Everything You Need to Know About Debt Settlement

Estimated read time: 18 minutes

Getting stuck in debt can feel like being trapped, putting a strain on your life and making it hard for you to move forward financially

The real issue is that when people end up in debt, they don't know there are options open to them, like debt settlement, debt consolidation, and debt management.

Unfortunately, the problem doesn't seem to be going in the right direction either.

Some debt, like credit card debt, has been steadily rising for the past few years, reports the Federal Reserve, and it doesn't seem to be slowing down.

In fact, 8 out of 10 Americans are in debt in one form or another, according to the public service organization, Pew Charitable Trusts.

It almost seems like everywhere you turn, someone has the weight of money owed on their shoulders.

These are problems that won't melt away with time.

If you want out of debt, now is the time to act.

Debt regrets statistics (2018)

The decisions you make now, even the small ones—like say, learning how to invest smartly—can grow into a stable and debt-free financial future.

Aside from paying off the debts directly, most people don't realize there are other options available to help manage your debt, options that might make it easier and cheaper payoff.

For instance, consolidating or settling your debt can help you lower the initial amount or interest you owe or interest on that amount down, making payment or worker compensation easier and getting out of debt quicker.

Now is the time to move towards settling some of your debt.

You need to get that amount owed down, and we're going to help by telling you everything you need to know about debt settlement.

What Is Debt Settlement?

When you're in debt, you have a lot of options available when it comes to paying back that money owed—but with more options come more confusion about what is what.

Debt settlement, at its simplest, is when a debtor (person who owes money) negotiates a reduced balance with a creditor (person who lent the money).

While on the surface that sounds like an option any debtor should take whenever possible, it's important to know there's more to debt settlement than meets the eye.

A debtor's credit score will take a hit when settling, and settlements are often done through a third party.

From the start, you should know that the first real step to fixing debt is identifying the habits or problems that landed you in debt in the first place.

Better financial habits take time to learn and practice, but they can keep you out of debt once you're in the black.

Techniques like saving money when you can, spending it wisely, and budgeting month-to-month are some of the best ways to reduce debt and increase your income.

But for those who are in a bind, debt settlement may provide some much-needed assistance.

Debt settlement allows you to pay a smaller lump sum than the initial balance you owed

If the debt owed is too great and you want to negotiate a smaller price and pay it back rather than declare bankruptcy, then you would likely need a debt settlement.

Debt settlement helps bring down or erase balances. Rather than paying off a massive amount of debt over the many years, debt settlement allows you to negotiate a more manageable sum to be paid off in less time.

If you owe $20,000 on an item, careful debt settlement through a reputable settlement firm might be able to cut the amount owed in half, but that will come with repercussions.

Debt settlement often comes with fees and mark on one's credit score. If debt settlement was without repercussions, why would anyone pay back the money they owed?

Therefore, if you choose settlement, you should know there are some drawbacks.

Since debt settlement is often done through a company, and because you are essentially failing to pay back money owed, you can expect the company or collection agency to collect fees and your credit report to reflect your behavior.

Debt settlement takes roughly 36 months. Debt settlement, when done through a firm, will take 2-3 years.

That can translate to money owed in late fees, and a larger window of time for a debtor to drop out of a debt settlement program.

It's important to keep the time frame in mind, as there is no one-step solution to debt settlement. That said, of all of the options, debt settlement tends to be one of the quickest.

Reaching debt goals research 2018

Debt settlement is often done through a company making a case on your behalf

Technically, debt settlements can be done in different ways since all it is is an agreement on a lower amount owed to creditors.

That means you can actually handle the entire affair yourself—however, the majority of settlements are done through firms specializing in debt settlement.

Debt settlement companies reduce your debt by negotiating with creditors. Over the course of a few years, the company gets your creditors to agree to a lump sum payment that is less than the total amount you owe.

Negotiations are largely based on your finances and credit history.

The debt settlement company may urge you to stop paying all debts. Creditors are far less likely to accept a settlement if you have been on time with payments up to that point.

For a settlement to succeed, creditors need to be convinced you are truly incapable of making payments in full.

Since creditors (like credit card companies) have access to your credit reports, debt settlement companies may also suggest you not pay debts on other accounts as well, so it is clear to all parties that you are in financial hardship.

Once your accounts are in default due to delinquency, the creditors should agree to receive a lump sum.

You make payments to the company and the company to the creditors. Most debt settlement firms will have you take the money you would be putting towards debt repayment and instead place it in an account with them.

After the account has grown enough, the settlement firm will use it to pay the creditors.

This is what's called an ‘escrow account', meaning a middleman account that receives the money and then delivers it.

If you're delinquent on multiple accounts, debt settlement may be a good option

Before applying for a debt settlement program, make sure you are fully aware of the risks and if such an option is viable for you.

