If you’re so far in debt you feel like you’re drowning, debt settlement may be the solution. But are you eligible, and will it work for you? Let’s take a look.
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Six Key Questions to Ask Yourself
- Do you have more than $10,000 in unsecured debt?
- Are you only making the minimum monthly payments to get by?
- Do you have a financial hardship?
- Are you getting calls or letters from credit card companies, lenders or debt collectors?
- Are you afraid to add up the full amount of your total debt?
- Are you willing to take a temporary hit on your credit score (or is your credit report already less than ideal)?
If you answered yes to the previous questions (especially the first two), then you likely qualify for debt settlement.
READ MORE: How to choose a debt settlement company
Is Debt Settlement Right for You?
Total consumer debt in the U.S. is $16.51 trillion. That’s a record high.
The average American owes money in one form or another, whether it is credit card debt, medical bills or student loans.
Chances are that you’re in that group. If so, there are a few different ways to get your debt under control.
Debt settlement programs are typically set up by for-profit companies. They will negotiate with your creditors and reach a “settlement” that will reduce the total amount of debt you owe. You will then pay the settlement in a lump-sum payment. The debt settlement company will ask you to set aside a specific amount of money every month in an escrow account to ensure that you have enough money to pay off the settlement once a deal has been reached.
Debt relief companies generally won’t enroll candidates with less $10,000 of debt; some programs require a $15,000 minimum.
The biggest factor in debt settlement is whether you can afford the program. Do you have enough income to make the escrow deposits over a consistent period of time to settle your debts? Debt settlement companies will evaluate this in your initial consultation.
READ MORE: Debt settlement fees
If you simply can’t afford it, you can call your creditors and try DIY debt negotiation by making your own settlement offers. While you may not get the same deal a professional agency could, it could still be a significant savings.
Is Hardship the Most Common Qualification for Debt Relief?
Debt settlement can be a viable option when a borrower cannot pay their monthly payments.
According to the Legal Information Institute at Cornell University’s School of Law, financial hardship is defined as the inability to meet basic living expenses for goods and services necessary for the survival of the debtor and his/her spouse and dependents.
Hardship is not a requirement, but it can help you be more successful with negotiations. Most debt settlement companies have pre-negotiated rates with creditors. (Not all creditors work with debt settlement companies, and no law forces them to.)
If you can’t afford to pay a debt settlement company, you can negotiate settlements on your own. If you can prove hardship, this will probably make your negotiations more successful.
READ MORE: Best debt settlement companies
Which Type of Debt Do You Have?
Before you start, you’ll need to ensure that the debts you have are eligible for settlement.
Unsecured debts are the most common that debt settlement. These include:
- Credit card debt
- Personal loans
- Medical bills (as long as they are in collections)
Secured debts are not eligible for debt settlement. These include:
- Home mortgages
- Auto loans
- Tax debt
- Most student loans
READ MORE: Debt settlement pros and cons
Think You Qualify? Here are the Next Steps
If you meet the qualifications for debt settlement, the next step is to decide whether you want to hire a debt settlement company to navigate you through the process.
If you opt for DIY debt settlement, you can call the creditors on your own to negotiate a deal, and that’s free. However, you need to be a skillful negotiator and be patient, because this process can take a long time.
To learn more about debt settlement, check out this video:
Other Options if You Don’t Qualify
If debt settlement isn’t right for you, don’t worry; there are other options available.
Debt consolidation rolls all outstanding debts into one larger loan with one monthly payment, usually with a lower interest rate.
You apply for a new, larger loan and use that money to pay off your other existing loans with higher interest rates. It also streamlines multiple credit cards into one payment, making it harder to miss a payment or incur a late fee.
Debt consolidation loans could be a good option for borrowers who have a lot of debts with high or variable annual percentage rates (APRs). If you can secure a low fixed rate, this new loan can save you a lot of money over the life of the loan.
READ MORE: Debt settlement vs. debt consolidation
Credit counseling could be another option to get creditors off your back. Credit counseling agencies advocate on your behalf to negotiate with creditors to resolve debt beyond a debtor’s ability to pay. This is known as a debt management plan, or DMP. Many credit counseling agencies are nonprofits that charge minimal fees, usually ranging from $15 to $50 per month, depending on the agency and the complexity of your case.
Note that there are some for-profit agencies where costs may be higher. Be sure to research the agency before handing over any money. Most will offer a free initial consultation.
READ MORE: Debt settlement vs. Debt Management Plans
Chapter 7, 11, or 13 bankruptcies may be the best option for some for a hard-stop financial reset. Though bankruptcy will hurt your credit score for seven to 10 years, it gives you a fresh start by erasing your debts. Once you’re debt-free, you can work on improving your overall financial situation. Learn more about which type of bankruptcy may be right for you.
Bankruptcy is best for those who simply can’t afford debt settlement. If someone doesn’t qualify because they don’t meet the $10k minimum, they will likely have other better repayment options.
The Bottom Line
Debt settlement has a few key risks. There’s no guarantee creditors will negotiate and you still may have to repay the full amount. Missed payments during the debt settlement process can lead to even higher debt and hurt your credit score, and if no deal can be reached, your financial situation will be worse than it was when you started. Be sure to weigh the alternatives to make sure settlement is your best option.
Debt settlement services are typically for-profit and ask you to stop making payments to your creditors while they negotiate to lower the total outstanding balance you owe. The company will charge you 15%-25% of the amount settled. Typically, you will owe 50%-80% of the balance. While you stop making payments, you will begin to receive collection calls from debt collection agencies, and the late payments will be reported to the three major credit bureaus and will remain on your credit report for seven years. Your credit will be damaged and could also have some tax implications with the IRS because the forgiven debt is reported as income.
Debt management companies are usually nonprofit credit counseling agencies that negotiate with your creditors to reduce your interest rates and fees or lower monthly payments. You still pay off the principal amount, so your credit score is not impacted as it would be with debt settlement. Credit counselors will also help you improve your money management skills and develop a workable budget.
Most companies require applicants to have at least $10,000-$15,000 of unsecured debt.
Paid in full is always a better option than paid as settled.
Paid as settled is how your debt will be noted on your credit reports when your debt settlement program is complete. Paid as settled indicates that you repaid less than you borrowed. It will push down your credit score because you didn’t fulfill the terms of your borrowing contract.
Paid in full means that you’ve paid your account as agreed. Paid in full will not hurt your credit score as much as a “paid as settled” notation, though your score might go down slightly because the paid debt will affect your debt-to-income ratio.
Unfortunately, there are a lot of scams in the debt settlement industry. First, check to verify that a company is licensed through your state. Next, scan some customer reviews and the Better Business Bureau (BBB) page. Ask about costs, review your finances, inquire how long it will take to complete the debt settlement process, know all the fees involved and how much money you will be paying over time and finally, understand the tax implications.
The most obvious sign of a debt relief scam is if the person/company offers to help get rid of your debt, but first, you have to pay them a fee. If you receive a robocall from the company saying they can wipe out most of your debt and will try to get all your personal information during the initial call.
If you think a company is trying to scam you, please report it to the Federal Trade Commission (FTC), the Consumer Financial Protection Bureau (CFPB.gov) or your state’s attorney general’s office.