Credit Settlement: How it Works and Risks You Face

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The Debt Settlement Process: What is it works and the risks you face
By Bev O'Shea personal finance writer | MSN Money, Credit.com, Atlanta Journal-Constitution, Orlando Sentinel Bev O'Shea is a former NerdWallet authority on consumer credit, scams and identity theft. She holds a bachelor's degree in journalism from Auburn University and a master's in education from Georgia State University. Prior to joining NerdWallet, she worked for daily newspapers, MSN Money and Credit.com. Her work has been featured on The New York Times, The Washington Post, the Los Angeles Times, MarketWatch, USA Today, MSN Money and elsewhere. Twitter: @BeverlyOShea.





Jun 24, 2022


Written by Kathy Hinson Lead Assigning Editor Personal finances, credit scoring debt and money management Kathy Hinson leads the core personal finance team at NerdWallet. Previously, she spent 18 years with The Oregonian in Portland in roles including copy desk chief and team director of design and editing. Previous experience included copy editing and news for various Southern California newspapers, including the Los Angeles Times. She graduated with a bachelor's in journalism and mass communications from the University of Iowa.







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A creditor has accepted less than what you owe in full as a payment. When it has accepted that offer it is no longer able to pursue you for cash and you don't need to be concerned about whether you'll be sued for that specific obligation.
It sounds like a good deal, but debt settlement can be risky:
Debt settlement can destroy your credit.
The process of settling a dispute can take a long time achieve -- typically between two and four years.
It isn't cheap.

If you're successful in settling your debt it may take years before you find that you owe taxes for any debt that you have forgiven. If you choose to use a debt settlement company that charges fees. It is an option that is only available in the last instance.
Make sure you track your debt the simple method
Sign up with NerdWallet to view your current payment schedule and breakdown of your debt all in one spot.






How does debt settlement work


Debt settlement can be used only when you've got many late or skipped payments and possibly collections accounts. The collector or creditor will not accept less than you owe if there's a reason to believe that you may have owed more than you initially agreed to.
Your confidence has been destroyed, you will feel overwhelmed and in debt, and your income isn't enough to pay your debt obligations.
Companies that negotiate with creditors to reduce what you owe, mostly for debts that are not secured, such as credit cards. It's not an option with certain kinds of debt for instance, a house that can be foreclosed on or a vehicle that could be taken back. The majority of companies do not deal with federal student loans but you may be in a position to . If you're having trouble paying your student loans and need help, this may be a good option for you.
Settlement offers only work if it seems you won't make any payments, and you cease making payments to your debts. Instead, you establish an account for savings and make the monthly installment into it. Once the settlement company believes the account is adequate to warrant a lump-sum payment the company negotiates on your behalf with the lender to accept an amount that is less.
Readers may also have questions.
Do debt consolidation loans hurt your credit?

The debt consolidation process can improve your credit if it helps you pay on time or reduces the balances on credit cards, particularly if credit card balances were near their limit. Your credit score will be affected if you rack up credit card balances again, close most or all of your cards or make a late payment on you debt consolidation loan.




How do I reduce my credit card delinquence?

The bankruptcy process and debt settlement may decrease or eliminate credit card debt, but they severely impact your credit. Debt management reduces interest ratesand the effect on your credit is less significant. It can also reduce interest rates too.




How can I lower my debt?

Reduce your debt in three steps: 1. Determine your debts. 2. Assess which payoff strategy will work for you. 3. Set a goal and keep track of your progress.







The risk of debt settlement


Some debt settlement companies say they can reduce your debt by 50% and get you debt-free within 36 months.
However, the procedure isn't as simple as it seems. We believe that debt settlement should be the last resort.
Here are risks associated with debt settlement:
Your credit will be affected If you're not delinquent on your accounts, you will be once you divert debt payments toward your settlement accounts. Debts that are owed and owing off by lenders will remain on your credit for seven years.
Interest and penalties continue to accrue: You'll probably be hit with late charges and penalty charges as well. Interest will keep racking up on your balance.
There's no guarantee of success: The two largest debt settlement companies are and . Freedom Debt, for instance claims to have settled greater than 10 billion dollars worth of debts for more than 650,000 clients since 2002. However, there's no guarantee that the debt settlement company will be able to settle your debt for significantly less, considering certain creditors don't negotiate with them.
According to a study by the Center for Responsible Lending, an independent research and policy group that surveyed consumers, the majority would need to settle at minimum four accounts before receiving the net gain. In addition, debt totals can increase as fees accumulate, and aggressive collection attempts could continue throughout negotiations.
You must pay the cost when a debt settles: By law, these firms aren't able to charge charges upfront. They typically have a percentage charge for each amount they pay, depending on the debt's balance when you enrolled it in the program. Some charge a portion of the debt that is eliminated through the settlement.
For instance, let's say you owe $10,000, and your agency negotiates with you a settlement of $6,000. The agency will charge 25 percent.
If the agency is charged a percentage of the settled debt, you'll pay the debtor the amount of $6,000 while paying the agency $2,500 in charges (25 percent of the total balance enrolled). Total: $8,500.
If the agency has a percentage charge for eliminating debt, you'd pay the creditor $6,000 and the agency would charge you $1,000 for charges (25% of the $4,000 of eliminated debt). Total: $7,000.

