What is Debt Settlement?
Performed by for-profit companies, debt settlement is a service that allows clients to pay back only a portion of the debt they owe on certain unsecured credit accounts.Accounts that may qualify for
Debt settlement is not available for the following types of debt:
- Credit Cards, including retail store and gas station cards
- Unsecured personal loans
- Mortgage short pay balances
- Auto repossessions (balance left after the vehicle is taken)
- Medical bills in collections
- Private student loans (not backed by the government)
- Cell phone and utility bills from past providers
- Past apartment leases (not your current residence)
- Current mortgage or apartment lease
- Second or third mortgage
- Home equity line(s) of credit
- Any Sallie Mae account or other federal student loans
- Criminal fines and penalties
- Court-ordered alimony or child support
- Back taxes
- Gambling debts
- Cell phone or utility bills from current providers
- Rent-to-own accounts
How Does Debt Settlement Work?
Debt Settlement is performed by for-profit companies, which direct clients to stop making payments to their creditors as a tactic to get creditors to accept a lesser amount in a lump-sum payment.
The client sets up a savings account and makes regular deposits until there is enough in the account for the debt settlement company to negotiate with creditors.
This could leave a debt settlement client responsible for making deposits into their savings account, as well as continuing to pay the creditors that refuse to participate in settlement negotiations.
If the lump sum payments are accepted, accounts are considered charge-off settled or paid settled, which future potential creditors view less favorably than accounts being paid-in-full. There are additional drawbacks to debt settlement, including how it affects your credit score.
How Long Does Debt Settlement Take?
Debt Settlement is not a quick-fix solution. The whole process can take up to 36 months or more before accounts are settled. During that time, creditors can continue to contact the borrower for payment, up to and including suing for non-payment.
How Does Debt Settlement Affect My Credit Score?
Unfortunately, allowing accounts to fall behind during debt settlement negotiations causes clients' credit scores to drop significantly. Because payment history makes up the largest percentage of a credit score at 35%, and delinquencies stay on your credit report for 7 years, your credit score will suffer the consequences.
Is There Anything Else I Should Know?
In addition to the negative effects on a credit score, debt settlement can also have tax implications. Many clients end up responsible for paying tax on the forgiven amount, which can end up being hundreds or even thousands of dollars.
Forgiven Amount (if over $600) x (your income tax rate) = Additional Income Tax You Pay
And of course, debt settlement isn’t free. By law, debt settlement companies can’t charge up-front fees. But they will charge a percentage of the amount of enrolled debt, generally 18-25%. Here again, a borrower could be looking at thousands of dollars in fees when all is said and done.
Enrolled Debt Amount ($) x 18-25% = Settlement Company's Fee
What are the Alternatives to Debt Settlement?
Debt Settlement is one way to conquer problem credit card debt, but it’s not the only way. Alternatives to debt settlement include:
Certain creditors may be willing to offer lower interest rates or other concessions to borrowers who are struggling to keep up with payments. These tips will increase your chances of success when negotiating with creditors.
- Be Sure You Have a Legitimate Reason – Creditors can’t lower interest rates unless you are experiencing a legitimate financial hardship, such as job loss or extensive medical expenses.
- Be Honest About Your Credit Card History – Customer service representatives can easily pull up your credit history during your conversation, so there is no use in bending the truth. Be honest when attempting to negotiate lower credit card interest rates.
- Do Ask to Speak with a Supervisor – Customer service representatives don’t have as much authority to alter an account as their direct supervisors do. If you feel you have a legitimate reason for a lower interest rate yet are denied on your first try, ask to speak with a supervisor to state your case.
- Don’t Act Rude or Impatient – Staying calm, cool and collected isn’t the deciding factor for determining an interest rate, but it won’t help your case to act forceful or impatient. You’re more likely to get help if you speak respectfully when negotiating credit card interest rates.
- Understand Your Limits – Every credit card company sets standards on interest rates based on your credit history. If you don’t qualify for a lower rate, then you can’t count on a phone call for a quick fix. Work on improving your credit, and try asking again once you’re in a better position to negotiate.
Offered by certified nonprofit agencies, including Take Charge America, credit counseling and debt management plans are some of the best ways to eliminate problem credit card debt.
With continuous financial education as the foundation, you will learn not only how to manage and eliminate your current credit card debt, but how to make smart choices going forward.
During credit counseling, you and your counselor will:
- Discuss your income, expenses and total debt
- Create a manageable budget
- Work out an action plan to eliminate debt, which may include enrolling in a debt management plan
If your circumstances allow you to enroll in a debt management plan, you make one monthly payment to the credit counseling agency, which then makes payments to creditors for you.
At Take Charge America, we have long-standing relationships with hundreds of creditors, which allow us to obtain lower interest rates to help you pay off your credit card debt faster—usually in five years or less.
Lower interest rates are just one benefit of participating in a debt management plan. Additional benefits include:
- An end to collection calls
- No more late or over-limit fees
- One convenient monthly payment
- Peace of mind knowing bills are paid on time, every month
- Continuing education to help you plan and save for the future
Want to know more? Provide your email below to see how much you could save on a debt management plan.
Declaring bankruptcy is a last-resort solution to problem debt. The decision to declare bankruptcy isn’t something to take lightly, as it will have long-term effects on your financial outlook. You’ll want to consult with a qualified bankruptcy attorney to discuss whether it’s the right option for your circumstances.
The two most common types of consumer bankruptcy are Chapter 7 and Chapter 13.
Declaring Chapter 7 bankruptcy eliminates most types of unsecured debt. You will still be required to pay back student loans, make child support payments, and be responsible for paying any money you owe to the IRS. Chapter 7 bankruptcy generally takes less than 6 months to complete.
Under Chapter 13 bankruptcy, your debts are reorganized and you still pay your creditors, either in part or in full. Most Chapter 13 repayment plans last 3-5 years.
Keep in mind that declaring bankruptcy isn’t free. You will need to have enough liquid assets to pay your attorney and court fees.
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