So you’ve resolved to become free from bad debt. It’s a good decision, and there are several ways to do it. One is debt settlement. You make a deal with a creditor to pay back only a part of what you owe. Many creditors are willing to negotiate settlements to avoid you filing for bankruptcy where they could get nothing. But before you decide to settle, there are some key things you need to understand first.
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How debt settlement works
Debt settlement works differently depending on the status of the debt and who initiates contact to begin the settlement negotiation. But there are three basic ways that debt settlement can work.
- Respond to a debt settlement offer from a collector
- Try to negotiate a settlement on your own
- Contact a settlement company or state-licensed settlement attorney to set up a debt settlement program
Ready to see if debt settlement is right for you? Talk to a certified debt resolution specialist for a free evaluation.
Method 1: Responding to a settlement offer
Settlement offers usually only come when a debt has been sold to a third-party collection agency or debt buyer. These entities buy debt that credit card companies and service providers write off. They purchase bad accounts for pennies on the dollar of what’s owed. As a result, even recouping a small percentage of the original balance you owed is a financial gain for them. So, they make offers to settle your debt, either by phone or by mail.
If you receive a settlement offer:
- Always insist that the collector send you the offer in writing.
- Make sure the debt is yours and that the collector has a legal right to collect BEFORE you acknowledge any obligation to pay. To do this, ask the collector to send you paperwork that verifies the debt.
- Only correspond with the collector by mail.
- Always try to negotiate the collector down from their initial offer.
- See if they will agree to pay for delete, which may remove the collection account from your credit report in exchange for payment.
Method 2: Negotiating settlements on your own
With this method, you contact a company first and make a settlement offer. You offer a certain percentage of what you owe and request for the remaining balance to be discharged. You can use this method with debt collectors, medical service providers for unpaid medical bills, or with a credit card company if your account is behind but still with the original creditor.
This is the method most commonly used when someone has a debt that they just want to be free of. Results may vary. You’ll usually have the easiest time negotiating with a debt collector. However, if you have a credit card that’s behind and you know you won’t be able to pay, you may find a creditor that’s willing to settle. Just keep in mind it often takes a higher percentage to get a creditor to settle.
Method 3: Enrolling in a debt settlement program
This is the most common type of settlement and often the most likely to get consumers the results they want. It allows you to settle multiple debts without having to negotiate on your own. You contact a debt settlement company to set up a settlement program. Here’s how you work with an accredited company:
- In a free consultation, a certified debt resolution specialist reviews your debts and budget.
- They will often make recommendations on which debts would be best to include in the program.
- They also check your credit and ask about your credit goals to make sure settlement is the right solution for you.
- Once they confirm you’re a good fit for the program, then it’s time to generate the money to make settlement offers
- Since most people usually don’t have a large lump-sum of cash just sitting around, the settlement company will usually set up a Trust Account. They’ll work with you to find a monthly amount you can afford to set aside in this account.
- You send them that amount each month and they hold the money in escrow until you have enough funds to start making offers.
- They call each of your creditors to negotiate.
- Once they reach an agreement that satisfies both sides, you sign a formal settlement offer and the money is paid out of the escrow account.
- The company also takes fees from the money saved in escrow, which is a percentage of the original balance you owed.
- All settled accounts are reported to your credit report as “paid as agreed.”
Debt.com can connect you with the right debt relief options for your unique financial situation.
The credit effects of settling a debt
Debt settlement may negatively affect your credit score, but not in all cases. In certain situations, there are ways to negotiate around the seven-year penalty you typically face for settling a debt. In normal circumstances, settling debt will create a negative item in your credit report that sticks around for seven years. When the clock starts depends on the status of the debt at the time of the settlement.
- If the debt is still with the original creditor, the seven-year clock starts from the date that the debt first becomes delinquent.
- On the other hand, the clock on a settled collection account starts from the date the collector discharges the remaining balance.
In either case, the account will generally be listed in your credit report as “paid as agreed.” This is considered negative information. However, it will have less of a negative impact than simply leaving a debt charged-off or in collections.
There are tricks like pay for delete and re-aging that could provide a way to potentially avoid the damage. However, these methods are not guaranteed. Even if you negotiate these into your settlement, the negative information may reappear later. So, it’s best to go into a settlement with the assumption that your credit may take a hit.
How to avoid getting scammed
Although there are plenty of accredited debt settlement companies that want to help you, there are also people out there that will prey on your desperation to get out of debt fast. These companies charge high upfront fees with a promise to settle your debts. Then they disappear with your money and leave you in a lurch.
Here are a few signs that a settlement company is out to scam you:
- They require upfront fees, which violate the Federal Trade Commission advance fee ban on debt relief services.
