This is a serious step you should consider carefully. As soon as you stop paying, creditors will start their collection process and your credit score will most likely take a serious hit.
- The debt settlement company sets up an account in the client’s name. Clients deposit as much money as they can afford into the account. This money will be used by the debt settlement firm to negotiate a lump-sum payment. The faster you save enough to settle the account, the sooner you can start rebuilding your credit.
- Once the settlement account has enough cash, the debt settlement company negotiates with creditors for a reduced payment.
- The debt relief firm transfers the agreed amount and the creditor closes the debt account.
How long does it take to settle an account?
The duration of a debt settlement depends on several factors, such as:
- How fast the debtor can save money in the settlement account
- The ability of the debt arbitrator negotiating on your behalf
- The debt settlement policies of the creditor
According to Charles Hughes, Business Development Director for Debtmerica, approximately 50% of clients achieve their first settlement within three months of enrollment. This is typical among leading debt relief companies. Timothy Cerruti, CEO of Consumer Debt Help Association, reports that a typical client will settle the first debt account within four months.
On average, debtors generally settle all their debt accounts within 24 to 48 months.
Related: Check out SuperMoney’s reviews of the best debt settlement companies here.
What are the pros and cons of debt settlement programs?
As with bankruptcy, debt consolidation, and other aggressive debt relief methods, there are pros and cons to consider. If you’re thinking about hiring a debt settlement firm, you are no doubt attracted by the possibility of a fresh start without the crushing weight of debt on your shoulders. Yet you might have heard about the negative effects debt settlement can have on your credit.
Most of what you have heard about debt settlement, for and against, is probably untrue.
Shady debt settlement companies – yes, every industry has them – exaggerate what they can do for their customers and “guarantee” they can settle their debts for pennies on the dollar. Although there are extreme cases when debtors do settle their accounts for single-digit percentages of the original loan, this is rare. A more realistic range is 15% to 75%, and that doesn’t include fees. When you include fees, debt settlement firms provide an average debt reduction of around 30% to 36%.
Credit card companies and bankruptcy lawyers often misrepresent the debt settlement industry by overstating its cost and the damage it causes to your credit score while minimizing its benefits. This is to be expected.
Here are a couple of things to consider when looking for a debt settlement company.
Do they have minimum and maximum limits on the amount of debt you can enroll?
Most companies require you to have a minimum amount of debt, which is usually around $10,000. Some lenders, such as Freedom Debt Relief, accept lower amounts. Other companies also have a maximum amount of debt you can enroll, such as $100,000. You will need to find a company with requirements that match your needs.
What is their customer service like?
We typically don’t care about the customer service of a company until we run into problems or have questions. It is important to find out ahead of time about the level and quality of support provided by a company. You can do so by researching the support channels they offer (phone, email, live chat, etc.) and by reading reviews from past customers. Look for companies like Debtmerica Relief and Rescue One Financial which are recommended by our community of users. Other debt settlement firms to consider are Pacific Debt and National Debt Relief.
Why do credit card companies and other creditors hate debt settlements?
Credit card companies don’t want to settle your debt. They are perfectly happy with you making minimum payments for years or even decades. No surprises there. To illustrate, the cost of making minimum payments on a large credit card debt, consider a typical case.
The average person with credit card debt owes over $15,000 and has an average interest rate of 15%. Credit card companies usually calculate minimum payments as interest plus 1% (up to 5%) of the debt balance. Using this scenario, a $15k debt would take over 33 years to repay if you only made minimum payments. That would amount to $18,230 in interest payments.
When pushed, credit card companies encourage clients struggling with debt to apply for consumer credit counseling. Consumer credit counseling programs generally don’t hurt your credit rating as much and can help you avoid debt collections calls. However, they don’t reduce your debt amount and can take up to six years to repay. If you can afford to increase your monthly payments and repay your entire debt, consumer credit counseling can be a good option. However, most of these agencies charge for their fees and only a small percentage of consumers complete the programs.
Related: How to pay off credit card debts?
Why do bankruptcy lawyers give debt settlement programs such a bad rap?
In some cases, filing for bankruptcy is the smartest move. That doesn’t make it the financial silver bullet some bankruptcy lawyers make it up to be. Bankruptcy lawyers charge their customers upfront fees to file for bankruptcy. Their fees run from $2,500 for a Chapter 7 bankruptcy to $4,000 for a Chapter 13 bankruptcy. These are average fees, experienced lawyers and firms in large metropolitan areas will charge more.
Debt settlement programs, consumer credit counseling, and bankruptcy are all valid debt relief options for debtors in the right – or should I say wrong – circumstances. Which is best for you will depend on your circumstances and your financial goals.
Most of what you have heard about debt settlement programs is not true. Debt relief companies, credit card companies (through consumer credit counseling agencies), and bankruptcy lawyers all highlight the benefits of the services they sell.
To find out more information, read this in-depth guide on debt settlement programs.
Although professionals can help you resolve your debt problems, you need to do your own research to determine which option is best for you. Click here for a free consultation with a senior debt relief specialist. Find out what debt relief options are available to you so you can make an informed decision.
Andrew is the managing editor for SuperMoney and a certified personal finance counselor. He loves to geek out on financial data and translate it into actionable insights everyone can understand. His work is often cited by major publications and institutions, such as Forbes, U.S. News, Fox Business, SFGate, Realtor, Deloitte, and Business Insider.