Is Debt Settlement Worth It?

We’ve all been there. Just when you think you’ve gotten all your bills paid, the new ones arrive and it’s getting tougher each month to cover them all. Maybe you’ve fallen behind on some pretty big debts and no matter how much you pay, they don’t seem to be getting any lower. Student loans can become particularly problematic in this regard; those monthly payments are paying off the interest more than the principal and it feels like you’ll never get out from under your mounting debt.

Many consumers who are looking for a respite from this vicious financial cycle turn to debt settlement in a bid to get out from the albatross around their neck. But this may not always be the smartest choice for alleviating your financial difficulties as it could end up causing you more headaches than it solves. Before you seek out a debt settlement agreement, consider these potential risks that come with making this important fiscal decision.

Defining Debt Settlement

You’ve likely heard the term before, from any number of television or radio commercials for firms advertising their services as a hassle-free way to clear out some of that crippling debt on your shoulders. But some consumers may not fully understand the definition of “debt settlement.”

For starters, it is often confused with debt consolidation. Both are done by companies that work for you to handle your debt problems. With consolidation, all of your debts are consolidated into one total that you can pay off in monthly payments. But debt settlement is different, and potentially riskier, as the settlement company negotiates with your creditors on your behalf to convince them to lower the amount you owe in exchange for paying off the new amount quickly. Once that amount is paid, your debts are forgiven.

The Way it Works

When you enter into an agreement with a debt settlement company, you establish an account with them into which you deposit money on a monthly basis. As you’re paying this money, the company is negotiating with one or more of your creditors to have them lower your debt.

When the money in your account can cover the negotiated settlement with one of your creditors, the company pays it off. If you have them working with more than one creditor, the process continues.

What are the Risks?

There are many risks involved with this process. The whole concept behind debt settlement is predicated upon people basically defaulting on their debt, which then increases with the addition of penalties and fees that are incurred when monies owed are not paid.

Most reputable settlement companies will try to prevent you from a full default, but it can happen very easily. This can have a significant impact on your credit rating, an impact that won’t quickly be remedied by paying a third party to come in and start negotiating on your behalf. In fact, many creditors simply refuse to deal with debt settlement companies because they would rather you use the money you’re giving to a third party service to pay off everything you owe to them instead.

When you hire a debt settlement company, you’re essentially paying them on an “if/come” basis. You’re betting the company will be able to strike up an arrangement with your creditors, but in the meantime, while your debt remains unpaid and possibly accruing more fees and penalties, your credit rating is getting hammered. The longer you don’t pay certain types of debts, the more you open yourself up to collections actions and possibly even lawsuits.

Then, if everything goes your way and the company can arrange a settlement that is ultimately paid off, that doesn’t necessarily ensure you’ll be in a better place financially. You may have unwittingly done more damage to your fiscal situation in the long run.

Just because you’ve settled this debt and paid off your settlement arrangement doesn’t mean your credit rating will start to improve. The debt may not be reflected on your report as having been paid off in full, but instead marked as settled. This will be a red flag to other potential lenders and might still negatively affect your standing, forcing you to pay higher rates with borrowers in the future, causing you to pay more out of pocket. Thus, the financial difficulties continue.

What are the Alternatives?

Obviously paying your bills will alleviate your debt. I know, easier said than done in many cases. But you can save yourself some money (and in the end, that’s what this is really all about) by contacting the creditors directly and negotiating on your own behalf. Many creditors are willing to help out, either by lowering the amount owed or working out a payment plan to make that debt less onerous.

A financial windfall would certainly be a big help, but those don’t come around too often. So work with your creditors directly and you may find faster relief from your debts than you might with a settlement company.

Should You Call a Debt Settlement Company?

Now that you know some of the facts, consider whether or not debt settlement is really a good idea for your particular situation.  It’s important to know that some debts are ineligible for settlement arrangements. Monies owed on taxes, student loan debt, or court-ordered debt such as alimony and child support will not qualify for debt settlement.

The companies also assess your debt and your ability to pay it off before accepting any new clients. If you’re drowning in large amounts of debt, then you’re likely to be taken on more readily than someone who’s just a little behind on their payments. Calling a debt settlement company makes sense if your credit score is already damaged and you have no recourse to paying off your debt.

There are other factors to consider as well, especially with the IRS. If they see that you settled a debt and the difference between what you paid and what you owed is more than $600, they will consider that income which you will then need to report and pay taxes on.