You may have read about debt settlement as an alternative to bankruptcy or a solution to your debt. The debt settlement ads usually read something like this:
“Get out of debt in less than six months!”
“Reduce your debt up to 65%!”
Debt settlement promises to reduce your debt by negotiating with your creditors, but the effect on your credit isn’t explained so clearly. If you’re considering debt settlement as a solution to your debt problems, then you need to get the full story first.
How Debt Settlement Works
What you do
You call a debt settlement company and tell about your situation. You need to give them the names of the creditors and the amount you owe. The debt settlement company will then give you an estimate for reducing your debt along with a new, reduced monthly payment. As advised by the settlement company, you stop paying your creditors directly and instead send your payments to the debt settler.
What the debt settlement company does
The first one to four payments you send go straight into the settlement company’s pocket. It’s their fee for providing settlement services to you. The remaining payments are put accrued in an account. Once your account has grown to a certain amount, the debt settlement company will call your creditors to begin negotiating a settlement with them.
What’s So Bad About The Debt Settlement?
On the surface, debt settlement doesn’t sound so bad. You pay the debt settlement company who, in turn, pays your creditors. In the end, everyone gets paid and you’re able to move on with your life. Do you remember the part about not paying your creditors while settlement of your debt is being negotiated? That’s the part that will come back to haunt you.
According to Jim Young of Accelerated Debt Consolidation, creditors can only settle your account after it’s been charged-off. That means you have to go at least six months without paying your credit accounts. In the meantime, the late-payments and subsequent charge-offs are reported to the credit bureaus and your credit suffers.
Jim also says that any forgiven amount over $600 will be reported as income and taxed by the government.
Delinquent accounts can be reported for seven years from the date you were first delinquent. Making a settlement on your account restarts the clock, lengthening the time the accounts will be reported to the credit bureaus and included in your credit score.
If the debt settlement company successfully settles with your creditors, the delinquent information isn’t erased from your credit report. Instead, your account is updated as “Charged-Off Settled” Or “Paid-Settled”, neither of which is as good as a “Paid in Full” account.
After debt settlement, it may take several months or even years to be approved for unsecured credit.
Debt Settlement Alternatives
If you are up-to-date on your accounts, even if you are only a few months behind. And if you want to maintain a good credit score rating, then debt settlement may just not be the best option for you.
Consider consumer credit counseling which will allow you to enter into a debt management plan with your creditors. There’s a possibility to reduce your monthly payments, but you’ll still be able to pay your balance in full. Consumer credit counseling will have no negative impact on your credit score as long as you keep making your payments on time every month.
You can work out your own payment plan with your creditors. If you’ve missed one or two payments, Jim suggests asking your creditors if they have a hardship program for customers who are having financial difficulty. (Tip: use the word “hardship” in your conversation.) You can often get a temporary reduction – six months to one year – in your monthly payment and interest rate.