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What’s Different About Debt Settlement?

You may have heard about debt settlement as one of the ways you can eliminate your debt burden. It’s often advertised as an alternative to bankruptcy that can drastically reduce the debt you owe or debt consolidation. Here are some facts about debt settlement.

You - or a debt settlement specialist working on your behalf - negotiate a lower lump-sum payment with your creditors. After you’ve fallen so far behind on your debts, your creditors realize there’s a low likelihood of you paying your debt in full. So, rather than have you file bankruptcy or forgo paying the debt all together, creditors are typically willing to accept a one-time payment that’s significantly lower than what you really owe. Depending on the size of the debt and the lateness of your payments, creditors may be willing to forgive up to 70% or even 80% of your debt, which is a lot lower than debt consolidation. That means you could end up paying only $200 on a $1,000 debt.

One drawback is that you may have to pay the settled amount immediately to have the creditor stick to the agreement. Once you’ve paid the settlement, your creditor will begin reporting your account to the credit bureaus as settled. Even though your current account status will be updated on your credit reports, past delinquencies will stay there. So, if your account was charged off prior to the debt settlement, that charge-off entry will still be seen in your payment history.

When you work with a debt settlement company, you have monthly payments that accumulate in an account. Once your account grows to a certain level, the settlement company then begins to negotiate with your creditors. When a settlement amount is reached, the settlement company uses the money from your account to pay the settlement. This differs from debt consolidation, where your payments are forwarded onto the creditors on a monthly basis.

Debt settlement companies have fees that may be a percentage of the debt that’s settled or a set amount. The fees may be taken from a portion of each month’s payment. Or, the settlement company may put your monthly payments toward the debt settlement fees before beginning to contribute to your settlement account.

Since creditors don’t settle on debts that are current, your payments will have to fall behind at least three months before they’ll even consider taking a settlement offer. The further behind you become, the more likely it is that you’ll be able to successfully negotiate a settlement amount. In debt consolidation, your accounts are kept current. Keep in mind that each late payment that goes on your credit report, has an effect on your credit score. So, if your accounts are current, your credit score will plummet. On the other hand, if your accounts are already behind, your credit score has already taken the hit, and debt settlement is a more reasonable solution.

If you’re considering debt settlement, you should calculate the cost of the program versus paying or settling debts on your own or using a debt consolidation company. Also consider that you’ll be paying into a debt settlement program for months, possibly even years before you see results. During that time, you’ll have to field calls from debt collectors and even risk being sued. Still, if you’re facing a Chapter 13 where you have to pay back your creditors over a few years, you might seriously consider debt settlement as an alternative. A credit counselor will be able to help you determine if you need debt consolidation or settlement.