What Is Debt Settlement — and Should You Consider It?

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Debt settlement is the process of negotiating payoff of your outstanding debts, often for less than what you owe. While you can attempt this yourself, there are also companies that can negotiate on your behalf.

How Debt Settlement Works

When you work with a debt settlement company, you’ll hire them to help you negotiate with each of your creditors to pay off your debts. Here’s a general walkthrough of the process:

1. Stop Making Payments

The first thing you’ll be asked to do is to stop making payments on your debts, but this can pose a risk to your credit score. If you’re already behind on payments, though, it may be worth it to negotiate.

2. Make Payments to a Debt Settlement Company

You’ll next make payments to a debt settlement company into an escrow account. These funds will be used to eventually negotiate a lump sum payoff of your debts.

3. Negotiation

The debt settlement company will begin negotiating with your creditors to come up with a payoff amount. The amount is usually much less than what you owe, and the funds in the escrow account will be used to pay off each debt over time.

This process can take years to complete, as you’ll need to build up enough in the escrow account to pay off each of your debts.

Should You Always Negotiate?

Negotiating only works with unsecured debts, like credit cards and personal loans. Secured debts allow creditors to seize your collateral, such as a vehicle or your home, so debt settlement doesn’t work the same way on secured debts.[/tipquote

Debt Settlement Costs

The debt settlement company may charge 10% to 15% — or more — of your outstanding debts as a fee. This can get expensive if you owe a lot of money, so make sure to account for the fee as part of your evaluation before hiring a debt settlement company.

Debt Settlement: What Are the Pros and Cons?

Pros:

• You’ll pay less than what you owe on your debts.
• You can become debt free faster.
• Debt settlement may help you avoid bankruptcy.
• Entering a settlement agreement can stop collection calls.

Cons:

• Can severely hurt your credit — up to seven years
• Comes with high fees, especially with a large debt balance
• Interest and penalties grow until an agreement is made.
• Forgiven debt may count as taxable income.
• There’s no guarantee it will work.
• The debt settlement process can take years.

Is Debt Settlement a Good Idea?

Debt settlement can be a good idea as a last resort before considering bankruptcy. If you’re unable to make your debt minimum payments and are falling further behind, debt settlement may provide some relief.

However, debt settlement will also wreck your credit, and it’s not guaranteed to work. Some creditors may refuse to settle your debts and will send you to collections instead. Plus the fees can be massive, and may not be worth it.

Debt Settlement vs. Debt Consolidation

Debt settlement and debt consolidation are very different solutions to paying off your debts. While debt settlement aims to pay off less than what you owe, debt consolidation simply consolidates multiple debts into a single loan. Here’s how they compare:

Alternatives to Debt Settlement

Debt settlement isn’t the only option for paying off your debts faster. Here are a few alternatives:

Debt Management Plans (DMPs)

Debt management plans are put together by nonprofit credit counseling agencies to help lower your payments to protect your credit score while paying off debts. You can work with a credit counselor to come up with a monthly budget and payment you can afford, and they will negotiate lower payments with your creditors.

DIY Negotiation

If you’re up for it, you can negotiate directly with your creditors. Tell them you can’t afford the payments or ask if they’re willing to settle your debt for less than what you owe. This can take some persistence, but will save you on fees.

Credit Counseling

Credit counselors can help you negotiate with creditors to lower your monthly payments and protect your credit score. The idea is to come up with a payment you can afford, and you pay the credit counselor while they distribute your payment among your creditors.

Bankruptcy

Bankruptcy can remove some of your debts, but may require selling your assets to cover some of the payments. The downside? It will wreck your credit for up to 10 years, which can be financially devastating.

Take Control of Your Debt

Debt settlement is more of a last resort than a first move when you’re considering how to pay off your debts.

Debt settlement can hurt your credit score and come with high fees, so make sure you understand all the terms and conditions of working with a debt settlement company before signing on.

That being said, debt settlement is a viable option if you simply can’t afford your payments and are drowning in debt.

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