What You Need to Know About Debt Settlement Before Diving In
Debt repayment can be confusing. There are numerous options and considerations to weigh, depending on your financial situation. While debt settlement and debt management have similar names, the processes and outcomes are very different.
How Debt Settlement Works
Offered by for-profit companies, debt settlement is a service that allows clients to pay back only a portion of the debt they owe. Here’s a simple breakdown:
- People who choose debt settlement make regular deposits into a savings account until there is enough for the debt settlement company to negotiate lump-sum payments.
- During this process, the debt settlement company may advise clients to stop making payments to their creditors. This is a tactic to get the creditor to accept a lesser amount to settle the debt.
- Once creditors accept the lump-sum payments, accounts are considered paid-in-full.
There are serious drawbacks and consequences to this process, which aren’t always shared upon signing up.
Risks of Debt Settlement
Failure to pay your creditors, even at the advice of a debt settlement company, can have serious negative consequences, such as:
- High fees to the debt settlement company to “settle” the debt
- Tax implications related to any forgiven debt, potentially resulting in a large and unexpected tax bill
- Significant drop in credit rating, affecting your ability to get housing, apply for an auto loan or even find a job in some cases
Any benefits gained during the debt settlement process are commonly canceled out by the hidden costs and lower credit score.
Additionally, it’s important to note that debt settlement is only offered by for-profit companies, which means their focus is mainly on making a profit rather than helping consumers improve their overall financial health.
Take Charge America is a nonprofit organization, meaning we keep your best interests in mind at all times. We are not incentivized to steer you in a specific direction. Credit counselors are trained and certified in consumer credit, debt management and other money matters, providing you with objective advice and personalized guidance to eliminate debt.
Debt Settlement vs. Debt Management
When choosing the best debt repayment solution for you, it’s important to think about your long-term financial goals, rather than what’s most convenient in the near future.
A debt management plan can reduce the length of time it takes to repay credit card debt and lower the total amount of interest paid. Participants receive ongoing education to develop effective spending habits, budget to meet living expenses, manage debt and save for the future. The following chart offers a side-by-side comparison of the two options.
- Make a single monthly payment to the debt management company that they will distribute to your creditors on the plan
- Nonprofit agency works with creditors on your behalf to lower credit card fees and interest rates
- Cancel debt management plan anytime without penalty. But you still would owe creditors any remaining balances
- Seeking credit counseling assistance will not hurt your FICO score
- Modest fees regulated by state law
- No more collection calls
- No potential tax implications
- Stop credit card payments for 2-4 years before debts are settled and make payments into a dedicated bank account instead
- No reduction in interest rates or fees, which are added to your debt
- Cancellation fees vary. You still would owe creditors any remaining balances
- Severely impacts your credit score that will take time to rebuild
- Fees usually run 18-25% of your total debt
- Collection calls do not stop
- Potential taxes on any forgiven debt amounts
- Creditors may begin collections or sue you for non-payment
- No guarantee the creditors will accept a settlement offer
Frequently Asked Questions About Debt Settlement
How long does the debt settlement process usually take?
Debt settlement is not a quick-fix solution. The entire process can take up to 36 months or more before all accounts are settled. During that time, creditors can continue to contact you for payment, up to and including suing for non-payment on debts.
How does debt settlement impact my credit score?
Because debt settlement companies advise consumers to stop making payments and purposely fall behind with creditors, the process can have a drastic impact on your credit score. Payment history makes up the largest percentage (35%) of your credit score and delinquencies stay on your credit report for up to 7 years, which means debt settlement will have a severe effect on your credit score.
Are there any tax implications with debt settlement?
Yes. You may end up responsible for paying taxes on any forgiven debt amounts, which can run anywhere from a few hundred dollars to a few thousand dollars.
Is debt settlement free?
No. Debt settlement is offered by for-profit companies. By law, debt settlement companies cannot charge upfront fees. But they will charge a percentage of the amount of enrolled debt, generally between 18% and 25%. Depending on the size of your debts, that could translate into several thousand dollars in fees.
What are the alternatives to debt settlement?
If you’re overwhelmed by debt, there are several alternatives to debt settlement that may be a better fit for your situation.
Some alternatives include:
If you are unsure which is the best path forward, consider a free and confidential credit counseling session. We will review your finances and situation to determine the best course of action.
Assessing Next Steps in Debt Relief
If you’re unsure where to turn, start with a free and confidential credit counseling session. We will review your income, expenses and debts to determine the best course of action.
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You can also call us Monday – Friday from 6 a.m. – 6 p.m. MST at 866-528-0588 to speak with a certified credit counselor.
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