That's not to say that it isn't, but as a consumer, you can never be too careful.

If you have already defaulted on accounts, debt settlement may be a good option. In fact, those who have already defaulted on their accounts are probably the ideal candidates for debt settlement, as you have dealt with the potential risks already.

If you have already defaulted, your credit report will show as much, which means settling will do less damage to your credit score.

Likewise, there is no need to convince lenders that you are in financial hardship—you probably really are!

That doesn't mean settling is completely risk-free, but there shouldn't be anything too new or out of left field if you choose to go this route.

Before deciding to go with debt settlement, consider your other options. Debt settlement is not the only option when it comes to managing the money you owe.

Doing your research like you are now is the perfect way to set yourself up for making better decisions later on.

Also, debt settlement is not a get-out-of-debt-free card.

Unless you're settling on your own, money will still be owed to someone, in this case, the firm you use.

If even owing a smaller amount of your current balance sounds impractical to you, you may want to consider declaring bankruptcy.

The Pros and Cons of Debt Settlement

Debt settlement can be advantageous when it comes to managing your debt, but it comes with some serious drawbacks as well that need to be carefully considered.

Debt settlement can keep you from filing for bankruptcy and reduce your debt—simultaneously

If there was no situation in which debt settlement helped out debtors, then people would never go this option when trying to get out of debt.

Naturally, there are pros to consider that might make it worth your time and effort to pursue a settlement.

You can breathe easier once your debt is gone or reduced. This one goes without saying, but the point of debt settlement is to get out of debt, and if done carefully and correctly, it may help you do just that.

Being freed from debt will also have positive effects on the rest of your finances, as well as your emotional and mental wellbeing.

Not having such a heavy burden on your shoulders can be a very positive change in a person's life.

Households struggling with finances by income

The main pro of debt settlement is that it can be used to free up your finances and future life.

You don't have to file for bankruptcy. It's true, your credit score will take a hit if you choose to settle, but it's not nearly as bad as filing for bankruptcy.

The hurdles you will have to overcome after experiencing a bankruptcy are much larger than when you seek to settle your debts.

Debt settlement can hurt your credit score, comes with fees, and puts you at risk of being scammed

Getting out of debt isn't easy, and if you're going to choose to settle your debt, you should be equally prepared for the risks associated with it.

Not paying your creditors is risky and can affect your credit score. While you wait for your debt to be negotiated, your debt settlement company will likely ask you to stop paying your creditors and make payments to an escrow account held by the company.

Since you may have to actively default on your account(s), that will naturally leave a stain on your credit report for up to seven years.

The long-term implications of this are that it may keep you from achieving other financial goals in the future, like securing a home or auto loan.

Not only will it potentially affect your credit score, but there's also no guarantee that your debt settlement company will successfully renegotiate your debts.

Your creditors are not obligated to agree to a settlement.

If they do not agree, this could land you in a worse place than you were before.

You might not pay as little as you were expecting. Debt settlement companies are not going to work for free, so be prepared to pay the fees associated with their services.

If the fees from the company are greater than what you are saving by negotiating your debts, you may be better off not settling.

In addition to the fees the company charges, fees associated with defaulting on an account, namely late fees and interest, will continue to grow.

Even if you settle with your creditors for a large sum, the interest and fees may make it negligible.

For example, if your APR is 25%, as it is on most credit cards, then you're losing about $42 in monthly payments just on interest.

The longer you go delinquent on payments, the higher that interest owed.

On top of this, expect to pay around $30 in late fees. And that's not even mentioning the debt settlement firm's fees.

Make sure the debt settlement company you are using is official. Don't use a company until you have made sure they are legitimate and have all their necessary qualifications.

You don't want to risk hurting your credit score only to get swindled in the end!

Especially since the recession of 2008, many debt settlement companies seeking to take advantage of those experiencing financial hardship began popping up.

This has made the world of debt settlement a little trickier, so make sure you are on your guard.

The amount forgiven may be considered income on your taxes. It's important to keep in mind that any money forgiven might be seen as taxable income.

So long as the forgiven amount is more than $600, your creditor will provide you with the appropriate tax form.

It may not work and lenders may refuse to settle. When you seek a settlement, the ball is in the lender's court.

Your creditors may not wish to grant you a lower amount owed for any reason.

Unfortunately, that means you are taking a bit of a gamble here.

That said, reputable settlement firms with a long history of working with certain creditors have a better chance of achieving that sweet settlement you're looking for.

It all depends on the situation.

Creditors may sue you. While not incredibly common, it is also not unheard of that creditors sue consumers for attempting to settle their debts.

If you are set on debt settlement, talk to your settlement company about the realities of the possibility of a lawsuit coming your way.

