Many Americans struggle with an increasing amount of debt and a desire to be in a more stable financial situation. In contemplating how to overcome large amounts of debt, some consumers may pursue the route of debt settlement in order to decrease the amount of money they must pay back to their creditors. Although debt settlement can be an effective way to pay off your financial obligations, you must consider the benefits with any potential setbacks that may occur.
Debt settlement is when you negotiate with creditors to pay less than the full amount for a debt you owe. Negotiations occur and you make an offer to the creditor, for example, to make a lump sum payment of $2,000 instead of the $4,000 you owe. If the creditor accepts your offer, you then would make your payment and the account will be settled, meaning you will have no additional obligation to pay the creditor for the full amount.
The benefit of not having to pay your full obligation to the creditor seems very attractive on its face, but must be reconciled with the potential downsides of the settlement. Many people do not want to undertake the task of negotiating the debt themselves and will hire a debt settlement company to work on their behalf. The following are a few of the main things you should look out for and consider when deciding if debt settlement if the right path for you:
Making payments towards your debt during the settlement process
Some companies will advise you not to make payments during the process as it will make your financial situation seem more dismal, and possibly more likely the creditor will want to settle the account for less than the full amount. By not paying your bills, however, you may rack up more fees and interest during this period, and there is no guarantee the creditor will agree to a settlement.
Amount of Fees charged
Make sure to pay attention to and fully understand the fees associated with using a debt settlement company. Often times, the company will charge you a fee equal to the amount of money paid to settle the debt, which could be as high as 25% – 30%. Alternatively, companies may charge you a lower percentage equal to the total amount of debt owed. You should also ensure whether money paid to the company is going directly towards your debt or if it is being applied to the company’s fees.
Because the amount you ultimately settle for is less than your total obligation, the creditor will report a loss on the amount of money not paid. If this amount exceeds $600 then the creditor will report this to the IRS, who will in turn consider it income and require you to list it with your taxes. Depending on the amount of debt forgiven in the settlement, this may cause your refund to be significantly lower or cause you to owe more money in taxes to the IRS.
Impact on your credit score
If you choose to settle an account instead of paying the full amount owed, the account will show as “settled” on your credit reports and will reflect negatively on your credit history. The account will reflect this way regardless of whether you previously paid the account on time or not. If the account was never late and then settled, it can remain on your credit reports for up to 7 seven years from the date of the settlement. If the account was already late or delinquent before being settled then it can stay on your report for up to seven years from the date the account first went late or delinquent. Furthermore, failure to pay a debt in full will almost always be a sign of risk to potential lenders.
The decision to attempt to settle your debts either yourself or through a company should be carefully thought out and based upon your own personal circumstances, with both the advantages and disadvantages kept in mind. It is also important to consider other means to begin paying down your debts, such as debt consolidation or a debt management plan in connection with credit counseling. If you have questions about what method would be best for you then strongly consider speaking with someone who can assist you along the way or point you in the right direction.