Debt settlement, also known as debt negotiation or debt arbitration, is a process where a debtor works with a debt settlement company to negotiate with creditors to reduce total debt owed. Debt settlement programs have become an increasingly popular option for consumers struggling with high amounts of unsecured debt like credit cards, medical bills, and personal loans. This article provides a comprehensive overview of debt settlement programs, including how they work, pros and cons, costs, and tips for choosing a reputable company.
How Debt Settlement Programs Work
The goal of enrolling in a debt settlement program is to negotiate with creditors to settle debts for a fraction of the total balance owed. The process typically works as follows:
- The debtor signs up with a debt settlement company and agrees to make monthly payments into a dedicated account.
- The settlement company negotiates with creditors on the debtor’s behalf to settle debts, usually for 50-60% of the total owed.
- Once a satisfactory settlement amount is agreed upon, the settlement company uses the funds in the dedicated account to pay the settlement to the creditor.
- When the creditor accepts the payment, they agree to forgive the remaining debt balance.
- The process is repeated until all debts enrolled in the program are settled.
It usually takes 24-48 months to complete a debt settlement program. As funds accumulate in the dedicated account, the settlement company has more leverage to negotiate debt relief with creditors.
Pros of Debt Settlement Programs
Debt settlement programs offer several benefits for consumers struggling with debt:
- Debt reduction: Settling debts for less than owed can reduce total debt by 50% or more. This greatly accelerates debt repayment.
- One monthly payment: The program consolidates debts into one monthly payment to the settlement company. This simplifies repayment.
- Avoid bankruptcy: Settling debt through a program is less damaging than filing bankruptcy. Bankruptcy stays on credit reports for 7-10 years.
- Immediate relief: Creditors stop collections efforts once enrolled in a program. This provides immediate financial relief.
- Flexible terms: Programs can take 12-48 months to complete. Consumers can choose a term that fits their budget.
- No tax consequences: Debt forgiven through settlement is not treated as taxable income, unlike forgiven credit card debt.
Cons of Debt Settlement Programs
While programs offer benefits, there are also downsides consumers should consider:
- Fees: Most settlement companies charge 15-25% of enrolled debt in fees over the program term. This can amount to thousands in fees.
- Credit damage: Settling debts usually leads to additional late payments being reported. This can lower credit scores by 60-100 points.
- Tax issues: Any savings from settled credit card debt can be taxed as income in some states. This diminishes savings achieved.
- Debt not guaranteed: Creditors are not obligated to settle debts. However, experienced companies achieve over 90% settlement rates.
- Risk of lawsuits: Creditors may sue consumers for unpaid debts despite enrollment in a program. Being sued can add legal fees and court judgments.
- Early withdrawal penalties: Many companies charge fees for withdrawing from a program before all debts are settled. Penalties can amount to a few hundred to a few thousand dollars.
Costs of Debt Settlement Programs
The primary costs of debt settlement programs are enrollment and monthly administration fees charged by settlement companies:
- Enrollment fees range from none up to $400-600 to get started. This covers the initial account set-up.
- Monthly fees are typically 15-25% of total enrolled debt. Fees are collected over 12-48 months until the program is completed.
- For example, on $20,000 of debt the fees could range from $3,000 to $5,000 or more over a 36 month program.
- Most companies also charge a small monthly account maintenance fee around $10-30/month.
Settlement companies generally require an upfront deposit equal to one monthly payment. Consumers should make sure they understand all fee options before enrolling. Non-profit credit counseling programs may have lower fees.
Tips for Choosing a Reputable Debt Settlement Company
With numerous settlement companies to choose from, it is important to select a reputable provider. Here are some tips on what to look for:
- Check certifications: Seek companies accredited by the International Association of Professional Debt Arbitrators (IAPDA) or the American Fair Credit Council (AFCC).
- Read reviews: Check third-party review sites like Trustpilot for consumer feedback. Be wary of fake reviews.
- Compare settlement rates: Ask companies for their average settlement rates and timeframes. Reputable firms settle over 90% of debt enrolled.
- Verify licensing: Confirm the company is properly licensed in your state if required. Licensing gives recourse for complaints.
- Consider alternatives: Ask if the company offers other options like debt management plans or credit counseling.
- Read the contract: Review contract terms closely and make sure you understand all fees and policies before signing.
- Check transparency: Opt for companies that provide access to your dedicated account and settlements achieved.
- Know your rights: Federal law requires settlement companies to explain your rights including a 3-day cancellation period.
By following these tips, consumers can find a trustworthy and effective debt settlement company to assist them in resolving unmanageable debt outside of bankruptcy.
Frequently Asked Questions about Debt Settlement Programs
Which debts are best for a debt settlement program?
Unsecured debts like credit cards, medical bills, personal loans, and utility bills are best suited for settlement. Student loans, auto loans, mortgages, and tax debt are usually not eligible.
How much can I save with a debt settlement program?
Most creditors will settle eligible debts for 50-60% less than the original balance owed when enrolled with a program. This can save thousands in total debt.
Will settling debts hurt my credit?
Settling debts almost always causes additional late payments to be reported to credit bureaus. This typically drops credit scores 60-100 points until debts fall off a credit report.
Are debt settlement payments taxable?
The IRS does not consider settled credit card debt as taxable income. However, the savings achieved from settling other types of unsecured debt may be taxed in some states.
Can creditors sue me while enrolled in a program?
Yes. Creditors have every right to continue collections efforts including lawsuits while you are in a program. An experienced settlement firm can help defend against lawsuits.
How long do I have to be in a program?
Programs can take between 12-48 months depending on your financial situation. The more access to funds you have, the quicker debt can be settled.
For consumers overwhelmed with high amounts of unsecured debt, debt settlement programs can be a viable alternative to bankruptcy. Negotiating with creditors offers the ability to settle debts for a fraction of balances owed. While programs have both pros and cons, they do allow struggling debtors to resolve debts they are unable to pay off through normal repayment channels. By selecting a reputable settlement company, being realistic about fees and timeframes, and staying committed to the process, many who enroll can successfully negotiate debt relief.