Debt Settlement Companies

While you can go it alone, when it comes to debt settlement, most people choose to rely on a settlement firm to handle any negotiating in their place.

How to compare and consider the different companies out there

If you're going to go the debt settlement route, you should be as educated as possible before you begin your search.

While the goal of each company is the same, reputation, services, and expectations may vary greatly.

The company should be a member of the American Fair Credit Council (AFCC). If it's not, proceed with extreme caution.

By being a member of the AFCC, you know that the debt settlement firm complies with the strictest of standards.

These standards are in place for both the company AND consumer's sake.

In addition to these, you can inquire to see if it's accredited by the International Association of Professional Debt Arbiters (IAPDA), as well as the Better Business Bureau (BBB).

The more accreditation a firm has, the more standards it has strived to meet.

Older firms have security, stability, and reputation. If a firm has significant age behind it, not only can you trust it must be doing something right, but it has probably made fruitful relationships with plenty of creditors.

Not only does that mean you can probably trust them, but you can expect a better chance of settlement due to those relationships.

That's not to say a younger company is not to be trusted, but just make sure you are careful before you hand over any money.

Top Financial Frauds in the USA

In addition to securing better settlements, older firms tend to work more quickly, once again due to the laurels of past relationships with creditors.

Make sure fees are low and the settlement time is quick. You should always inquire about any fees when choosing a service to go with.

After all, if the fees are higher than the money saved, you're actually spending more, rather than less!

A company with low fees and a clear description of them is worth your time.

Likewise, a company with high and complicated fees is a red flag.

Also, make sure to ask when the fees are applied; be wary of any companies trying to apply fees before any settlement is reached.

The last thing you want to do is buy a service you never get.

Avoiding companies that take more than four years to reach a settlement is also a smart move—the average wait time for settlements is 2–4 years.

Anything more is not only excessive but may cause you to drop out prematurely.

Some debt settlement companies may not work with your situation. Most settlement firms deal with debt of $10,000 or more, and the majority of that debt tends to be credit card debt.

If your situation doesn't quite fit the mold, look for a company that will be more flexible to meet your needs.

Good customer service should be expected. If the debt settlement company you've chosen doesn't respond to emails or phone calls, can you really trust them with your finances?

You already have enough weight on your shoulders.

The company you've chosen should make those shoulders feel lighter, not heavier.

If you struggle to get answers to questions or feel like the people you're working with are rude or stubborn, it's probably not worth your time.

Even in financial hardship, courtesy is still just a minimum.

Debt settlement companies are not all created equal, so here are our top picks

Truth be told, there are a lot of options out there, and with the list above telling you what to keep an eye out for, you should make sure to check all your options before deciding.

But just to point you in the right direction, here are our three top picks for debt settlement companies.

New Era Debt Solutions:The oldest of our top picks, this company was first established in 1999. On top of that, it is accredited by both the BBB and IAPDA.

It maintains a high level of transparency on its website and offers low fees (15%) and fast turnaround (27 months).

It also gets reduced an average of 44% of the original balance.

The only downside is that the service is offered in a few states (17).

Also, the size of your debt should never be an issue, since New Era Debt Solutions has no minimum amount owed required to apply.

That's great news for those with under $10,000 dollars in debt!

Freedom Debt Relief: Another excellent debt settlement option that was first established in 2002.

It offers great customer service but unfortunately lacks any dedicated customer representatives programs.

Usually, plans last 24-48 months with a standard 20% in fees and a rather high 45% negotiated deduction.

On top of this, it tends to be very transparent with its customers about the risks involved.

It requires a minimum of $7,500 of debt to enroll and is available in 33 states across the US.

National Debt Relief:A consistent favorite amongst finance experts due to its A+ BBB rating (a rare site amongst debt settlement firms), this company's is accredited by both the AFCC and the IAPDA.

On top of this, it operates in 41 states!

The fees associated with its services are around 20% and savings after those fees are going to be around 30%, which is a handsome amount.

It's rather open about the type of debt it can help settle but will require you be $7,500 in debt to enroll.

The only downside to all this is that the company is a bit younger, having been established in 2009.

If age is an important factor to you, you may want to investigate a bit more here before deciding.

Tackling debt settlement on your own is an option, but it's daunting and risky. Unless you have familiarity with finances and owe an amount below $10,000, going at it alone is probably not the best course of action.

On top of that, debt settlement companies often have built-up relationships with creditors that they can rely on when negotiating a settlement, which helps get a higher deduction from the original amount owed.

The only advantage of negotiating a settlement on your own is that no fees will have to be paid.

While this is a nice perk, it may not turn out the way you hoped anyway.

