While there are several ways to manage and pay off debt, many people turn to debt settlement companies for help. Thanks to their ability to negotiate with creditors on your behalf, they seem like a smart solution to get rid of credit card and other personal debt. Still, while debt settlement could help in some situations, it isn’t the right choice for everyone.
Top Debt Relief Options
Pros
- You might pay less than you owe
- Avoid collections, lawsuits, and bankruptcy
- You don’t have to handle negotiations yourself
- Make one payment per month instead of multiple
Cons
- It’s not a guaranteed solution
- Debt settlement fees can be costly
- It can hurt your credit
- Settlements aren't tax-free
- Your monthly payment might be tough to maintain
What Is Debt Settlement?
Debt settlement is a process in which specialists negotiate your debts on your behalf to help you pay less for your current debts. For example, say you have $10,000 in credit card debt that you’re struggling to pay due to high interest charges. A debt settlement company might be able to negotiate that debt down to $5,000 with lower interest rates, allowing you to pay off your debt sooner.
When you work with a debt settlement company, you pay just one payment to the company each month, allowing you to consolidate the payments of your enrolled debt. Doing so can make paying off your debts much more manageable. While it’s not the same as debt consolidation, debt settlement has a similar premise: Make one lump payment toward your debts each month until you pay them off.
Advantages of Debt Settlement
Debt settlement works for hundreds of thousands of people each year, helping them climb out of the burden of debt and get closer to a debt-free life. Here are the most common advantages of debt settlement.
You might pay less than you owe
The primary goal of debt settlement is to reduce your debt, so it’s not surprising that this is the most heavily touted benefit of debt settlement companies. Before you enroll in a debt settlement program, the specialist you speak to can let you know how much you can expect to save once you pay off your debt in the program versus what you’d pay without it. This is usually anywhere from 10% to 50% savings compared to your initial debt.
When a debt settlement company works with your creditors on your behalf, they usually either negotiate the balance of your debt or your debt’s interest rate. Or, they may negotiate a combination of both. Either way, you can potentially save money by paying off your debt this way.
You could avoid collections, lawsuits, and bankruptcy
Bankruptcy helps people get out from under the financial burden of their debt by essentially forgiving the debt they owe. While bankruptcy is unavoidable in some cases, it comes with a negative mark on your credit that lasts for years and can potentially cause you to lose some of your assets.
Many people turn to debt settlement before beginning the bankruptcy process to avoid the consequences of bankruptcy. Although it won’t work in every case, debt settlement can sometimes help people climb out of debt, preventing bankruptcy altogether.
On a similar note, debt settlement can also help some people avoid lawsuits stemming from unpaid debt or having their debt turned over to collection agencies, both of which can quickly escalate into stressful situations.
You don’t have to handle negotiations yourself
Anyone with debt has a right to negotiate their debt with their creditors. For example, suppose you have $5,000 in credit card debt and are finding it difficult to pay more than the minimum payment due to high interest rates. In that case, you can contact your credit card company to negotiate a lower interest rate or settle your debt for a lower amount. While it’s allowed, it doesn’t always work when the debtor tries to negotiate.
Debt settlement companies have longstanding relationships with many creditors, though, especially common creditors like credit card companies. When you work with a debt settlement company, a debt specialist handles all negotiations on your behalf, leveraging their relationships with creditors to get you the best deal. Debt settlement specialists know who to speak to and what to say to increase the chances of creditors reducing your debts.
You can make one payment per month instead of multiple
Say you pay multiple creditors per month. Maybe you have one personal loan, a private student loan, and three credit cards you’re trying to pay off. That means you make five separate payments to creditors every month. If you forget to make one payment or are late making a payment, you could face hefty late payment fees.
When you work with a debt settlement company, you make just one payment toward your debt settlement plan every month. The majority of this payment goes toward your debts while a portion may go toward the debt settlement company’s fees for its services. Because you make one lump payment, you don’t need to worry about remembering different due dates or how much to send to each creditor. Instead, your debt settlement specialist divides the money where it needs to go.
Disadvantages of Debt Settlement
Debt settlement has several pros, but there are also some disadvantages regarding its potential outcomes and costs.
