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When you are struggling with past due debt, you might wonder if debt settlement is the right way to deal with it. This can be a viable option, depending on which approach you take: going to a third-party debt settlement company or settling the debt on your own.
Experts warn that using a debt settlement company can be an expensive and risky alternative. Meanwhile, a do-it-yourself settlement plan may work, but it can be difficult to achieve.
Read on to learn more about the ins and outs of working with a debt settlement company.
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The basics of debt settlement
Debt settlement, also known as debt negotiation, involves writing off debt by paying off part of it all at once. This sum is usually much less than what you owed initially.
For the borrower, debt settlement can provide financial relief and put them on the path to rebuilding their credit. For the creditor, debt settlement allows him to receive at least part of the money owed to him rather than no money at all. Also, it can mean that the borrower can avoid filing for bankruptcy. Although, according to some experts, filing for bankruptcy may be the best alternative in some cases.
Normally, debt settlement involves money you owe credit card issuers, rather than other types of debt. But you may also be able to settle other unsecured debts.
How Debt Settlement Works
Debt settlement handled by a debt settlement company differs from taking a DIY approach. Here is what the process looks like when hiring a debt settlement company.
1. Look for debt settlement companies. A number of legitimate debt settlement companies operate in the United States. Most states require them to be licensed. Debt settlement companies are supposed to follow industry regulations designed to protect consumers and their money.
2. Be careful. If a debt settlement company promises certain results, proceed with caution. For example, they cannot guarantee that a creditor will even agree to a debt settlement. As you research, check the websites of your Better Business Bureau, your state’s attorney general’s office, and consumer protection agencies like the Consumer Financial Protection Bureau (CFPB).
3. Learn about the costs. Once you’ve focused on a debt settlement company, find out how much they charge for debt settlement. If the company sidesteps your cost questions, it may be a sign that this is a shady transaction. Debt settlement companies typically charge a fee of 15% to 25% to settle your debt; it can be a percentage of the original amount of your debt or a percentage of the amount you agreed to pay. Let’s say you have $ 10,000 in debt and you settle for 50%, or $ 5,000. In addition to the $ 5,000, you may be required to pay an additional $ 750 to $ 1,250 in fees to the debt settlement company.
4. Review your finances. Debt settlement companies often require that you put money in a special savings account for 24 months or more before the debt is fully settled. These payments are used as a lump sum settlement of your debt. In some cases, you may find it difficult to keep up with these payments. Therefore, you may give up on the settlement agreement before all or part of your debt is paid off. To avoid this scenario, take a look at your budget to see if you would be able to pay off debt for 24 months or more.
5. Ask about the schedule. It often takes two to four years to complete the debt settlement process. During this period, you can accumulate interest and fees charged by the creditor, in addition to the fees charged by the debt settlement company. Why might you be charged interest and fees by a creditor? Because debt settlement companies often suggest that you stop making payments to your creditor while you are working with a settlement company and instead transfer that money to a special savings account. Be aware that if you have interrupted payments to your creditor, you could be contacted by debt collectors or even be sued.
6. Select a debt settlement company. If you are fully aware of the potential pitfalls and ready to move forward with debt settlement, it is time to choose a debt settlement company based on your research.
7. Nail the details. Before doing business with a debt settlement company, make sure you are familiar with the schedule and fees. Additionally, ask how much of your upfront payments will go to company expense and how much money you will end up paying over time.
8. Know the tax consequences. The IRS considers any canceled debt as taxable income if it exceeds $ 600. So if you settle a debt of $ 10,000 for $ 5,000, the $ 5,000 that was forgiven will likely be taxed.
The risks of debt settlement
Debt settlement can be good or bad, depending on your situation. Here are some potential risks associated with debt settlement.
The harsh truth is that the creditor can reject the offer to settle. Therefore, you and the debt settlement company may need to submit a counter offer. You might also be required to contact the original creditor to see if you can work out a payment plan. In the worst case, you may owe more than you initially owe and a rejected settlement offer could send you out of business.
Increase in debt
Fees paid to a debt settlement company or fees and interest charged by an original creditor could add hundreds or even thousands of dollars to your debt.
Negative impact on credit rating
Since creditors are motivated to settle debt only when they think it’s the only way for them to get paid, your accounts may already be or will become overdue when you make payments to the settlement company. debt. A debt settlement will lower your credit rating, perhaps by more than 100 points, and the damage could last awhile: a debt settlement will stay on your credit report for at least seven years.
Alternatives to debt settlement
If you find yourself burdened with debt, you have several options that are less risky than debt settlement, whether working with a debt settlement company or conducting homemade debt settlement negotiations. Here are four alternatives to debt settlement.
You may be able to transfer your debt through a balance transfer to a credit card that offers 0% APR for an introductory period, up to 18 months. If you pay off the balance before the 0% period expires, you can avoid accumulating interest on the debt.
Debt Consolidation Loan
A debt consolidation loan can allow you to combine multiple debts into one reasonable monthly payment at a lower interest rate than you are currently paying.
Non-profit credit counseling
Visit with an advisor to a non-profit organization credit counseling agency can help you get back on your feet financially. Among other things, a credit counselor can help you budget, make recommendations on debt consolidation, advise you to close at least some of your credit card accounts, or advise you on bankruptcy.
Debt management program
One of the tools available to a nonprofit credit counselor is a debt management plan, or debt management program (DMP). If you’re enrolled in a DMP, the advisor will consult with your creditors to work out a debt repayment plan that combines your debts into one monthly payment, a payment that may be less than the total of all the payments you make. now.
Next Steps If You Want To Move On With Debt Settlement
If you want to proceed with debt settlement, be sure to consider the impact it will have on your credit. For example, how much could your credit score drop and how long will the debt settlement stay on your credit report? And how much will the debt settlement company charge for negotiating with your creditors?
There are significant risks involved in settling debts through a business. Therefore, it is important to weigh potential alternatives, such as debt consolidation or nonprofit credit counseling, before entering into a relationship with a debt settlement company.
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Frequently Asked Questions
What percentage of a debt is generally accepted in a settlement?
Typically, you can expect a creditor to agree to repay around 50% of the total debt owed. In settling your debt, the creditor agrees that it is better to receive partial payment than to risk not receiving payment.
How Does Debt Settlement Affect Your Credit?
Settling debts can drop more than 100 points in your credit score, and it stays on your credit report for seven years. If your creditors close accounts as part of the settlement process, it can lead to increased use of your credit, which also negatively affects your credit score.
Can you negotiate debt settlement yourself?
Yes, you can negotiate your debt settlement on your own, although it may take a long time and patience to get there. You will need to have the necessary cash to make the required payments. And remember that your creditors are not required to agree to a debt settlement.