When it comes to getting help with credit card debt, understanding all the different debt relief options can be confusing. Debt settlement is one option that can seem very attractive at first glance while not delivering in the end. Learn what debt settlement is and the risks associated with it.
What is Debt Settlement?
Debt settlement involves a client using a company to negotiate with creditors a reduced payment to settle their debts. Sometimes debt settlement is also called “negotiation” or “resolution.” The term “settlement” implies that there is a quick or cheap solution to getting out of debt, but this is not a realistic expectation.
The Settlement Process
First, debt settlement clients are instructed to stop paying their creditors directly which can cause debts to go into default and then to collections. Instead, the client makes a monthly payment into an escrow account. Payments are made until there are enough funds to make lump sum payments to creditors. It usually takes around 36 months or more. At this point, the settlement company then contacts the creditors to negotiate “settlements” to resolve outstanding debts.
The Drawbacks of Debt Settlement
It’s important to know that creditors are under no obligation to negotiate with settlement companies. Even if a client puts the necessary amount of money toward the debt settlement, there is no guarantee that the creditor will settle the debt for any amount less than what they’re owed. This leaves borrowers with a defaulted debt that is larger than they started with due to fees and interest. They are also more vulnerable to legal action from creditors who have not been paid.
Because it takes a long time to collect the lump sum payments, many clients struggle and leave the program. Dropping out of a settlement program leaves a client much worse off. They are deeper in debt due to the interest and late fees accrued, and their credit will be severely tarnished.
Even if a client successfully completes a debt settlement program, their credit report will have a negative notation that they were unable to repay what they borrowed. This lowers their credit score for up to seven years and makes it significantly harder to obtain credit in the future.
Lastly, debt settlement may not save any money in end. The settlement company will charge fees or possibly a percentage of the savings on settled debts. Savings on settled debts can be categorized as taxable income resulting in a significant tax burden for the client.
All of these factors combined can make debt settlement more trouble than it’s worth. Anyone dealing with credit card or other debt should research multiple debt assistance programs. Knowing all the options is essential for choosing the most appropriate method.