Debt Settlement Pros and Cons

What Is Debt Settlement?

Debt settlement refers to the process of negotiating with lenders to settle your debt for less than what you owe. If a lender accepts your settlement offer, you’ll resolve the debt by making a lump sum payment for the negotiated amount. The rest of your balance will be waived or simply forgiven.

A debt settlement may be a viable option when you've maxed out credit cards or are behind on payments by several months.

However, it’s important to weigh the pros and cons of debt settlement carefully. Exploring other debt relief options helps you choose a payoff strategy that makes sense for your financial situation.

Pros of Debt Settlement

Debt settlement is often considered by borrowers who have limited options to pay off what they owe. Here are the benefits worth considering:

1. Pay Off Debts Faster

Debt settlement can reduce the amount you owe, which makes it possible for you to pay off your remaining balance faster. Compared to other options like debt management, payoff is typically quicker. Most settlement programs can be completed within 12 to 48 months.

2. Avoid Bankruptcy

Lenders often agree to settle debt because they still receive a portion of the money you owe. With Chapter 7 bankruptcy, creditors typically receive nothing at all. As a result, they’re often more willing to negotiate a settlement rather than demand the full balance and risk getting zero funds.

Bankruptcy proceedings stay on your credit report for up to ten years, depending on whether you’re filing for Chapter 7 or Chapter 13 bankruptcy. While debt settlement does lower your credit score, bankruptcy has a longer-lasting impact on your finances and credit.

3. Stop Collection Calls

Once you reach an agreement with your lenders, you won’t receive debt collector calls. Collection calls can be a major source of stress for most people, so this is an important benefit if you’re feeling harassed and overwhelmed.

4. Save Money

One of the major benefits of debt settlement is that you’ll be able to save a considerable amount of money. Experienced debt negotiators can often help you save as much as 50% of your debt before fees.

For example, if you owe $10,000 on your credit cards, you may be able to resolve the debt by making a lump sum payment of $5,000.

Cons of Debt Settlement

While there are several advantages of debt settlement, there are also a few disadvantages to note:

1. Lenders May Not Negotiate

You’ll only be able to settle your debt if your lenders agree to it. If your lender refuses to accept your settlement offer, you’ll need to come up with an alternative repayment plan.

Typically, lenders and credit card companies will only accept settlement offers when they feel there is a better-than-average chance they won’t be able to recover any money from you. In many cases, you'll have to prove financial hardship to qualify for debt settlement.

2. Late Fees

When you settle debt, you stop making payments toward your balance. Instead of making continued payments to your lender, you’ll redirect those payments to a separate bank account with a debt relief organization. This account is used to accumulate money for the lump sum payment of your negotiated settlement amount.

Lenders aren’t likely to accept your settlement offer if you’ve only missed one or two payments. However, once you stop making payments, you’ll start accumulating late fees each month you skip a payment.

3. Credit Score Impact

You’ll see an immediate impact on your credit score once you stop making payments on your account. Once you settle the debt, your lender may report it as a “partial payment” to the credit bureaus or mark it as “settled for less than the full amount” or something similar. This can also hurt your credit score.

One option to boost your credit quickly after settlement is to ask the lender to report the debt as “paid in full” as a part of your negotiations.

4. Tax Consequences

Any amount that your lender forgives through a settlement is known as canceled debt and is considered taxable income by the IRS. Depending on your income and tax filing status, you may need to pay federal and possibly state income taxes on this amount.

Factors To Consider Before Choosing Debt Settlement

Will debt settlement work for you? That depends on your unique situation.  Listed below are a few factors to consider before you decide if debt settlement is right for you:

• Amount of Debt — Debt settlement is most effective when you have over $10,000 in unsecured debt from accounts such as credit cards, lines of credit, and medical bills. You may want to consider other options if you owe less.
• Credit Score  —  If your credit score is declining or is already so low that you can’t qualify for other debt-relief options like consolidation, debt settlement may be a better idea. The settlement method doesn't factor in credit score as much as other options.
• Ability To Save  — To settle your account, you’ll need to make a lump sum payment to your lender. You must be able to consistently put aside money each month to save this lump sum.

Alternatives to Debt Settlement

After weighing debt settlement pros and cons, if you think that it’s not a good option for you, you may find that there are other reasonable alternatives available.

• Credit Counseling
  Counselors at nonprofit credit counseling services can review your finances and provide personal finance education. They can also help you create a budget and develop a personalized payment plan to help you pay off your debts.
• Debt Management Plans
  Credit counselors can also enroll you in a debt management plan (DMP) to consolidate what you owe. A DMP can offer benefits like reduced interest rates and waived late fees, making your debt balances more manageable.
• Debt Consolidation
  If you have a good credit score and stable income, consider securing a debt consolidation loan or opening a 0% balance transfer card. Debt repayment may be easier with a single monthly payment.
• Bankruptcy
  Filing for bankruptcy may be a last resort option if you have a significant amount of unsecured debt and very few assets. Consult with a bankruptcy attorney to determine if bankruptcy is right for you.

Is Debt Settlement Right for You?

If you have a lot of personal loans, medical bills, or credit card debt from maxed-out cards, and are finding it difficult to keep up with minimum payments, debt settlement can offer relief. It allows you to settle your debts for less than you owe.

Carefully consider debt settlement pros and cons before you decide to enroll in a program. Here are the next steps to follow if you’re contemplating this option:

1. Ask yourself if you’ll be able to make consistent monthly payments to save for your lump sum settlement.
2. Research debt settlement organizations in your area and verify that the one you choose is accredited and trustworthy. Check records from the Better Business Bureau or the Consumer Financial Protection Bureau (CFPB).
3. Start a consultation with a debt relief company to learn about all your options and determine whether debt settlement makes sense for you.

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It only takes a few minutes to find out if you qualify for one of our customized plans. Contact the experts at TurboDebt today for a free consultation!