What is debt settlement?

By Connie Shlosberg

In a nutshell, debt settlement organizations help you negotiate or settle your debt to creditors and debt collectors. Debt settlement can be a financial lifesaver if you've hit the limit on all your credit cards and find yourself getting deeper in debt.

How does debt settlement work?

When you decide to go the debt settlement route, a representative from the debt settlement company will work with your creditors to lower the debt you owe and help you get out of the red and back in the green.

Your representative will create a debt settlement plan specifically for your situation. The goal is to resolve all your debt owed to credit card companies, medical facilities, and other debtors. Your outcome with the settlement should be less than the total amount you owe. Once the plan is created, you will have a lump-sum payment due each month. The debt settlement company typically asks you to transfer the money every month into an escrow-like account (managed by a third party not affiliated with the debt settlement company) until you reach the pay off amount that you and the creditors settled on. You will probably be instructed to stop making monthly payments to the credit card companies, medical facilities, and any other debtor included in the debt settlement.

Not sure where you stand on debt? Try this free debt analyzer tool.

Is debt settlement risk-free?

While a debt settlement organization may be able to resolve one or more of your debts, there are still risks you need to consider. You should answer these five questions before you enroll in a plan:

Will there be tax consequences for debt forgiveness?

Depending on your situation, there may be tax consequences for debt forgiveness. If the creditor forgives a portion of your debt, that amount could be considered taxable income on your federal income taxes. You should consult with your tax accountant, advisor, or attorney to find out how debt settlement may affect your federal income tax.

Will you be able to cover the monthly payment for three or more years?

When you agree to a debt settlement plan, you are required to deposit money in an account for about 36 months or more until your debt is settled. Check your budget very carefully to see if you will be financially capable of the monthly payments for the length of the plan before signing anything. If you think you will have trouble making these payments, debt settlement may not be the best plan for you.

Will you be able to settle all your debt?

Unfortunately, your creditors are not obligated to agree to a settlement of your debt to them. That said, there is a possibility that the debt settlement company may not be able to reach an agreement with some of your debts. For those debts you can’t settle, you will still be required to pay them each month regardless of your debt settlement plan.

How does this impact my credit rating/score?

Your representative at the debt settlement organization may persuade you to stop sending payments directly to your creditors. You need to realize that this could have a damaging impact on your credit report and credit score. You may even continue to accrue late fees, higher interest rates, and penalties on the debt owed. Also, creditors and debt collectors may call to collect payment from you although there are laws that prevent them from harassing you.

What fees will I incur working with a debt settlement company?

Most debt settlement organizations are for profit. Before you sign up with a debt settlement company, you need to ask what fees you will incur as the cost of doing business with them. Also, inquire if you will be charged any fees for the savings account where you will be transferring your monthly payment.

What should you avoid when looking for a debt settlement company?

When it comes to getting rid of debt, there is no shortage of scammers looking to make a buck off your desperation to be debt-free. You should stay away from any company that absolutely guarantees it can settle your debt. You should also avoid any debt settlement company if it:

  • Neglects to inform you of the risks involved.
  • Bills any fees before it resolves your debts. (By the way, this is prohibited under the FTC’s Telemarketing Sales Rule.)
  • Tells you that it can settle your debt for a guaranteed percentage reduction such as 30 to 60 percent of the amount owed.
  • Pushes a "new government program" to eliminate all your credit card debt.
  • Promises it can make your debt go away or can be discharged for pennies on the dollar.
  • Tells you it can stop all debt collection calls.

If it seems too good to be true, walk away.

What should you expect from the debt settlement company?

Before you enroll in a debt settlement service, the organization is required to provide you with the following information about the plan:

Pricing and Terms of Services:

The debt settlement company must reveal all fees and conditions of services.

Offers to Each Creditor:

The company must inform you how much money (or the percentage) of each outstanding debt you must save before an offer will be made to the credit card companies and debtors.

Length of Time Before Results are Realized:

The debt settlement company needs to tell you how many months or years it will take to get results before it will make an offer to each creditor for a settlement.

Negative Consequences of Non- payment:

If you are asked to stop making payments to your creditors, the debt settlement company must inform you of the potential negative consequences of stopping payments. This includes the negative impact of your credit report and credit score.

Find a Debt Settlement Company

Once you decide debt settlement is the right choice for you, it’s time to find a company that fits your needs. DebtMD partners with debt settlement companies that we have personally vetted as safe and credible and fit our mission of helping you reach financial freedom. The choice is always yours. No pesky sales calls. (We don’t like them either!)

When you’re ready, click here to find a debt settlement company that’s best for you.

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