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When you are struggling with overdue debts, you may be wondering if debt settlement is the right way to take care of it. This can be a viable option depending on which approach you take: relying on an outside debt settlement company or settling the debt yourself.
Experts warn that using a debt settlement firm can be an expensive and risky alternative. In the meantime, a DIY settlement plan can work, but it can be difficult to carry out.
Read on to learn more about working with a debt settlement company.
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The basics of debt settlement
Debt settlement, also known as debt negotiation, involves paying off debt by paying a portion of it in a lump sum. This amount is usually much less than the amount originally owed.
For the borrower, the debt settlement can mean financial relief and put him on the way to rebuilding his credit. For the creditor, settling the debt allows him to receive at least some of the money that is owed to him rather than having no money at all. In addition, it can mean that the borrower can avoid filing for bankruptcy. Even if, according to some experts, filing for bankruptcy may be the better alternative in some cases.
Usually the debt settlement is money you owe credit card issuers rather than other types of debt. But you can also pay off other unsecured debts.
This is how the debt settlement works
Debt settlement, which is handled by a debt settlement company, is different from a DIY approach. This is the process of hiring a debt settlement company.
1. Research debt settlement companies. A number of legitimate debt settlement companies operate in the United States. Most states require a license. Debt settlement firms are supposed to adhere to industry regulations designed to protect consumers and their money.
2. Be careful. If a debt settlement company promises certain results, proceed with caution. For example, you cannot guarantee that a creditor will agree to a settlement in the first place. As part of your research, check the websites of your Better Business Bureau, your prosecutor’s office, and consumer protection agencies such as the Federal Office of Consumer Protection (CFPB).
3. Ask about the cost. Once you have your focus on a debt settlement company, do some research to find out how much they charge for debt settlement. If the company bypasses your questions about the cost, it could indicate that it is a seedy operation. Debt settlement companies typically charge a 15 to 25% fee to address your debt; This could be a percentage of the original amount of your debt or a percentage of the amount you were willing to pay. Let’s say you owe $ 10,000 and you settle with 50%, or $ 5,000. In addition to the $ 5,000, you may have to pay an additional $ 750 to $ 1,250 in fees to the debt settlement firm.
4. Check your finances. Debt settlement companies often require you to deposit funds into a special savings account for 24 months or more before the debt is paid in full. These payments are used to settle your debts in a lump sum. In some cases, these payments can be difficult to keep up with. Therefore, you can abandon the settlement agreement before all or part of your debt is paid off. To avoid this scenario, go over your budget to see if you can afford the debt payments for 24 months or more.
5. Inquire about the schedule. It often takes two to four years for the debt settlement process to complete. During this time, interest and creditor fees may be incurred in addition to the debt settlement company’s fees. Why might a creditor charge you with interest and fees? This is because debt settlement firms often suggest that you stop paying your creditor while working with a settlement company and move that money to a special savings account instead. Note that once you’ve stopped making payments to your creditor, collection agencies may contact you or even have you sued.
6. Select a debt settlement company. When you are fully aware of the potential pitfalls and are ready to move on with debt settlement, it is time to choose a debt settlement company based on your research.
7. Nail the details in place. Before doing business with a debt settlement company, make sure that you are clear about the schedule and fees. Also, ask how much of your initial payments will go towards company fees and how much money you will pay over time.
8. Know the tax consequences. The IRS considers all canceled debts as taxable income if they exceed $ 600. So if you settle a $ 10,000 debt for $ 5,000, the $ 5,000 that was forgiven would likely be taxed.
The Risks of Debt Settlement
Debt settlement can be good or bad depending on your situation. Here are some potential risks associated with debt settlement.
The hard truth is that the obligee can refuse the settlement offer. Therefore, you and the debt settlement company may need to make a counteroffer. You may also be forced to contact the original creditor to see if you can work out a payment plan. In the worst case scenario, you might owe more than you originally owed and a rejected settlement offer could drive you into bankruptcy.
Fees paid to a debt settlement company, or fees and interest charged by an original creditor, can add hundreds or even thousands of dollars to your debt.
Negative impact on creditworthiness
Since creditors are only motivated to pay off a debt if they believe this is the only way to pay it, your accounts may already be overdue or become overdue by the time you make payments to the debt settlement company. Settling debt causes your credit score to drop – perhaps by more than 100 points – and the damage can last for a while: a debt settlement will stay on your credit report for at least seven years.
Alternatives to debt settlement
When you find yourself feeling burdened with debt, you have several options that are less risky than debt settlement – whether it be working with a debt settlement company or conducting DIY debt settlement negotiations. Here are four alternatives to paying off debts.
You may be able to reallocate your debt by transferring the balance to a credit card with an APR of 0% for an introductory period, perhaps up to 18 months. If you pay the balance before the 0% deadline, you can avoid the interest on the debt.
Debt Consolidation Loan
A debt consolidation loan can allow you to combine multiple debts into one manageable monthly payment at an interest rate lower than what you are paying now.
Loan advice for non-profit organizations
Visiting a consultant at a non-profit organization Credit counseling center can help you get back on your financial feet. A credit counselor can, among other things, help you draw up a budget, make recommendations on debt consolidation, advise you on closing at least part of your credit card accounts, or advise you on bankruptcy issues.
Debt management program
One of the tools available to a nonprofit credit advisor is a debt management plan or debt management program (DMP). If you are enrolled in a DMP, the advisor will consult with your creditors to create a debt settlement plan that will combine your debts into one monthly payment – a payment that may be less than the sum of all the payments you are making now.
Next steps if you are ready to move on with debt settlement
If you are looking to move forward with debt settlement, you should consider the implications for your creditworthiness. For example, how low could your credit score be and how long will the debt settlement stay on your credit report? And how much will the debt settlement company charge to negotiate with your creditors?
Corporate debt settlement involves significant risks. Therefore, it is important to weigh the potential alternatives, such as debt consolidation or nonprofit credit counseling, before entering into any relationship with a debt settlement firm.
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frequently asked Questions
What percentage of a debt is usually accepted in a settlement?
In general, you can expect a creditor to agree to a repayment of about 50% of the total debt. In paying off your debt, the creditor agrees that it is better to receive a partial payment than to risk not receiving payment.
How does debt settlement affect your credit score?
The debt settlement can cause your credit score to drop by more than 100 points and it will stay on your credit report for seven years. If your creditors close accounts as part of the settlement process, it can increase your credit utilization, which also has a negative impact on your creditworthiness.
Can You Negotiate Debt Settlement Yourself?
Yes, you can negotiate the debt settlement yourself, although it may take some time and patience to achieve this. You need to have the cash on hand to make all the required payments. And remember, there is no obligation on your creditors to accept any debt settlement.