One topic I get asked about frequently yet know absolutely nothing about is Debt Settlement. So I had a great time-saving plan. Hunt down an expert in the field. So I found Lyle Solomon who seems to be an expert so that he could explain it. And Voila!
One of the main issues many American individuals and households are facing is the growing number of debts. With student loans, credit card debts, etc., many people find themselves in debt-related troubles.
It is a major reason why many turn towards the two strategies, which are common for reducing debt. One is debt settlement, and the other is debt consolidation. Both of these strategies have their pros and cons.
So, if you are choosing debt settlement as an option, there will be some questions in your mind regarding it, such as whether debt consolidation hurts your credit score more than debt settlement? Is it worth the risk?
Before you go into a debt settlement program, it is vital to know about its financial outcomes. Here are a few things that you need to know about debt settlement and how it works.
The Difference Between Debt Settlement and Debt Consolidation
The main aim of both strategies is to reduce the burden of the debt. However, both have different functions and apply to different scenarios.
Debt consolidation is where you combine all your loans from different creditors into a single one. It helps you keep a record of your creditors and saves you from the stress of dealing with multiple creditors.
On the other hand, debt settlement is where you ask your creditors for a settlement of your loans. You can ask them to reduce the loan amount for a lump sum payment or in installments.
Now that you have an idea of the difference between them, let’s see how debt settlement works.
How Does Debt Settlement Work?
The process of a debt settlement is a bit time-consuming. The first thing you need to do is find a good debt settlement company. These companies negotiate with your creditors on your behalf to get a better deal for you.
Although you might go online and choose the first debt settlement company, it is wise to research them first. As a result, you will ensure that you are doing business with a legitimate company.
Here are a few things that you need to focus on while doing your research on finding a good debt settlement company:
- Inquire about their Costs and Charges
Before you sign a deal with a debt settlement company, you must know about all the charges and costs. Usually, companies charge up to 25% of the amount you owe or your repayments.
Any company not disclosing their details beforehand is a red flag. Eventually, they will throw a high amount at you with hidden charges on it.
- Find Out About the Time frame
The next thing to do is inquire about the time frame it will take to get out of the debt. The timetable can vary from two to four years.
It is also vital to know how much interest you will be paying the creditors and the debt settlement company. Many times, companies suggest individuals divert their interest payments into a saving account.
As a result, you might fall short or stop paying your creditors, which in return result in additional fees. In addition to that, creditors can also take the matter to court, which is why it is essential to know about the time frame.
- Know about their Commitments
There are debt settlement companies that make certain commitments which they cannot fulfill. It is just to bring the customer to their doorstep. For instance, if a company says that it will get you a particular percentage of discounts on your loans, it is most likely a scam.
No companies can guarantee if your creditors will agree to a settlement, let alone the discount percentage. Therefore, you need to be careful and stay away from such companies.
- Have Complete Knowledge about Taxes
Even though your creditors are willing to give you a discount on your loan, the IRS won’t. Your forgiven debt is taxable income as per the IRS. Therefore, you will have to pay taxes on your debt if it is above $600.
For example, if you have a debt of $5000, you pay $3000 for the settlement. The $2000 discount that you get on your loan is a taxable income as per the IRS.
- Get all the Details in Writing
Having everything in the documentation is imperative. Also, make sure that you go through the details of the contract before signing it.
It needs to be as per the terms that you and your debt settlement company set. If you feel like anything is missing or shady, you can contact the BBB (Better Business Bureau) or Consumer Financial Protection Bureau (CFPB).
- Pros and Cons of Debt Settlement
To find out if a thing is beneficial for you, you need to weigh the pros and cons. The same is the case with debt settlement. If the pros outweigh the cons, you should go for it, and if not, then you need to refrain.
Let’s go through the pros and cons of debt settlement.
One of the biggest benefits of a debt settlement plan is that you will lower your debt burden. Unlike debt consolidation, where you combine your loan to get lower interest rates, you get a chance to reduce your loans.
In addition to that, you are more likely to pay fewer amounts than you owe. Since you are making a lump sum payment, it gives you the leverage to negotiate for a lower amount. As a result, you can reap the benefit of debt relief.
Moreover, you will get free from the stress of paying your debt. Creditors often make your life hectic by repeatedly calling for payments. You can get rid of all those calls with just one payment.
Furthermore, it can help you save from bankruptcy. Bankruptcy can be detrimental to your credit score. And through debt settlement, you can avoid it and protect yourself from extreme financial hardships.
While there are a lot of benefits of debt settlement, there are also some risks that come along with it. For instance, your creditors might not be willing to even negotiate on the loans. Even if they do, they can reject your initial offer and demand a higher counteroffer.
They can also charge a high-interest rate which will make your debt increase. Failure to settle can push you towards bankruptcy.
Additionally, debt settlement significantly affects your credit score as well. While your financial situation determines how significant the impact can be, it will cause problems in the future.
You will have to pay higher interest rates on new loans or even face rejection for a loan.
Furthermore, the fees of the debt settlement companies can lead you to end up in more debt than before. Their fees are payable even if you don’t reach a settlement plan with your creditor.
Bottom Line: Is Debt Settlement Worth the Trouble?
Now that you have a comprehensive idea of what debt settlement is and how it works, you might be wondering, is it worth it? Does debt consolidation hurt your credit score more than debt settlement? And should you go for any other alternatives?
Well, it depends on your situation. For someone that does not have a hefty loan, debt settlement can be ideal. This is because creditors will be willing to negotiate as the amount you owe may not be that big. And by making a one-time payment, you can get off the stress of debt. So, it would be best to understand your financial situation, find a good debt settlement company to guide you, and make the right decision.
About the Guest Author:
Lyle Solomon has considerable litigation experience as well as substantial hands-on knowledge and expertise in legal analysis and writing. Since 2003, he has been a member of the State Bar of California. In 1998, he graduated from the University of the Pacific’s McGeorge School of Law in Sacramento, California, and now serves as a principal attorney for the Oak View Law Group in California. He has contributed to publications such as Entrepreneur, All Business, US Chamber, Finance Magnates, Next Avenue, and many more.