- They advise you to do something illegal, such as stopping all payments to the credit companies you have open accounts with.
- During your free consultation, they refuse to discuss other solutions versus debt settlement or try to make their service seem like another solution.
- The company is not a member of a nationally recognized trade association, such as the American Fair Credit Council.
Debt settlement for specific types of debt
Credit card debt is the most common type of debt seen in a settlement, but it’s not the only type you can settle. If you have other types of debt that you want to get out of for less than you owe, we have some additional guides that can help you.
Medical debt settlement
Unpaid medical bills can quickly turn into collection accounts. Whether you’re facing collections because of insurance gaps you didn’t know you had or out-of-pocket expenses that your insurance didn’t cover, you need to be proactive if you want to avoid credit damage that medical debt can cause. Learn about new credit reporting rules related to medical debt and what you can do to solve these challenges.
Private student loan settlement
Although it’s not possible to settle or discharge balances on federal student loans without declaring bankruptcy, it may be possible to settle private student loan debt. Some student loan servicers may be willing to let you out of a student loan for less than you owe. However, you need to go into the settlement negotiation with realistic expectations and the right negotiating tactics.
Tax debt settlement
If you owe tens or even hundreds of thousands of dollars to the IRS, it may be possible to settle it. In fact, thanks to the Fresh Start Initiative, it’s now easier for taxpayers to settle with the IRS. This guide will explain how to negotiate a settlement and what you can realistically expect from the IRS.
No matter what types of debt you owe, Debt.com can match you with the best debt relief services for your need.
Debt settlement pros and cons
Deciding to settle your debt for less than you owe is a big decision. While it can help you get out of debt for less than you owe, you must weigh the advantages of that versus the downside of the credit damage you’ll likely face.
|Pros of Settlement||Cons of Settlement|
|Debt settlement is usually the fastest way to get out of significant debt without filing for Chapter 7 bankruptcy.||Each debt you settle may result in a negative item in your credit report that will stick around for seven years.|
|Settlement is also usually the cheapest option since the average person pays just 48% of what they owe.||In most cases, debt settlement will result in at least some credit score damage.|
|You can avoid the fees and hassle of filing for bankruptcy.||The settlement industry is filled with unscrupulous companies, so it’s possible to get scammed.|
Breaking down the benefits of debt settlement
Unless you file for Chapter 7 bankruptcy, which can take as little as six months to complete, debt settlement is typically the fastest way to get out of credit card debt. Debt settlement programs can be completed in as little as 12 months, depending on your financial situation. Even if you have limited funds for generating settlement offers, a good debt settlement company may be able to help you set up a plan that would have you out of debt less than 48 months. That’s equal to the average term you’d face with a debt consolidation loan, and you’ll likely eliminate your debt for half the cost!
Cost savings is the other big advantage of debt settlement. While other debt relief solutions focus on reducing the interest rate applied to your debt, debt settlement makes APR a complete non-issue. With debt settlement, you only pay back a percentage of principal – that’s the actual debt you owe. Interest charges and penalties don’t even factor into the final settlement.
If you’re looking for the fastest, cheapest exit possible without the expense of bankruptcy, settlement may be the best choice. Keep in mind that bankruptcy isn’t free. The filing fee for Chapter 7 is $335, then you’ll also have fees for your attorney. This is why it’s important to have the right filing expectations before you take your case to the courts.
Let a certified debt relief specialist help you weigh the pros and cons of debt settlement based on your needs, credit, and budget.
Overcoming the cons of debt settlement
Most of the disadvantages of debt settlement have to do with the potential damage it can do to your credit. These are all the ways that debt settlement could affect you:
- Unless you take steps to prevent it, each debt you settle with result in a negative credit report item.
- This sticks around for seven years from the date of first delinquency if it’s still with the original creditor
- If it’s a collection account it’s seven years from the date of final discharge.
- The date will be listed as “settled in full” instead of “paid in full”
- Any missed payments leading up to debt settlement may also negatively affect your credit history.
- All of this may negatively affect your credit score.
According to The Balance, settling one credit card would drag down your score by 45-65 points for a 680 FICO. It would affect your score even worse if you started with a 780 FICO score. Then you might see your score drop by as much as 160 points.
However, the credit score damage caused by debt settlement may not be nearly as dramatic as what you might expect. In fact, there are a few ways that you can negotiate to potentially minimize the credit damage caused by settlement.
If your account is still with the original creditor, then you may be able to ask them to re-age the account in exchange for payment. The creditor basically agrees to adjust the credit history on the account to remove any missed payment notifications. Removing these missed payments will help alleviate some of the credit damage caused by your financial hardship.
Pay for delete
If you are settling a collection account, you can negotiate to remove the collection account from your credit report. You basically agree to pay back a certain percentage of the balance owed and in exchange, the collection agency agrees to remove the account from your credit report.
