Many experts will try to warn you against debt settlement. However, even though it isn’t the right choice for everyone, sometimes it’s actually a good idea.
Suppose you don’t qualify for a consolidation loan or are considering bankruptcy. In either case, debt settlement will be a better option – especially if you think you’ll need an apartment, personal loan, credit card, student loan, house, utility service or even a cell phone over the next ten years.
Here’s a look at when debt settlement can be a good idea – and when it might not be.
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9 signs debt settlement is a good idea
- You have more than $7,500.in unsecured debt (or $1,000 in payday loan debt): This is generally the minimum amount of debt needed to enroll in a debt settlement program. Unsecured debt includes credit card debt, medical bills, personal loans and some student loans.
- You’re currently facing financial hardship: If you’ve been laid off, are facing a sudden medical crisis or have another type of temporary hardship that prevents you from repaying your debt, this may be the best way to solve your immediate problems without filing for bankruptcy, which could make it more difficult to find work.
- You’re getting calls from debt collection agencies and have already missed a few payments: This is a good sign that you’re in over your head and need quick relief.
- You have charge offs on your credit report: A charge off means your credit card company has written off the loan as uncollectible. This will be noted on your credit reports with all of the major credit bureaus. This is what causes your credit score to fall. However, the damage won’t be long-term.
- You’re seriously considering bankruptcy: But you’re also worried that you can’t afford the out-of-pocket costs and the fees for a bankruptcy attorney, plus you’re worried that it will destroy your credit score and want to avoid a court appearance.
- You don’t have money to pay upfront fees: Federal Trade Commission guidelines prohibit debt settlement companies from charging upfront fees, so you don’t actually have to pay their fees until settlements are reached. You will, however, have to make the monthly payment into your designated savings account.
- You can’t afford to repay the total amount you currently owe: If you’re so underwater with debt that you’re afraid to total it all up, and you don’t see any way to realistically repay the full amount.
- You need an option that’s fast: Though a debt settlement program can take up to four years to complete, settlements could be reached within a few months, which will put a stop to collection calls and ease the pressure on your monthly budget from too many minimum payments.
- You’ve been threatened with a lawsuit: If you’re being threatened with wage garnishment or debt collectors say they will sue you, simply knowing that you’re enrolled in a debt settlement program with a legitimate company can stave off legal action. In addition, some debt settlement companies include certain legal protections when you enroll in their programs.
Pro tip: Once an account is charged off, that notation on your credit report will hurt your credit score. But once a settlement is reached, the notation on your credit report will change to “settled,” and that will cause your credit score to increase.
READ MORE: Debt settlement — how to get your debt under control now
5 signs debt settlement is not a good idea
- You can afford to pay your debt in full: Debts that are paid in full will always be a better option than settled debt, particularly for your credit history. However, most people simply can’t afford it. If they could, there would be no need for debt settlement companies.
- Your credit score is good enough that you qualify for other better options: This includes debt consolidation loans and balance transfer credit cards with lower interest rates than what you currently pay. In general, these are the best way to tackle multiple debts for a low out-of-pocket cost. However, debt settlement still may be a good idea if you have a substantial amount of debt and you’re in a position where paying off a debt consolidation loan would result in monthly payments that you’re unable to realistically afford.
- You’re worried about your credit score: If you need to keep your credit score as high as possible because you anticipate a need to buy a car, for example, you will need to continue to make minimum monthly payments and seek out other consolidation options. If you don’t anticipate a major purchase within the next two to three years, debt settlement may be a good idea.
- You think you might be dealing with a scam company: Unfortunately, the debt settlement industry is filled with scammers. If a company tries to charge you upfront fees, calls you out of the blue, guarantees results, tells you that they can solve your problems in a matter of a couple of months or cites vague “government programs,” find a different company. If you think a scammer has tried to contact you, don’t hesitate to contact your state attorney general’s office.
- You want to try DIY negotiations: It’s possible to settle debt directly with lenders, particularly if you have less than $7,500 in unsecured debt or you only have one or two debts to worry about. Keep in mind that it will take a significant amount of time, organization and discipline, and if you stop making your payments and rack up late fees but then are unable to negotiate a settlement, you could end up in a worse financial situation
Pro tip: The FTC offers a good list of red flags to watch out for when choosing a debt settlement company.
READ MORE: Rewards vs. risks of debt settlement
How debt settlement works
A third-party debt settlement company will contact your creditors and offer to “settle” your debts for an amount lower than the total you owe.
During the debt negotiations, you will be asked to stop making monthly payments on your unsecured debts. Instead, that money will go into a savings account earmarked for repaying the eventual settlement offers. This means you’ll likely have to deal with some calls from debt collection agencies in the program’s early days. After your debt payment plans start, the creditors should leave you alone.
Why stop making monthly payments? Most creditors aren’t willing to even consider settlement negotiations until your debt has been charged off. This usually takes between three to six months of missed payments.
Your credit score will initially decrease: When your accounts are charged off, your credit score will decrease, possibly by as much as 100 points. The overall impact will depend on the credit score you start with. However, as each account is settled, the black marks will be removed from your credit history and your score will start to rebound. The recovery will be significantly faster than if you have to file for bankruptcy.
READ MORE: Debt settlement qualifications
Pro tip: You’ll see a lot of information that states that “settled” notations on your credit report will negatively impact your credit score. This isn’t true. The negative impact comes from late payments and charge offs. Once your accounts are actually settled, the “settled” notation doesn’t hurt your credit score at all and will actually cause it to increase
READ MORE: Debt settlement companies
The debt settlement company will then begin negotiating settlement offers with your creditors, one at a time. In exchange, the company will charge a fee that ranges from 15% to 27% of your total enrolled debt.
According to the American Association for Debt Resolution, a debt settlement customer saves about 30% of their total debt after fees.
Note: The American Association for Debt Resolution was previously known as the American Fair Credit Council.
READ MORE: Debt settlement fees
Before any payments are issued, you must agree to the settlement amount. At that time, you’ll also pay the fee for that particular debt (but don’t worry, it will be deducted from the savings account.)
A repayment plan will be set up for settlement payments, or occasionally, they could involve a lump sum payment.
READ MORE: How does debt settlement work? What you need to know
Make an informed decision
- Tally up your debts: Figure out how much you make in monthly minimum payments. Use a debt consolidation calculator to determine how long it would take to pay off a new loan (and how much it would cost.)
- Learn your credit score: If you’re considering debt settlement, check your credit reports and corresponding scores first. You can get free credit reports at annualcreditreport.com and free credit scores from services including Credit Karma and many credit card issuers.
- Schedule a free consultation: Contact a debt settlement company directly and speak with an expert. Find out whether they believe they can help you and discuss the impact the settlement process will have on your credit score.
READ MORE: Debt settlement vs. debt management
More debt relief options
- Talk to a credit counselor
- Consider a peer-to-peer lending app
READ MORE: Debt relief programs
The bottom line
Personal finance requires a solution that’s specific to you. Debt settlement will not be a good idea for everyone, particularly those who have good to excellent credit scores and will qualify for debt consolidation offers or have other options available to them, like home equity loans or 401(k) loans. But if you’re struggling to stay above water, can’t make your monthly payments and are starting to feel desperate, debt settlement can be a good idea if it solves your debt problems or prevents you from having to file for bankruptcy.
Does debt settlement sound like a good fit?
If you think debt settlement is the best option, the next step is to consult a debt settlement company.
Contact DebtHammer directly by clicking here to learn more about debt settlement and whether you are a good fit, then set up a free consultation.
