It’s a fact that debt always comes with an overwhelming burden especially if it’s unmanageable due to financial distress. For people struggling with such a situation, there are multiple debt relief options out there and debt settlement is the most common one. Before you turn to this financial strategy as a potential solution, it’s important to learn what it is, how it works, what are the consequences and whether it’s a good idea or not. Let’s talk on some of the most frequently asked questions by people regarding debt settlement. This will help you make a more informed decision.
Q1. What Is Debt Settlement?
Debt settlement is a debt relief strategy where you put up a request to your creditor to reduce your debt. In return, you have to pay the creditor a lump sum amount (that’s less than the original amount). Once your creditor agrees on the terms, he’ll then waive off a portion of your debt and will mark it as “Settled”. This strategy is mostly used for unsecured debts like personal loans, credit card loans and medical loans.
Q2.What Is The Debt Settlement Process?
There are five steps of a debt settlement process;
- Financial Assessment: Before approaching your creditor, you first have to assess your finances. You can also get it done by a financial counselor. From calculating your total income to assessing your necessary expenses and making a budget for debt settlement, this step includes it all.
- Delinquent Account: Most creditors don’t settle with debtors until the account is past due. Before beginning your negotiation, you should stop making payments to your creditor at least 3 to 4 months before. This will lead to a delinquent account and your creditor will be more inclined towards accepting your offer.
- Negotiation Stage: The debtor offers a 40% to 60% lump sum of the total amount of debt.
- Settlement Agreement: The creditor accepts the offer and forgives the rest of the debt.
- Payment: You pay the creditor as a lump sum amount or in installments (as per the decided agreement).
Q3. What Kind Of Debts Can Be Settled?
Debt settlement is specifically for unsecured debts that don’t have a collateral. For example;
- Personal loans
- Medical loans
- Private student loans
- Credit card debt
- Collection accounts
Creditors do not agree to settle a secured debt as it comes with a collateral and the creditors prefer reclaiming that collateral instead of forgiving a portion of the debt.
Q4.How Does Debt Settlement Affect My Credit Score?
Debt settlement comes with a few downsides and one of them is its negative impact on your credit score. It will lower down your credit score because;
- Before settlement, your account will go into “Default”
- The settled debt will appear on your credit report as “paid less than the full amount”
- All your missed payments and collection statuses will stay on your credit report for 7 years.
Your credit score will also suffer before the settlement when you stop making your payments to the creditor.
Q5. How Long Does Debt Settlement Take?
There’s no one answer to this question because it varies from person to person and situation to situation. On average, a debt settlement can take anywhere between 2 years to 4 years. It mainly depends on how quickly you can save for a lump sum payment and how many creditors you are dealing with.
Q6.What Are The Advantages Of Debt Settlement?
Debt settlement is one of the best ways to get out of debt quickly but only if you really are eligible for it and only if your creditor accepts your offer. Here are some advantages of debt settlement;
- It reduces your debt
- It helps avoid bankruptcy
- You can resolve your debt with your creditor with minimum payments
- You won’t have to deal with any harassment from your creditor’s end anymore
Q7.What Are The Disadvantages Of Debt Settlement?
Just like any other financial strategy, debt settlement comes with its own downsides too. For example;
- It will negatively impact your credit score
- It’ll stay on your credit report for 7 years
- It comes with tax consequences (if the forgiven amount exceeds $600)
- You’ll have to pay a fee (if you opt for a debt settlement service)
- There’s no guarantee whether your creditor will agree on settling your debt.
Q8. Is DIY Debt Settlement Better Or Should You Hire A Settlement Company?
Yes, it is possible to settle your debt yourself and avoid paying any fee to a settlement company. However, it’s not always the best option especially if your creditor is a little tough to deal with. You should hire a proper professional debt settlement company as they have more experience and expertise required to negotiate with your creditor. Moreover, some companies do provide legal protection too. While searching for a debt settlement company, you should do your thorough research. There are some scammers out there in the industry waiting to take advantage of your vulnerability so you should be aware of them.
Q9. Will The Collection Calls Continue After Debt Settlement?
No, after your debt has been settled, the collection agencies can’t call you or harass you anymore. If they do, you can file a complaint against them or take legal action under the FDCPA (Fair Debt Collection Practices Act).
Q10. What’s The Difference Between Debt Settlement And Debt Consolidation?
Debt settlement and debt consolidation, both are debt relief strategies but they are very different from each other. In debt settlement, you negotiate with your creditor to reduce your debt. On the other hand, debt consolidation is all about taking up a new loan to pay off the rest of your loans. This way, you’ll only have to deal with a single creditor and a single interest. In other words, debt consolidation is for those who want to manage multiple debts and combine them into one.
Q11. How To Choose The Right Debt Settlement Company?
Choosing the right debt settlement company can be a little overwhelming especially when there are multiple fraudulent companies waiting to scam vulnerable customers. To ensure that you end up with a reliable company, here are a few things you should consider;
- The company must be accredited by the AFCC (American Fair Credit Council)
- Check their reviews on Better Business Bureau
- They should have a clear fee structure
- They should offer free consultation
- They shouldn’t be using any pressure sales tactics
If a company is using aggressive tactics to force you to sign up or if they are making any “too good to be true” claims then you should avoid them at all costs.
Q12. Are There Any Tax Implications In Debt Settlement?
Yes, there are some tax implications in debt settlement. If your creditor forgives more than $600 of your debt then the IRS considers it as taxable income. You’ll receive the 1099-C form and you’ll have to respond to it accordingly. Most people don’t know about the tax implications when settling their debts and then they end up with a shocking tax bill. It’s important that you talk to a financial or a tax counselor to be prepared for what’s to come after the settlement.
Q13. Can I Be Sued During The Debt Settlement Process?
Yes, creditors and collectors can sue you even if your negotiations are in process. Debt settlement cannot protect you against legal actions until an agreement is signed. In case you get sued, you should immediately consult an attorney.
Q14.Can “Settled” Accounts Be Removed From A Credit Report?
No, you cannot remove “Settled” accounts from your credit report. If your creditor has reported your debt as “settled” or “paid less than full balance” then it’ll stay that way for 7 years from the day of delinquency.
Q15. How Much Lump Sum Is “Reasonable” To Offer?
You should always start low when offering a lump sum to your creditor because there are high chances that your creditor will reject your initial offer. After some negotiation, you can offer your creditor 40% to 60% lump sum payment of the total debt.
Final Takeaway
Before choosing debt settlement, it’s important that you first understand your options and make a more informed decision that can lead you to complete financial freedom. This isn’t the kind of process that you should rush into. In fact, take your time, do your research, assess your financial situation and then move forward with confidence. With consistent efforts and persistence, you’ll achieve your goals within no time. Debt settlement takes months and sometimes years, you just have to be patient.
Looking for a reliable and trustworthy debt settlement service that can help you resolve your debts with your creditors without any complexities? Try Mountains Debt Relief. Our team of professionals have just the right expertise you need to successfully negotiate with your creditors!