It’s not a guaranteed solution
People often enter into a debt settlement plan thinking it’s a guaranteed solution for their debt problem. It can work for many, but it doesn’t always. Many debt settlement companies are transparent about this from the beginning.
There are a few reasons debt settlement may not work, including:
- The enrollee doesn’t keep up with their monthly payment toward their debt settlement plan
- The enrollee’s creditors refuse to negotiate their debts
- Creditors still decide to open a lawsuit against the debtor
- The debt settlement company’s high fees make it nearly impossible for the enrollee to get ahead
People who enroll in debt settlement expecting the process to move quickly may be disappointed to know that it can take a few years to finish their plan. A Better Business Bureau study found that about half of people who enter into debt settlement plans drop out of their plan before finishing it.
Debt settlement fees can be costly
While debt settlement companies are there to help you get out of debt, they’re also businesses that need to make money for their services. Charges for debt management services are based on the amount of enrolled debt, usually between 10% and 30%. If you enroll $10,000 of debt into your plan, you can expect to pay anywhere from $1,000 to $3,000 in fees to your debt settlement company.
The problem is that some fees can come close to or surpass the amount of negotiated debt. Say, for example, your debt specialist negotiated a $5,000 credit card bill down to $3,500. However, your debt settlement company charges 30% of enrolled debt, making your fee for that credit card bill $1,500. That’s the same as the negotiated amount, putting you back to square one for this particular debt.
It can hurt your credit
While your debt is enrolled in a debt settlement program, your debt specialist will likely advise you not to continue paying your debts on your own. This is because the company will work to settle your debts, and creditors often don’t accept settlements if you’re not already behind on payments.
Once you fall behind on your payments, your credit score can dip — in some cases, substantially. The good news is that when you complete a settlement and begin getting your accounts current again, you should see your credit score rise, but it can be a long process from start to finish.
👉 Related Reading: How To Get Out of Debt
Settlements aren’t tax-free
Typically, canceled debt is counted as taxable income. Therefore, if you had $5,000 canceled through your debt settlement program, that $5,000 would need to be added to your taxable income when you file your taxes, effectively increasing the amount you owe in taxes for the year.
You can prepare for this ahead of time by setting aside some extra cash once you find out how much your debt is settling for. You can also use the Tax Withholding Estimator tool from the IRS to estimate how much you’ll pay in taxes based on your income, debt settlement, and other adjustments.
Your monthly payment might be tough to maintain
Your debt settlement company determines the minimum amount of cash you need to pay monthly for your debt settlement plan. That money goes toward paying your settlements, so paying at least that amount each month on time is important.
However, if you’re struggling to pay your current debts, you might also find it challenging to keep up with your debt settlement payment. If you fall behind on the payment, you could be subject to extra fees, and the debt settlement company won’t be able to help you pay off your debt.
DIY Debt Settlement
Do-it-yourself debt settlement, also known as DIY debt settlement, is the process of someone in debt settling their debts themselves. As mentioned previously, you can contact creditors yourself to propose debt settlements, such as settling a $3,000 credit card bill down to $2,000 if you’re able to wipe it away with a lump payment. Not all creditors accept settlements from their debtors, especially if a debtor is far behind on their payments, but it works in some cases.
DIY debt settlement can potentially save you some money versus working with a debt settlement company, as you won’t need to pay fees for the service. Unfortunately, you also won’t have the help of an experienced debt specialist on your side to walk you through the process and tackle negotiations for you.
If you do decide to go the DIY route, be sure to get proof of all settlements in writing for your records.
👉 Related Reading: What Is Good Debt vs Bad Debt?
Should I Work With a Debt Settlement Company?
Debt settlement is the right move for some people with large amounts of debt who are struggling to make their monthly payments. You could end up reducing the amount you owe and find it easier to make a lump payment each month rather than multiple payments to various creditors.
For other people, DIY debt settlement or credit counseling could be better options, allowing them to pay off debts while rebuilding their credit without the extraneous fees some debt settlement companies charge.
If you’re on the fence about debt settlement, consider reaching out to some of the best debt relief companies. Many offer a free debt settlement estimate to give you an idea of how much debt you can expect to wipe away and how much you may need to pay in fees for your debt settlement program.
