Dealing with debt can take a toll on your mental health and it gets even worse when your financial situation isn’t up to the mark. There are people struggling with their day to day expenses and for them, managing debt gets really difficult. In such a stressful situation, choosing between debt settlement and minimum payments is like choosing the lesser of two evils. Both come with their own downsides but for your financial health, you still have to make a decision and that’s what we will help you with today.
Let’s break down both methods, how they work, what’s their financial impact and which option is better for you in the long run;
Understanding Debt Settlement And How It Works
In debt settlement, you negotiate with your creditor to reduce your debt and in return you have to pay a lump sum amount (less than what you originally owe). The creditor then forgives the rest of your outstanding balance and marks your debt as “Settled”. People often use debt settlement services for the negotiation but you can do it yourself too.
Key features of debt settlement include;
- You have to stop making payments to your creditor temporarily
- Debt settlement will negatively impact your credit score
- You’ll have to pay a fee to the debt settlement company
- You’ll settle for 40% to 60% of your original debt
Understanding Minimum Payments And How It Works
Making minimum payments means that you’ll have to pay the smallest amount required every month on your credit card or other loans. The percentage lies between 2% to 4%. This method will help you keep your account in a good standing but in the long run, it’ll lead to accumulation of interest and it’ll do little to reduce your principal balance.
Key features of minimum payments include;
- It can help you make a positive payment history which will then reflect on your credit score
- Your credit score will remain intact
- It’ll take you longer to pay off your debt entirely
- You’ll have to deal with higher interest in the long run.
When Debt Settlement Is The Better Option
As said earlier, choosing between debt settlement vs minimum payments is like deciding to choose the lesser of two evils. There’s no one-size-fits-all answer to this question because the right choice depends on your financial circumstances and the kind of risks you can afford to take.
Debt settlement can be the right option for you when;
- You are falling behind on your payments
- You have a valid financial hardship that’s making it difficult for you to manage your monthly repayments
- The only other option you have is bankruptcy
- You can save up for the lump sum payment
- You understand the tax and other legal consequence of debt settlement
- You can afford a drop in your credit score
When Minimum Payments Are More Appropriate
Debt settlement comes with serious consequences like your creditor can sue you for the missed payments. Your credit score will suffer a lot and you might even have to pay taxes on the forgiven amount. On the other hand, in case of minimum payments you don’t have to worry much about the credit score impact or any legal consequences.
Minimum payments is the better option for you when;
- You just need to buy time
- You have a steady source of income
- You don’t want to hurt your credit score and it’s a priority for you
- You are thinking about debt consolidation soon
- You can easily afford to pay more than the minimum amount to reduce your interest.
Long Term Costs
In case of minimum payments, you’ll be spending at least 2 to 3 times more money due to the accumulation of interest over the years. On the other hand, debt settlement can help you save at least 30% to 60% on your total debt. However, you’ll have to pay taxes if your creditor forgives more than $600 and sometimes it can also incur fees from settlement companies.
If you want to save money in debt settlement, it’s important that you first evaluate your finances, make a budget and a proper plan. Also, make sure that you know about the tax implications and how much you would owe to the IRS if the forgiven amount exceeds $600. When you have all the calculations in mind and when you understand and accept the consequences, debt settlement will become a lot easier for you.
Which Option Will Save You More Money?
At the end of the day, for someone drowning in debt, saving money is the main goal. Among debt settlement and minimum payments, the former will save you more money and it’s cheaper than the latter.
Debt settlement will save you more money if you are already behind your payments. You can get your debt reduced and if you avoid using a third party service, you can save some more money. However, it comes with credit score drop, tax implications and possible chances of a lawsuit.
If you want to avoid any legal proceedings and don’t want to see your credit score drop then of course making minimum payments is the better option. You’ll see slow progress in this case but at least it’ll save you from tax implications and legal stress.
Best Alternatives To Consider
If you still aren’t sure between debt settlement and minimum payments then here are some of the best alternatives to consider;
Debt Management Plans
If you don’t want to hurt your credit then opting for a debt management plan is the best solution. A non profit credit counseling agency will help by consolidating your debt and reducing your interest.
Debt Consolidation
Debt consolidation is more of a debt management technique where you combine all your debts into one. You take up a new consolidation loan to pay off the rest of your loans and then you’ll only have to deal with a single interest rate and a single monthly payment.
Bankruptcy
Not the best alternative but when nothing else seems to work then declaring bankruptcy is the best solution. It comes with a long lasting credit damage but it’s a great step if you want to take a fresh start.
Final Thoughts
In the shorter term debt settlement will help you save more money but again, it comes at a cost. You’ll have to deal with credit damage, tax implications and on top of that, there’s absolutely no guarantee whether your creditor will accept your settlement offer. Even if you involve a third party, a debt settlement company, you still can’t be sure if the deal will go through. On the other hand, minimum payments will protect you from credit damage but it’s the most expensive and the longest route of debt repayment.
The truth is that debt settlement takes the lead here because even if it’s risky, it offers quicker results and you save more. All you need is a clear and careful plan to ensure that you walk through this process without any hassle. Moreover, you should be mentally prepared whether you choose debt settlement or minimum payments, in both cases, you’ll have to wait for months and sometimes for years to see the final results. Using these financial strategies to pay off your debt isn’t magic and you don’t become debt free overnight. It takes time, effort and consistency to become financially independent.
FAQs
Q1. Will Making Minimum Payments Hurt My Credit?
No, it’s not necessary. In fact, when you choose minimum payments, your credit score will stay stable especially if you manage to make your monthly payments on time. The only problem is that high balances exceeding your credit limit can have a negative impact on your credit score. To ensure that no such damage happens, you should properly plan your payments and if possible, seek help from a financial counselor.
Q2. Can I Get Sued During Debt Settlement?
Yes, you can get sued during debt settlement. It’s one of the downsides of this strategy that your creditor can file a lawsuit against you any moment. It’s a huge risk especially when you have large balances to pay or if you are dealing with an aggressive collector. If you are using a debt settlement company’s services, make sure that they provide protection against such lawsuits.
Q3. How Long Will Debt Settlement Take?
Debt settlement can take anywhere between 1 to 3 years. It all depends on your creditor, the lump sum you’ve saved up and the total amount of debt you owe. If you have already saved up a reasonable lump sum payment then this process won’t take much long and if your creditor is cooperative, you’ll be able to settle your debt within months.
Struggling with debt and don’t know how to resolve it? Try Mountains Debt Relief services and take your first step towards complete financial freedom. Contact Now!