Additional fees will be charged: Besides the fees due the debtor when the debt is settled clients may be charged additional fees, such as an initial setup fee and a monthly fee to keep the account set up under the program.
If you have forgiven your debt, it could be tax deductible It is important to know that Internal Revenue Service generally regards forgiven debt as income. It is possible to speak with tax professionals about any the additional tax obligations you'll be taking upon settling your debt.
If you do decide to enlist the services of the debt settlement expert be cautious. It's easy to lose your guard when you're desperate and see promises of . It's been reported that the National Consumer Law Center has declared that debt settlement companies are "almost not worth the money and may lead consumers into deeper financial troubles."
The Consumer Financial Protection Bureau takes more of a softer approach, however it still warns consumers about dealing with these companies is risky , and other options should be explored before. There have been over 300 complaints about firms that offer debt settlement to the CFPB from 2014. Most of the complaints were fraud and excessive fees.
Other options to settle debt


Michael Bovee, a debt settlement coach, and a frequent critic of his business (he has presented evidence to the Federal Trade Commission in favor of greater regulation), advises erasing your debt through Chapter 7 bankruptcy and starting again, if you have the choice.
If you are a borrower who is overwhelmed by debt that is not secured, like credit cards, take a look at the alternatives to . A bankruptcy is generally the better choice. Yes, a bankruptcy will ruin your credit for years, but the rebuilding process can begin as soon as. Consultations with a bankruptcy attorney are typically free, though you'll pay legal and filing fees if you choose this option.
"If you are able to erase your debts with bankruptcy, such as a Chapter 7 bankruptcy, that's an excellent alternative to trying to reach the settlement," says NerdWallet columnist Liz Weston, author of "Your Credit Score" and "Deal With Your Debt." "Only in the event that Chapter 7 isn't an option or you choose not to file for bankruptcy, or you can only be eligible for a Chapter 13 repayment plan -or if you are considering debt settlement."
If you don't qualify for bankruptcy, or do not want to file one, think about the possibility of a donation through a nonprofit . The option you choose to take won't necessarily reduce the amount you must repay, but it may reduce your monthly payments by spreading them out, or through lowering your interest rate. It's less likely to have an impact on your credit score than either bankruptcy or an agreement to settle debts.
If you decide to pursue settlement


If you believe that you're in the most effective or the most suitable option for you, and you'd like some help with debt settlement, Bovee has tips for selecting a company with care:
Find out the history of complaints.
Beware of any company which offers cash in advance or guarantees that the debt can be paid.
Be sure that fees are arranged in a proportion of debt eliminated rather than of the debt balance at enrollment; that gives the company incentive to trim more of your debt.
Do not trust companies that claim to help you challenge the validity of your debts and declare them "invalid" (a tactic which could backfire and result in more aggressive action against you).

If you're not sure whether you want to work with a company for debt settlement think about hiring a lawyer or do it yourself.
Lawyers can bill by the hour, have one flat fee per creditor or be charged a percentage of the debt or debt that is eliminated.
Once you're significantly behind, it usually doesn't hurt to reach out to your creditors. Some banks have programs for hardship which could be able to aid. However, make sure you are able to afford any reduced payment options your bank may offer.
If you're considering trying learn about the likely outcomes.
You might want to collect enough cash are able to to make a lump-sum offer, whether this means taking a part-time job or selling equipment for sale that's been languishing in the basement, or borrowing money from your cousin. (Creditors are more likely to accept a lump-sum deal that allows them to receive money immediate, rather than risking payments that might not come.) Be aware that certain creditors may have a policy against settling debts.



About the author: Bev O'Shea is a former credit writer at NerdWallet. Her work has appeared in the New York Times, Washington Post, MarketWatch and elsewhere.







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