In the search for solutions, you might come across the term debt settlement. This is a process of negotiating debt terms with creditors. You can do this yourself, but it’s often offered as a service by debt settlement companies as an alternative to bankruptcy or as a way to resolve a growing debt. Persuasive advertisements might promise you an easy way out of debt or a way to simplify your payments. But these services often tack on expensive fees, and they don’t explain what potentially negative effects debt settlement can have on your credit score. Learn more about debt settlement and how it works, so you can make an informed decision that leaves you on solid financial footing.
How Debt Settlement Works
With debt settlement, creditors agree to take a settlement that’s less than the amount you owe. In return for the settlement, they close the account and stop the collections process. You can negotiate directly with creditors. Alternatively, you can work with a debt settlement company. Here is what happens when you work with one of these companies:
The Dangers of Debt Settlement
Debt settlement has its advantages. You pay the debt settlement company, which, in turn, pays your creditors. In the end, everyone gets paid, and you’re able to move on with your life. It’s less time-consuming to hire a debt settlement company than to negotiate with creditors on your own, especially if you have several creditors to deal with. Debt settlement also has its drawbacks. It can be a long process, and no debt settlement company can guarantee results. There is a chance that you will not see all of your debts settled under one of these programs. Borrowers who pursue debt settlement often have trouble keeping up with payments to their settlement account, dropping out before their debts can be settled. Creditors won’t typically settle debts unless they’re a few months past due. That means you have to stop paying your accounts and allow them to become past due if they’re not already. Regardless of the debt settlement action, those late payments remain on your credit history for up to seven years. Your payment history makes up 35% of your score, so having multiple late payments has a serious impact. Until your score improves, you’ll have some difficulty getting credit cards and loans with desirable terms, which means that you’ll pay significantly more in interest, and you might not be approved for some loans. For example, you might have challenges getting approved for a home loan.
The Fallout
If the debt settlement company successfully settles with your creditors, the delinquent information isn’t erased from your credit report. Instead, your account is updated to something that shows you’ve settled, such as “Charged-off settled” or “Paid charge-off.” A settled status isn’t nearly as good for your credit score as a “Paid in full” account (though it’s still viewed more favorably than delinquent or past-due accounts that remain outstanding). After debt settlement, it may take a few months or even a few years to rebuild your credit and get approved for unsecured credit. Creditors are required to send you a Form 1099-C for reporting canceled debts, and the IRS will expect you to include the debt on your tax return. You will include that information on your Form 1040.
Alternative Solutions
As of the first quarter of 2021, Americans were in debt to the tune of $14.64 trillion. And 3.1% of outstanding debt was in some stage of delinquency; of the $448 billion of debt that is delinquent, $343 billion is seriously delinquent, at least 90 days late. Debt is clearly overwhelming for many. If a debt settlement company doesn’t sound right for you, here are a few alternatives:
Setting up a payment plan with your creditors: If you’ve missed one or two payments, ask your creditors whether they have a hardship program for customers having financial difficulty. Specifically, use the word “hardship” in your conversation; you may be able to get help in the form of a temporary (six months to a year) reduction in your monthly payment or credit card interest rate. Settling on your own: This approach requires organization and persistence, but you can settle with companies directly. Do all of the negotiations in writing so you have a clear record of what happened, and check your credit report to confirm that your account was settled. Filing for bankruptcy: If you don’t have the resources to pay your debt, it may be time to consider bankruptcy. Chapter 13 bankruptcy sets up a repayment plan, and Chapter 7 liquidates your assets to pay your creditors. If you’re considering this option, consult a bankruptcy attorney. Consumer credit counseling: With this option, credit counselors review your debt, credit, and financial situation to develop a custom plan for you to move forward, which may include entering into a debt management plan with your creditors. There’s a possibility of reducing your monthly payments, and you’ll still be able to pay your balance in full, which will reflect on your credit report. As long as you make your payments on time each month, this process will not directly hurt your credit score and can provide you with new information and resources.
If you’re considering credit counseling, review our list to find the best credit counseling services.
