Sometimes called “debt arbitration” or “debt negotiation,” debt settlement is an agreement made between a creditor and a consumer in which the total debt balance owed is reduced and/or fees are waived, and the reduced debt amount is paid in a lump sum instead of revolving monthly. Maybe you’ve seen the signs on the side of the road, or you’ve gotten solicitor calls or brochures in the mail that promise to “Settle your credit card debt” or “Eliminate debt now!” The offers are tempting but are they legitimate? Unfortunately, in some cases, the answer is no. Not only may these claims be dishonest, some are simply scams, trying to take advantage of desperate people.
The term settlement comes from the idea that the creditor agrees to “settle” your account, and also generally includes the closing of the account. If you’re carrying a lot of debt or high credit card balances, you’ve probably seen the advertisements from debt settlement or credit card settlement companies that promise to help you settle debt for a tiny fraction of the amount of money you owe to creditors. But is debt settlement a good idea? And what are the benefits of debt settlement over other ways of resolving your financial difficulties? Debt settlement can help some people get out of debt at a cost that is less than what they owe. For others, debt settlement proves to be a costly mistake.
How debt settlement works
You stop making payments to your creditors for a period of time, often six months or more. Once your accounts are significantly overdue and your creditors are starting to get worried, you make a debt settlement offer of a small lump sum payment in exchange for erasing your debt. If your creditors believe this is the best they can get, they may be inclined to accept your offer. Alternately, they may choose to sue you or turn your case over to a collections agency. If your offer is accepted, you’ll have to pay your debt settlement agency as much as 25% of your savings, and the Internal Revenue Service (IRS) may take another 25%, leaving you with a much smaller windfall than you planned on.
Is debt settlement a good idea in terms of your credit rating?
Because it requires you to stop making payments on your bills and because you won’t be paying your debts in full, debt settlement will severely damage your credit rating. It may take up to seven years for you to restore enough credit to apply for credit cards, loans, rental agreements, and mortgages.
Is debt settlement a good idea if you can’t pay anything on your debt?
If your financial situation is so difficult that you can’t make any payment on your debt, debt settlement is not a good option. You need to be able to offer lump sum payment for debt settlement to work even the best debt settlement agreements are at least 25% of the total amount owed.
Is debt settlement a good idea for paying off debt fast?
When you apply for debt settlement, it will take several months before you can make a settlement offer. If your debt settlement plan is successful, you may be able to erase your debt more quickly than by making regular payments over time, but it’s not an ultrafast fix.
Is debt settlement a good idea compared to bankruptcy?
Conventional wisdom is that bankruptcy should be a last resort for people in financial trouble. Filing for bankruptcy will likely mean you’ll have to give up some of your assets, and your credit rating may be damaged for up to 10 years. One positive note: bankruptcy can be a quick process, enabling you to start a new financial life and begin rebuilding your credit more quickly than other options.
Is debt settlement a good idea instead of consolidation?
Debt consolidation is a way of simplifying your finances and reducing the amount of interest you’re paying on loans and credit cards. It will not adversely affect your credit rating, but it likely won’t help you pay off your debt quickly.
Is debt settlement a good idea compared to debt management?
Debt management is another strategy for paying down debt that does not involve stopping payments to your creditors. Consequently, your credit will not be significantly impacted under a debt management program. Debt management is essentially a way of managing your financial life more carefully to allow you to pay down debt more quickly, while getting help from financial professionals to learn to live debt-free in the future.
Is debt settlement ever a legitimate and viable option?
Yes, but only in certain conditions, and it can cause potentially negative effects to your overall monetary situation and credit score. Each creditor’s policy on account settlement varies, and it is always a creditor’s right to dictate their own terms. Determining factors may include the total amount of debt owed, the length of time an account has been active, and the length of time the account has been delinquent, along with other criteria.
Cons of Debt Settlements
1. Debt Settlement Fees
Many debt settlement providers charge high fees, sometimes $500-$3,000, or more. But these fees are not applied to your debt – they go straight into the agencies’ pockets.
2. Debt Settlement Impact on Credit Score
While not as devastating as a bankruptcy, a debt settlement will have a negative impact on your credit score, even if you work directly with your creditors, as the settlement may be reported by the creditor to each of the three leading credit bureaus. This will in turn affect your future loan terms, credit availability, employment opportunities, and more.
3. Holding Funds
Here’s one debt settlement scenario some consumers have reported experiencing: A provider requires you to give them a large lump sum, earmarked for debt repayment, which they hold in escrow for months or even years, telling you they need the time to “negotiate” with your creditors, while they make little or no progress on your case they simply hold your cash, which you could be using for better things. Worse, they may refuse to return the money, if you’ve signed anything giving them rights to it (even if you didn’t realize you had).
4. Debt Settlement Tax Implications
If a creditor agrees to settle your debt in exchange for a reduced payment, you may still be responsible for paying taxes on the reduced debt. Basically, if the settlement results in a debt reduction of $600 or more, the creditor is required to notify the IRS. For example, if you owe a creditor $10,000 and they agree to settle with you for a one-time payment of $7,500, the reduced amount, $2,500 may be included as part of your taxable income.
