Are you wondering whether debt settlement might be right for you but afraid it will be too expensive? Despite what you may read, debt settlement can be one of the cheapest ways to get out of debt.
Why? Let’s take a look.
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- Debt settlement companies charge usually charge between 15% to 27% of your total enrolled debt in exchange for their services.
- You won’t pay anything at all until each settlement is reached and you accept the settlement.
- After you accept, your debt settlement company will obtain your authorization to pay your settlement with the funds in your savings account. Settlements will be paid in either installments or a lump sum.
- Once settlements are reached, collection calls will stop.
- You could settle debts for no fee at all if you’re willing to do it yourself — though this will require discipline and a considerable time commitment.
How much do debt settlement companies charge?
Debt settlement may sound expensive. A legitimate debt settlement company will charge between 15% and 27% of the total debt you enroll in the settlement program, depending on various factors, including the company and the state where you live.
If you owe $25,000 across four lenders and pay 25% (the most common fee), that adds up to a total of $6,250. That may sound like a huge and intimidating amount. However, you pay nothing out of pocket at the start of the process.
In fact, you don’t pay at all until your debt is settled. If you settle at 50% of the total enrolled debt, or $12,500, and your fee is $6,250, your debts will be gone and you’ll pay a total of $18,750. That’s a savings of $6,250.
Debt settlement saves consumers $2.64 for every $1 in fees paid, according to the American Association for Debt Resolution.
Pro tip: The American Association for Debt Resolution was previously known as the American Fair Credit Council.
READ MORE: When is debt settlement a good idea?
There are no upfront fees or out-of-pocket costs
The debt settlement industry is heavily restricted under federal law. This is to help you, the consumer. A legitimate debt settlement company is prohibited from charging upfront fees. You only pay after each enrolled debt is settled.
The Federal Trade Commission’s (FTC) Telemarketing Sales Rule lays out guidelines for the debt settlement industry. Under that law, any debt settlement company is prohibited from charging you until:
- At least one of your debts is settled
- You officially approve the terms of the settlement
- The creditor has received at least one payment to the debt collector or creditor based on the settlement deal
- If you have enrolled multiple debts with multiple credit card issuers or debt collection agencies and only one is settled, the fee you pay will only apply to that particular debt.
For example, if you owe $25,000 spread out across four different creditors ($6,250 each), and the fee is 15% of the total debt settled, the company can only charge you $937.50 when it settled the first debt (or a quarter of the total settled debt.) With each subsequent settlement, the company will charge the same percentage.
If your debt is settled for $3,125, you’ll end up paying a total of $4,062.50 after the fees, which is still a savings of more than $2,000.
READ MORE: Debt settlement companies
Debt settlement can be good for your mental health
If you’re feeling depressed, overwhelmed, worried or the amount of debt you have keeps you up at night, debt settlement will give you some relief because you know you’re taking action.
You will also end embarrassing calls from debt collectors and your overall financial situation will improve, so you won’t need to worry about counting every penny. You may even have some extra money to build an emergency fund or occasionally treat yourself to a night out with friends.
Is debt settlement expensive?
Though costs for debt settlement may seem high, debt settlement can actually be the cheapest way to get out of debt.
Consider this comparison for a customer with a total of $25,000 in debt.
|Debt settlement||Debt consolidation loan*||Making the minimum payment|
|Total debt repaid||$13,800||$25,000||$25,000|
|Months to settle or pay off all debts||56 months||56 months||197 months (16 years and 5 months)|
|Total interest or fees paid||$4,950||$7,771.54||$14,873.48|
As you can see, you’ll pay more than double if you make the minimum monthly payments, which are almost triple the amount you’d be depositing into your debt settlement savings account. And even though you’re paying less per month for debt settlement, you’ll be debt-free almost 12 years sooner.
According to a 2020 report from Harvard’s John F. Kennedy School of Government:
- Debt settlement clients save an average of $1,700 after fees on every account that’s settled
- A customer who averages 6.68 settled accounts will save roughly $5,800 after fees.
You will get out of debt without paying the full amount you owe
After you miss three to six payments, a creditor will usually decide they aren’t getting paid and will write off your debt. This is known as a charge off. A charge off will hurt your credit score, and it does not mean you no longer owe the debt.
Pro tip: Charged off means that the lender has given up hope that your debt will be repaid and has notified the three credit bureaus (Equifax, Experian and TransUnion) that you’re in default. Charge-offs are noted on your credit report, will significantly hurt your credit score and do not release you from the obligation to repay the debt.
Creditors prefer to get paid a fraction of what you owe rather than get nothing. This gives you negotiating power, particularly if the creditors fear that you may file for bankruptcy. By letting these debts become charged off (and instead putting the money that you’d be using to make minimum payments into a savings account), you gain leverage for a debt settlement company to swoop in and make a fair settlement offer. After that, there may be some negotiations.
Once a settlement is reached and you sign off on it, a payment plan will begin, and the charge off will be removed from your credit report. Instead, the account will be closed and noted as “settled.” Because “settled” accounts don’t hurt your credit score, and the charge off will be gone, your credit score will start to rise again.
READ MORE: What does “charged off as bad debt” mean?
You’ll know the total cost before you commit
The Federal Trade Commission requires debt settlement companies to disclose the following information before you sign up. This includes:
- Fees, any conditions and terms of service
- How long it should take until you see the results
- The negative consequences when you stop making payments to your creditors
- How much savings you need to accrue in escrow before the company reaches out to creditors
You don’t necessarily need to pay anything at all
It’s completely possible to handle debt negotiation with creditors on your own. However, this is not a simple process. You’ll need to be a good negotiator, have thick skin and be willing to commit the time and research hours to the process.
