August 4th 2023.
What is Debt Settlement?
Debt settlement is an option for debt relief that involves negotiating with a creditor to settle an account for less than what is owed. This form of debt relief usually applies to money owed on credit cards or loans. In most cases, debtors work with a debt settlement company to negotiate on their behalf.
Not all creditors are willing to consider debt settlement, and the ones that do usually only consider it when an account has reached default status. In many cases, it’s a last resort before filing for bankruptcy.
How Does Debt Settlement Work?
The goal of debt settlement is to pay off your credit card or loan debt at a lower amount. You must come to an agreement with the lender or credit card company in order to do this. You can try to settle the debt on your own, or you can use a debt settlement company to negotiate on your behalf.
When you work with a debt settlement company, the first step is to identify which debts you want to settle. You’ll submit those to the debt settlement service, and it will create a payment plan, including its fees. In most cases, the company will advise you to stop paying the creditor for every account you submit. The money that you pay the debt settlement company goes into a reserve account.
After a certain amount of time, usually a few years, your credit accounts will default due to non-payment. At this point, the accounts are usually charged off and sold to a collection agency or debt collector. The debt settlement company will then begin negotiating with the creditor using the money you paid into the reserve account. It will attempt to get the creditor to accept a lower amount to settle the account. You will make a lump sum payment or set up a payment plan to pay the settlement, and the debt settlement company will take its fee.
Avoiding Debt Settlement Scams
It’s important to research a debt settlement company before enrolling in a program. Watch out for companies that require you to pay a fee before negotiating, claim to be working with a "new government program," make upfront guarantees, or tell you to stop communicating with creditors without explaining the impact it will have on your credit history.
DIY Debt Settlement
You can also try to negotiate the debt on your own. You’ll contact the creditors directly and explain your financial situation. Most creditors won’t consider settlement if they believe you still have the ability to pay the loan, so it’s unlikely they’ll negotiate if your payment is just past due or delinquent. Creditors may be more willing to consider settlement once an account goes into default and gets sent to collections. You can start by asking to pay 25 cents on the dollar, then 50 cents on the dollar, and so on until you reach an agreement with the lender.
Does Debt Settlement Affect Credit Scores?
Debt settlement can lower credit scores, but not as much as defaulting and paying nothing. The exact damage to a credit score depends on where the score was, the size of the debt, and how creditors report it. Generally, the higher the credit score, the more significant the drop when you settle a debt. The size of the debt also affects how much the score drops. Settling larger debts is seen as a greater credit risk, so the larger the debt, the more it lowers your score.
However, chances are the events leading up to the settlement have already lowered your credit score. Most people only consider settlement once they’re overdue on payments and know they can’t afford to pay off the debt. Those missed payments and high debt usually lower your score long before settlement. It also depends on how creditors file the settlement in your credit report.
Most creditors are aggressive and actively report delinquency and defaults. Once you settle, they’ll usually mark the account as “Settled in Full,” indicating it was a settlement, which will lower your credit. However, some creditors are more lenient and may list the settlement as “Paid in Full” or “Paid as Agreed,” which will have a much less impact on your score.
Credit Scores After Settlement
The good news is that any damage done to your credit score is only temporary. Once the debt is removed from your credit report, it will have a positive impact over time. Continuing good credit habits, such as making all monthly payments on time, keeping credit usage below 30%, and maintaining a good credit mix, will help raise your score, even if it takes a few years. However, debt settlement is still a serious mark on your credit, so it’s important to consider all alternatives before proceeding.
What Are the Pros & Cons of Debt Settlement?
Debt settlement has some benefits, but there are serious risks involved. The pros include helping to avoid bankruptcy, a settled account being better than a defaulted account, the potential to save money by paying less than what’s owed, and stopping collection calls and debt collectors.
The cons include no guarantee that creditors will negotiate, ending up with more debt from late fees and penalties, and the potential for debt settlement scams. It’s important to do your research and understand the risks before choosing this option.