Will Settling a Debt Affect My Credit Score?
Settling a debt instead of paying the full amount can affect your credit scores. When you settle an account, its balance is brought to zero, but your credit report will show the account was settled for less than the full amount. Settling an account instead of paying it in full is considered negative because the creditor agreed to take a loss in accepting less than what it was owed.
Settling an Account Is Better Than Not Paying at All
Although settling an account is considered negative, it won’t hurt you as much as not paying at all. And, if you are planning on making a major purchase, such as buying a home, you may be required to either settle or pay in full any outstanding delinquent debts before you can qualify for a loan. If paying the debt in full is not an option, settling the account is typically more beneficial than letting it go delinquent or, worse, to default.
Settled Accounts Remain on Your Credit Report for Seven Years
When you settle, the account will not be removed immediately from your credit report. If you were late on payments, the account will remain on your credit report for seven years from the original delinquency date. If the account was positive, meaning there are no late payments in the account history, the account will remain on your report for seven years from the date it was settled.
How to Begin Improving Your Credit Score
If you’ve had financial troubles in the past, but now you’re working to improve your credit, you’re on the right track. A good first step is to bring any past due accounts current. More tips for building and maintaining good credit scores include:
• Make all payments on time going forward: Your payment history whether you make all payments on time is the most important factor in credit scores. If you are ever in a situation where you may not be able to make a payment on time, you should contact your lender to discuss your options before the account becomes delinquent.
• Reduce balances on revolving accounts: The second most important factor in credit scores is your utilization rate the amount of credit you’re using relative to your overall credit limit. If you tend to carry high balances on your credit cards, reducing that debt load will improve your utilization rate.
• Focus on your risk factors: If you haven’t already, request your credit score from Experian and pay close attention to the risk factors provided with your score. These factors tell you what you need to do to improve your credit scores.
How Debt Settlement Affects Your Credit Score
The reason debt settlement is considered a negative mark on your credit report is because settled debts are those that you’ve paid off for less than what you owed. Which means you didn’t pay the debt in full or as agreed. In most cases, it’s better to settle a debt than to continue to miss payments, but it will still ding your score. If possible, it’s best to settle your debts before they are charged off. A charge-off is when a lender “writes off” a debt after 180 days of not receiving a minimum payment from you on the debt. However, you still owe the debt and it will still appear on your credit report. This is also the point where a lender might sell the debt to a third-party debt collector. When a lender writes off your debt, they close your account and list it as a charge off, which hurts your credit score. For many people, though, it can be tough to both negotiate and come up with the money to settle several debts within a six-month time frame. So you might want to settle one card and target one that you can take care of before a charge off happens. The debt settlement process will especially hurt your credit score if you’ve stopped paying your creditors to save up money to settle your debts. That’s often what a debt settlement company will ask you to do if they’re negotiating on your behalf. When you pay off an account, your creditor updates your account to reflect the new status (closed or paid in full, for example). Debt settlement is the same: After you settle a debt for less than what you owe, the account will be designated settled. If you have no history of late payments, aka “delinquencies,” the account will remain on your credit report for seven years from the date the account was settled. Or if you did fall behind on your payments, the account will stay on your credit report seven years from when it first became delinquent and was never current again. But you can start improving your credit score before those debts disappear from your report. And the older those debts get, the less they’ll hurt your score.
How is my credit score calculated?
When considering how debt settlement affects your credit score, first it’s helpful to understand the factors involved, and how each is weighed. The amount of time it takes for your credit to start improving will largely depends on your credit history. If those settled debts are somewhat of an anomaly for you you’ve successfully paid off several debts in the past that will help your credit rebound. That shows lenders you are capable of paying your debts on time. Having other debt you’re still paying and are current on, such as a mortgage, car loan or other credit accounts will help, too. People with a fairly robust and positive credit history might be able to start improving their credit score in six months or possibly as little as half that time. If your credit history is skimpier, it could take much longer. For example, if you don’t have a history of paying off debt and you aren’t currently making timely payments on a mortgage, a loan or other credit cards. And if the accounts you settled were ones you’ve had for a long time, it could hurt your score because the length of your credit history (including the age of your oldest account) makes up 15% of your credit score. If you have a poor and/or thin credit history, it could take 12 to 24 months from the time you settled your last debt for your credit score to recover. Either way, you’ll benefit from debt settlement if that means you’re no longer missing payments. It will also improve your debt-to-income (DTI) ratio, the amount of monthly debt payments you have compared to your monthly gross income, and your credit utilization, which is how much credit you have available versus how much you’re using. Lenders look at your DTI in the loan approval process and your credit utilization makes up 30% of your credit score.
Bankruptcy Lawyer For Settling Debt
When you need to settle your debts and file for bankruptcy, please call Ascent Law LLC for your free consultation (801) 676-5506. We want to help you.
8833 S. Redwood Road, Suite C
West Jordan, Utah
84088 United States
Telephone: (801) 676-5506