Being overwhelmed with debt is one of the worse feelings ever – you’re constantly getting calls from creditors, your heart races when going to the mailbox because of what you might find, getting a good night rest is impossible because your mind contemplates how you’re going to get off the mess you’re in.
Then one day, you see an ad: “Hounded by creditors? More than $15,000 in debt? Call us today to lower your debt and monthly payment! You’d be free of debt within 24 months!”
You think to yourself, “This is too good to be true. I’m down for it. Where can I sign up?” Hang on a minute! Anything too good to be true is probably not as good as you think. The same is true of debt relief. Before you decide to opt for debt settlement, it’s wise to know the pros and cons so you’ll know if it’s right for you.
How Debt Relief Works
Debt relief (also known as debt settlement) is the process where a debt settlement company contacts your creditors on your behalf to negotiate a better payment plan or settle or reduce your debt. If they’re able to agree, they charge a percentage of the amount saved on the settled debt as their fees.
In most scenarios, the debt settlement company will try to negotiate a lump-sum payment that’s less than the amount you owe. During the negotiating phase, the company will suggest you stop making your monthly payments. Instead, the money will be transferred to another account that’s owned by you, but administered by the third-party company. The money is accumulated to save up for the lump-sum. Also, by refusing to pay, it nudges your creditors to agree to negotiation because if you declare bankruptcy, they’ll receive very little or nothing.
If an agreement is reached, you must stick to the new payment plan. Then, the debt settlement company can charge you for its services.
Benefits of Debt Relief
Here are some of the common lures of debt settlement.
At least, theoretically speaking, the goal of debt settlement is to help you substantially reduce the amount of debt you have. This will help ease your financial burden.
Declaring bankruptcy will greatly damage your credit score. Moreover, it will remain in your credit report for 7 or 10 years, making it difficult to secure new loans. Although debt settlement will impact your scores, it’s not as insidious as declaring bankruptcy.
Peace of Mind
Once you get to an agreement, you get the creditors and collectors off your back. This can help you regain your sanity.
Drawbacks of Debt Settlement
Although debt settlement looks good, its cons outweigh its pros. Here are some of the disadvantages of debt settlement.
Your creditors many no agree to a settlement
Creditors are not obliged to either negotiate or come to an agreement with a debt settlement company. You can only hope they do.
More Debt burden
If your creditors refuse to agree, you’ll mostly end up with more debt. Why? Because during the negotiation process, you would have stopped making monthly payments. This means you’ll end up paying late fees or interest. And if you refuse to make payments, you can potentially face a lawsuit from your creditors.
Even if they agree, you may be obliged to pay tax on the debt forgiven. For instance, if the debt settlement company negotiates to reduce your debt to $4,000. The forgiven debt of $6,000 is taxable. So, you’ll end up paying more than you thought.
Negative Impact on Credit Score
You’ll be asked to suspend making monthly payments for the next 6 months or so during the negotiation phase. As you’re ignoring your lenders, they will continue to report late payment updates to the credit bureau and will continue to do so until either an agreement is reached or you pay up. This will, in turn, reduce your credit score.
Debt Settlement Fees
In the past, debt settlement companies could charge for their services even if an agreement was not reached, putting the debtor in even greater debt. The government had to cancel that practice. Now, debt settlement companies cannot collect a fee until they reach an agreement with your creditors, you agree to the payment plan, and you’ve made, at least, one payment.
But what you might not know is that even if only one of your debts has been settled by the company, you can legally be charged a portion of the company’s full fee on the rest of your unsettled debts.
Another thing you may not know if that a debt relief company is allowed to charge up to the same proportion of what they helped you save. For instance, if you owe $10,000 and the were able to reduce your debt by 40% to $6,000, they’re allowed to charge up to 40% of the total agreed-upon fee (in this case, up to $2,400 in fees).
Is Debt Settlement Worth It?
As you can now see, Debt settlement is nowhere as attractive as those ads paint it to be. That’s why they should be used with caution. Here are some tips to bear in mind.
Before making use of a debt settlement company, try negotiating your debts on your own, especially if it is less than $10,000. Offer a lump-sum you can pay (even if it’s less than your debt) or work out a more favorable plan. Realize that most creditors are inclined to be considerate because what they want, at the end of the day, is to receive their money back. By negotiating yourself, you get to preserve your credit score and avoid paying debt settlement fees. But remember, there are no guarantees.
If you owe more than $10,000 a debt settlement company can help you navigate the waters. But make sure you work with a reputable debt settlement company whose priority is helping you get the best agreement and not racking up service fees.
Call us today to find out your options.