Negotiating a favorable outcome for your credit during debt settlement
Minimizing the potential damage to your credit score when negotiating a settlement takes skill. But it’s possible to avoid at least some of the negative information in your credit report that settlement can cause. In some cases, you may need to agree to paying your creditors a higher percentage of the balance owed in order to get more favorable terms for your credit.
Even if you do end up with some credit score damage, the effects may not be quite as drastic as you think. Any negative items will remain on your credit report for seven years. However, the “weight” of those penalties on your credit scores will decrease over time. In other words, the effect of a debt settled last year will be more significant that one settled five years ago.
Comparing debt settlement to other solutions
As you’re working to get out of debt, it’s important to weigh the pros and cons of various types of debt relief you may decide to use. This table can help you understand how debt settlement compares to other solutions.
|Balance Transfer||Consolidation Loan||Debt Management Program||Debt Settlement||Bankruptcy|
|APR||0% APR for 6-18 months, based on your credit score||Low fixed interest rates, currently averaging 13%||Negotiated to between 0-11%, on average||n/a||n/a|
|Monthly payment||As high as possible to eliminate your debt during 0% APR period||May be lower than your total payments now||Total credit card payments reduced up to 30-50%||May require monthly set aside; amount based on your budget||Chapter 13 we create a court-ordered repayment plan|
|Credit required to use||Excellent||Good||Any||Any||n/a|
|Debt amount||Less than $5,000||Up to $25,000||$5,000-$100,000+||$5,000-$100,000+||Any|
|Credit score effect||Positive||Positive||Neutral or positive||Negative, but subject to negotiation||Negative, up to 10 years for Chapter 7|
|Fees||Balance transfer fees up to 3% of each balance transferred||Loan origination fees, typically up to 1% of amount borrowed||Regulated by state, up to $69 per month||Typically, a percentage of the original amount settled||$335 for filing fee for Chapter 7, $310 for Chapter 13; attorney fees|
|Time to become debt free||6-18 payments||24-48 payments||36-60 payments||12-48 payments||6-12 months for Chapter 7, 3-5 years for Chapter 13|
What about consumer credit counseling services?
If you’re looking for debt relief, you might have heard of consumer credit counseling services. This is not a solution, in and of itself. Nonprofit credit counseling is simply meant to provide a free, unbiased debt evaluation to help you find the best option for relief. A good credit counseling agency won’t drive you into a single solution. Instead, they’ll recommend the best solution based on your needs and budget.
In theory, a credit counselor may recommend debt settlement if it’s the best option for your unique financial situation. A credit counselor should never try to push you into a debt management program, even though that’s the solution that a credit counseling agency provides. Just make sure that the credit counselor that you’re talking to works for a nonprofit agency. Otherwise, they may promote their own debt management program instead of giving on an unbiased opinion the best solution for you to use to get out of debt.
Getting out of debt shouldn’t take guesswork. Talk to a certified debt relief expert for a free evaluation.
Debt Settlement FAQ
Q:Do debt settlement programs work?
Always make sure to work with a settlement service that doesn’t charge fees up front. Companies that offer a money-back guarantee can be good, too. Then check the companies rating with the Better Business Bureau and read third-party reviews. As long as a company is above board and they say you’re a good candidate, a settlement program can work.
Q:Do I need to work with a professional to settle my debt?
It’s up to you which path you take. But we always recommend working with a trustworthy debt settlement company.
Q:How bad does debt settlement hurt your credit?
Just keep in mind two things:
- The settlement remains on your credit report seven years from when the account first became delinquent.
- The “weight” of negative items on your score decreases as time goes by
This means you can build credit long before the penalty for settlement expires. It also lets you know when you should review your credit. You want to make sure the negative item disappears at the designated time.
Q:How does debt settlement affect your taxes?
The good news is that you can request get the IRS to waive this tax liability. You basically need to show that you settled the debt during a period of financial hardship. If you can show you couldn’t afford to pay the debt, then you also effectively show you can’t afford to pay the taxes on it either.
Q:How long does debt settlement take?
Q:How much does debt settlement cost?
Q:Is debt settlement bad?
Q:What is better: debt consolidation or debt settlement?
|When Debt Consolidation is Better||When Debt Settlement is Better|
|Most of your debts are still current with the original creditors||Most of your debts are in charge-off or default status.|
|You want to avoid credit damage.||The debts you want to settle are in collections.|
|You have a good credit score.||You’re not concerned about credit damage|
|You have the ability to make monthly payments.||You don’t have the credit score or income to qualify for consolidation.|
Article last modified on December 22, 2021. Published by Debt.com, LLC