What is debt settlement?

Debt settlement (also called debt negotiation) is a process of negotiating with your creditors to pay off your credit cards and other unsecured debt (student loans, auto loans, and home mortgages are secured debts, and don’t qualify) for an amount less than you currently owe, often at a 40-60% savings. You will need to be behind in your payments in order to gain the leverage needed to get the creditors to settle your debts at a reduced amount (if you are making your payments on time, creditors won’t want to give you a “deal”). Typically you will pay the settlement company a percentage of the savings.

Does debt settlement really work?

Yes it does. Debt settlement works best for people who cannot pay their bills, are behind in their payments, or are considering bankruptcy. It is not designed for consumers who have small amounts of debt or who can still make their payments. It is a more aggressive approach to getting out of debt, and is not right for everyone. But debt settlement is a proven method, that does work (and worked very well for me personally).

How is it different from debt consolidation or credit counseling?

Debt consolidation or credit counseling is a more traditional debt reduction option, which lowers your interest rates, monthly payments, and fees, but does not directly reduce the amount you owe. However, debt consolidation can help you get out of debt faster by lowering your interest rates and helping you pay more each month towards the amount you owe, and pay less in interest. Unlike with debt settlement, you do not need to be behind in your payments to use debt consolidation or credit counseling (although you can be).

Will debt settlement ruin my credit score?

A credit report lists your payment history and amount of debt, so debt settlement is noted on your credit report, and can lower your credit score. However, many people don’t realize that having a lot of debt also lowers your credit score. And with very high debt, many lenders won’t lend you money (which is one reason to have good credit in the first place) and you may not be able to afford to borrow more money (another reason to have good credit) anyway. So, when considering debt settlement, make sure to compare the benefits (getting out of debt faster & saving lots of money) against the against the drawbacks (lowering your credit score). For me, getting completely out of debt and getting my life back to normal was well worth it.

Can my credit be repaired after I am done with debt settlement?

Yes it can. You have the right to request than any information be removed from your credit report. All information must be verified correctly, or the credit bureaus must remove it from your credit report. Personally, I was able to remove all of the negative items on my credit report (except for one) and now have my credit back to normal.

How does debt settlement affect my taxes?

Any money saved through the settlement process from the original amount you owed is treated as taxable income by the IRS (so you will owe money to the IRS). However, the amount of tax paid will still be much less than the amount of money you would have paid in interest, so it probably should not be a deciding factor when considering debt settlement. And you don't pay the tax until after the settlement, at the time you prepare your income taxes after the new year. You should consult with a tax advisor for more information.

How do I know if a debt settlement company is legitimate and I won't get ripped off?

As with hiring any professional to do work with you, do your homework: ask lots of questions, make sure you feel knowledgeable and comfortable with the process, read the fine print, and check with the Better Business Bureau. Learn more about choosing an honest and reliable debt settlement company before you get started.

How do the fees work?

The fee structure can differs depending on the settlement company you use. Typically, fees are based on a percentage of the savings, approximately 25%. For example, if you owe $10,000 and the company works out a settlement of $4,000 and you save $6,000, you would owe 25% of $6,000 or $1,500, leaving you with a total savings of $4,500, a significant savings. Some companies will require a lump sum payment (which you can get from savings, borrowing money from a relative, etc.) and others will help you set up a savings plan while they work out the settlements, which depending on your situation can take up to a few months. Beware of companies that ask you for payment up front (although they may ask for the savings plan money to be sent directly to them, which is usually acceptable).

I haven't missed any payments, can I still use debt settlement?

It depends on which settlement company you hire. Some debt settlement companies will require you to have a financial hardship, and may not work with you if you are not already behind on your payments. Others will ask you to stop paying your credit card bills and have the money you would have used on the payments sent directly to them as a savings plan to accumulate enough money for a settlement while they negotiate with your creditors. So it is possible to use debt settlement if you are not behind on your credit card payments - especially if you cannot pay your other bills.

Can’t I just settle my debts on my own?

Yes, you may be able to settle your own debts. However, many people find negotiating difficult. And from my personal experience, I received a better discount using a professional debt settlement company (even with the fees added in) than I did when I tried it on my own. A professional debt settlement company knows the right steps to take, typically has established relationships with many credit card companies, and is often taken more seriously by the creditors. If you do decide to do it on your own, take your time and learn how to settle your own debts properly.

Isn't using debt settlement like cheating?

If you can honestly pay your bills, then debt settlement is probably not the right option for you. But if you cannot, then debt settlement is a perfectly honest and legal debt reduction solution. After all, is it ethical for the credit card companies to keep sending you credit card offers when you are struggling? And raising your interest rates? And increasing your credit limits? Getting you further and further into debt? Of course, getting into debt was your responsibility, and so is getting out. But credit card companies are willing to settle with consumers because for them it is a better option (and they'll get more money from you) than suing you or having you file for bankruptcy. So if debt settlement is right for you, don't hesitate to consider it as an option.

Is debt settlement right for everyone?

Debt settlement is not right for everyone. It is a more aggressive approach to getting out of debt, but it may help you get out of debt much faster than doing what you are currently doing. Please take your time, ask lots of questions, and make the right decision for your situation. Most debt settlement companies offer a free consultation, so you can determine if debt settlement is right for you.

Debt settlement is not an "easy way out" of paying back what you rightfully owe. So make sure you know exactly what you are getting into before you get started!

Image courtesy of Stuart Miles: FreeDigitalPhotos.net