Debt settlement is a means for resolving debt obligations through partial payment to a creditor. A creditor may be willing to accept a portion of the debt to satisfy the obligation. Sometimes the costs of pursuing a judgment are so high that the creditor would rather accept a reduced payoff in order to clear the account.
When to Settle
The first step to settling debt is understanding when it is your best option. All of your credit card and unsecured loan accounts must be in collections. If any of your unsecured debt accounts are still with the original creditor, then you should consider alternatives to debt settlement instead. If your accounts are about to be charged off, find out how to send a minimum amount in order to delay charge-off for another 30 days. You will likely have more attractive options when your accounts have not yet been turned over to an outside collection agency or attorney.
If all of your unsecured debt is assigned to collections, then you might want to consider settling. However, if an account is so old that the statute of limitations has expired on the account, then settling could actually do more harm to you. Each state has its own legal statute of limitations on written contracts, and some differentiate revolving debt accounts from other types of contracts. To be sure, you should consult qualified and licensed legal counsel to determine whether you are still liable for an old debt.
How Debt Settlement Companies Work
Debt settlement companies tout their services as ways to eliminate your debt typically in less than 3 years, and for a fraction of what you owe. They usually look for debtors owing $10,000 or more. This is how a typical debt settlement company operates. This example assumes debt of $20,000:
- When you have enough debt to qualify, you sign a contract to pay a monthly payment to the debt settlement company. They would quote you an amount that might pay half the debt over 36 months.They come up with $278 plus a $35 fee for a total monthly payment of $313. Usually your first monthly payment is a fee. COST TO YOU: $313
- Each subsequent payment of $313 would be made toward your trust account with the settlement company, and they would deduct a fee of $35 each month. COST TO YOU: $1,260
- You make monthly payments until one of your creditors agrees to settle. Assuming all settle for 50% of the balance, you would pay at least $10,000. For this example, we will ignore the additional fees and interest that would still be accruing on your debt balances. COST TO YOU: $10,000+
- Most debt settlement contracts include a final fee of 25% of the “savings.” COST TO YOU: $2,500
- You will receive Form 1099-C from any collector where the debt is settled for an amount of at least $600 below the balance. Unless you can prove insolvency, you must pay taxes on this forgiven debt. You should consult with a qualified tax advisor to understand how this might affect you. Since the most common federal tax bracket is 25%, we will use that for this example. State taxes could be additional. COST TO YOU: $2,500+
For this example, you would end up paying a whopping $16,573, plus additional interest charges and fees. Keep in mind that using a debt settlement company means that nothing is being paid on your debt until settlement occurs, which means that normal collection attempts by debt collectors may continue. This can include harassment (even though it is illegal), judgments and possibly garnishments from your paycheck.
In addition, your credit is substantially damaged. It reflects the late payments, collection accounts, any public records (like judgments) and settlements for less than the full amount.
If you are comfortable with these costs and just want to find a reputable debt settlement company to work with, then look for one that is in good standing. If you would rather avoid some of these unnecessary costs, then you might try settling debt on your own.
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