Debt Consolidation Loans and Other Options

Debt settlement is one of many different options to those in debt, and before choosing to settle your debt, there may be better options available to you.

Debt settlement is not the only option

Not only is debt settlement one of many options, it's possible another option might suit your situation even better.

Aside from debt settlement, debtors can choose to consolidate the debt into a single loan, or go through a debt management program.

Debt consolidation turns all of your separate debts into one easy-to-pay loan. Often those who end up in debt usually have debt on more than one account.

The practices and financial habits that had us spending money we couldn't pay back weren't exclusive to just one line of credit from a credit card company.

The advantage of turning all of your separate debts—say, a credit card, an unsecured loan, and a student loan—into one single loan is that not only is it easier to keep track of, but the interest may be lower, saving you money!

Debt Owed for Education by Type

To ensure you are getting a better deal by consolidating your debts, you will need to do some quick math to check the interest paid.

Using an online debt consolidation loan calculator, you can compare the interest on money owed in a few easy clicks.

Debt management or credit counseling may make debt more manageable. Debt management plans are usually confused with debt settlement plans, both of which aim to help you pay off your debt quicker.

It doesn't help that the names both sound similar.

The main difference is that debt management aims more at counseling you into freedom from debt.

Debt management services work on your behalf to lower monthly payments and interest rates, as well as reduce or remove any fees and penalties.

There is no loan offered here and the initial debt must still be paid in full.

What you'll do is deposit money into an account with the company you choose and have them assist you in paying back what you owe through a plan that works for you.

Not only does debt management leave your credit score unscathed, but it will provide counseling services to ensure you are making good choices in budgeting and using credit.

Debt management is often accompanied by few to no fees, with many services being non-profit.

Even if your debt has left you very short on cash, non-profit debt management will always remain an affordable option.

If debt settlement seemed a bit extreme, it's possible debt management is the right service for you.

The important thing is to make sure that whatever firm or company is helping manage your debt is an accredited institution. Before pursuing this option, make sure you do adequate research.

If you can budget wisely, you may be able to manage your debt on your own. While it's not the cleverest solution, it is the most practical and affordable step to take to become debt free.

In fact, even if you declare bankruptcy, this should still be something you take into consideration.

Your finances are yours, and while it's important to receive help where you can, good financial habits will lead to good financial health.

In terms of the debt you already have, it's important to face it head on and see the situation for what it is rather than let the debt intimidate you

Often times those under the pressure of debt may feel intimidated by collection agencies and debt collectors, which will frequently harass debtors with phone calls and letters.

While it might be difficult, you should take these phone calls as an opportunity to get in touch with your creditors.

Actually communicating with collection agencies may allow you to work out a payment or worker compensation plan without a middleman, and that means no fees or time wasted.

In fact, creditors will probably appreciate talking to someone that truly wants to pay off their debts.

Filing for bankruptcy is still an option. Just like debt settlement, filing for bankruptcy is not free.

This option can help you if you are deep in debt, but it cannot make your debt disappear without consequence or payment.

States with Highest Bankruptcy Filing Rates 2017

Make sure to compare the costs of all your options before making a decision.

The two main types of bankruptcy are Chapter 7 and Chapter 13. Chapter 7 bankruptcy clears your debts completely, but you'll have to meet a specific income requirement to qualify.

You also may have to forgo some of your assets during the bankruptcy process.

Chapter 13 bankruptcy is also an option if you don't qualify for Chapter 7. Unfortunately, it takes longer than Chapter 7 and you will have to repay some of your debts. though you will be able to keep all of your assets.

If you have recently lost your job, fallen very ill, or do not have any way of repaying your debts anytime soon, bankruptcy may be a better route than debt settlement, but only as a true last resort.

Bankruptcy will be on your credit history longer than debt settlement will, and that may have larger consequences on your financial ambitions in the future, but it may be the right option for you if nothing else works.

Debt settlement is one of a number of options to consider if you're deep in the red with your finances

If you're stuck in debt, it often feels like there's no good way out—but there are options.

Debt settlement is risky, but it can provide you just the chance you need to pay off the money you owe and move on with your life.

Debt settlement will allow you to negotiate a decrease in the original amount owed, usually through a company, so that you as the debtor can owe less money.

That said, there are consequences and risks associated with such settlements that need to be taken seriously.

If you do decide debt settlement is for you, choosing the right firm to act on your behalf is crucial, as there are many scams and shady companies looking to take advantage of your economic hardship.

Accredited companies with low fees and high transparency are ideal here.

Hopefully by this point, you know everything you need to know about debt settlement, or at least most of it!

Is there anything we forgot to mention?

Are there some options for people stuck in debt that we missed, or maybe some things about debt settlement we forgot to mention?

Let us know in the comments below!

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