What is Debt Settlement?
Debt settlement is a form of debt relief. It involves negotiating with a creditor to settle a delinquent debt for less than the amount owed. This could be for a loan or a credit card. Creditors are typically lenders and credit card companies. Often, debtors will work with a debt settlement company to negotiate on their behalf.
Debt settlement is often a last resort option that people turn to before filing for bankruptcy. This is because not every creditor is willing to negotiate on debt settlement. Those that do usually only consider it when an account reaches default status.
How does Debt Settlement work?
Debt settlement works by allowing you to pay off a credit card debt or loan with a lower amount than what you owe. To do this, you must come to an agreement with the lender or credit card company. You can try to do this by yourself, or you can work with a debt settlement company. Neither of these methods guarantees you the outcome you want, but a debt settlement company will have more experience negotiating with creditors.
If you choose to work with a debt settlement company, the first step is to identify which debts you want to settle. You submit these to the debt settlement service, and they will create a payment plan, which may include their own fees. As part of the process, you will be advised to stop paying the creditor on each account you submit. The money you pay the debt settlement company will be placed in a reserve account.
At some point, usually after a few years, your credit accounts will default due to non-payment. At this time, the accounts will be charged off and sold to a collection agency or debt collector. The debt settlement company will then begin negotiating on your behalf with the money in the reserve account. They will try to get the creditor to accept a lower amount to settle the account. You will then pay the settlement either as a lump some or as part of a payment plan. When the account is settled, the debt settlement company will take their fee.
Avoiding Debt Settlement Scams
It is important to do research on the debt settlement company you choose to work with. Look for reputable companies and watch out for any that:
- Require you to pay their fee before negotiating with creditors.
- Claim it’s working with a “new government program.”
- Make upfront guarantees.
- Tell you to stop communicating with creditors without explaining the impact that will have on your credit history.
- Promise to stop all lawsuits and collections calls.
- Claim they can settle your debt for very cheap.
DIY Debt Settlement
You can also try to settle the debt on your own. You will contact the creditors directly and explain your financial situation to them. Most creditors will not consider settlement if they believe you still have the ability to pay the loan, so it is unlikely they will negotiate if your payment is just past due or delinquent.
Creditors may be more willing to consider settlement once an account goes into default and gets sent to collections. You can start by asking to pay 25 cents on the dollar and then 50 cents on the dollar until you reach an agreeable percentage with the lender.
Does Debt Settlement Affect Credit Scores?
Debt settlement does lower credit scores, but not as much as defaulting and paying nothing. The exact damage to your credit score depends on where your credit score was, the size of the debt, and how creditors report it. Generally, the higher your credit score, the more significant the drop when you settle a debt.
The size of the debt also affects how much your score drops. Settling larger debts is perceived as a greater credit risk, so the larger the debt, the more it lowers your score. However, chances are the events leading up to the settlement have already lowered your credit score.
It also depends on how creditors file the settlement in your credit report. Most will be aggressive and actively report delinquency and defaults. Once you settle, they will usually mark the account as “Settled in Full”, indicating it was a settlement, which will lower your credit further. However, some creditors are more lenient and may list the settlement as “Paid in Full” or “Paid as Agreed”, which will have less of an impact on your score.
Credit Scores After Settlement
The good news is that any damage done to your credit score is only temporary. The process removes the debt from your credit report, which will have a positive impact over time. Good credit habits such as making all monthly payments on time, keeping credit usage below 30%, and maintaining a good credit mix will raise your scores, even if it takes a few years.
What are the pros & cons of Debt Settlement?
Debt settlement has some benefits, but it also has serious risks that you should be aware of. The pros include: helping to avoid bankruptcy, a settled account is better than a defaulted account, potential to save money by paying less than what’s owed, and it stops collection calls and debt collectors.
The cons of debt settlement include no guarantee that creditors will negotiate, and you could end up with more debt from late fees and penalties.
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