This option won’t be right for everyone, and if you do it incorrectly or can’t follow through with the payments to successfully meet the settlement terms, you’ll end up in a worse situation.
Pro tip: Hiring a debt settlement company will simplify the process. Though most won’t be able to guarantee results, companies have already established relationships with various creditors and will have a good idea of which creditors are willing to consider settlements.
READ MORE: DIY debt settlement
Be on the lookout for scams
Debt settlement customers are prime targets for scammers. They are vulnerable because they have a lot of debt and might be a bit desperate. Watch out for the following red flags if you’re seriously considering debt settlement:
- They call you – unprompted
- They require upfront fees
- They don’t offer a free consultation
- They guarantee settlements
- They make specific promises, like saying settlements will be reached in days or the process will only take a couple of months.
More red flags
- Attorney partnerships: Because attorneys are not prohibited from charging upfront fees, some scam companies will partner with law firms. If you’re hiring a debt settlement attorney, make sure that any attorney you choose isn’t simply a front for a shady debt settlement company.
- In-person meetings: Telemarketing Sales Rule does not apply to in-person meetings, so if a company tries to pressure you into visiting the office in-person, they may be trying to sidestep federal laws. The telemarketing laws only apply to business conducted by phone.
Before hiring a debt settlement company, read the Better Business Bureau ratings, check Trustpilot, see if complaints have been filed with any local consumer protection agency and check with your state attorney general’s office to ensure the company you choose is legitimate.
How debt settlement works
The company will ask you to stop making payments on your enrolled debts. This will cause debt collectors to call (if they aren’t already), and you’ll rack up late fees. It will have some impact on your credit score.
After your initial consultation, the debt settlement company will tell you to stop making monthly payments on your unsecured debts.
Why do they want you to stop making payments? Because it’s effective. Many creditors won’t even consider settling debts until your account is charged off.
Pro tip: You will keep making monthly payments on any debts that are not eligible for settlement and routine monthly bills like rent and utilities.
Instead, you will start depositing a fixed amount of money each month into a bank account. Once enough funds have accumulated, the company will contact credit card companies or debt collection agencies with settlement offers, and negotiations will begin. Once debt settlement agreements are reached, they are paid with funds from your bank account, either over a fixed term or (less frequently) in one lump-sum payment.
READ MORE: How does debt settlement work?
Your credit score will initially fall
Many people fear debt settlement because they’re worried about the negative impact on their credit scores. Debt settlement will initially cause your credit score to drop, but any damage will be relatively short-term.
Keep in mind that if you’re already overwhelmed by your debt, you likely have already established a pattern of late payments and high credit utilization ratios. This means your credit score will already be damaged.
Pro tip: If your credit score is currently below 600, the impact from debt settlement will be relatively small. And once the settlement process is complete, your scores will rebound quickly.
How much your score will drop depends on your credit score when you start a debt settlement program. Borrowers with the highest credit scores will see the biggest declines.
Which types of debt are eligible?
Debt settlement only works if you have unsecured debts. This includes:
- Credit card debt
- Personal loans
- Medical bills
- Some student loans
However, it doesn’t work on all unsecured debts. It will not work, for example, if you owe:
- Back taxes
- Child support
Pro tip: Secured debts, including auto loans and home loans, cannot be enrolled in debt settlement programs. Since these loans use your car or home as collateral, creditors have no incentive to settle. If you miss payments, they will simply repossess your car or you’ll face foreclosure.
READ MORE: Debt settlement qualifications
Possible tax consequences
The Internal Revenue Service (IRS) may count your forgiven debts as taxable income, so you may not save as much as expected when income tax time rolls around. You’ll probably want to consult an income tax professional. Keep in mind that there are usually exceptions for households that aren’t financially solvent.
READ MORE: Debt settlement pros and cons
Other debt relief options
READ MORE: Debt relief programs
The bottom line
If you’re worried about the cost of debt settlement, don’t let that deter you from researching programs. Though it might sound expensive, it can be actually be a relatively inexpensive way to get out of debt since you repay less than the total you owe.
Still not sure? Schedule a free consultation today with one of our experts to see whether you’re a good candidate for debt settlement.
The cost of hiring a debt settlement attorney can vary depending on several factors, including the attorney’s experience, location, and the complexity of your case. Attorneys usually charge either an hourly rate or a flat fee for their services.
Hourly rates for debt settlement attorneys can range from $100 to $500 or more. Some attorneys may require an upfront retainer fee, which can range from a few hundred dollars to several thousand dollars.
Other debt settlement attorneys may offer a flat fee for their services, which can range from a few hundred to several thousand dollars. This fee typically covers the entire debt settlement process.
In most cases, you don’t need to pay extra for a debt settlement attorney unless you’re already facing legal issues.
In general, debt settlement fees are not tax deductible. The Internal Revenue Service (IRS) considers debt settlement a personal expense, similar to paying off your own debts, and personal expenses are typically not tax deductible. However, settled debts could be considered taxable income.
Freedom Debt Relief’s fees typically range from 18.25% to 25%, depending on the state. However, Freedom Debt Relief has been the subject of legal challenges based on the amount of money they told customers they’d save. If you’re seriously considering Freedom Debt Relief, it’s important to pay attention to the allegations and settlements.