Questions to Ask When Considering Debt Settlement

Debt settlement can also be known by other names such as debt arbitration or debt negotiation. It is a process through which your creditor accepts less than the full amount owed, yet considers the balance as paid. Settlement companies often advertise that they can save you 50 percent or more of what you owe, with repayment typically taking between two and four years.

A settlement company may suggest that you stop paying your creditors and instead begin making deposits into a special third-party account. The settlement company will attempt to negotiate a settlement offer with your creditor once enough money relative to the debt is on deposit. This may take six months or more, although the exact length of time will vary with circumstances. During this time, the balance on your account can continue to grow if interest and various penalty fees continue to be charged by your creditor. As a result, you may owe more than when you started and your credit may suffer because of your failure to make any payments on your debt. Even worse, legal actions such as wage garnishment or a judgment may be filed against you during this time.

Debts paid off as part of a negotiated settlement will generally show “Paid by Settlement” on a consumer’s credit report. If you later apply for new loans, the prospective lender(s) will understand that a debt paid by settlement means that your repayment did not cover the total debt that you had accumulated, but that your creditor accepted a lesser amount.

Your credit score is based on information contained in your credit report, with the highest consideration given to how you repay your debts. As stated above, if you’re not repaying the creditor or have missed payments, it will show on your credit report and potentially lower your credit score substantially.

Different settlement companies have different fee structures, but there are two basic approaches. In one model, the settlement company’s fee will be a percentage of your total debt. The fees under this arrangement typically range from 13-20 percent. For example, if you owe $30,000 and the settlement company charges you 15 percent of the total debt, then you will pay them $4,500 in fees.

Another option the settlement company may offer is to base their fee on the amount of debt reduction they can negotiate. Fees under this model can be as high as 35 percent. If the settlement company negotiates your $30,000 debt down to $15,000, and charges you a 25 percent fee, you will owe the settlement company $3,750 in fees.

Additionally, some settlement companies also charge a monthly fee that can range from about $19 – $89 a month for the entire program.

Some debt settlement companies frontload their fees. In other words, they collect a significant part of their fees before any payment is made to your creditor. If you’ve stopped paying your creditor and are instead sending money to the settlement company account, that money is likely going to satisfy the settlement company fee before you see any benefit. It can be months after you start the settlement program before your creditor receives any payment.

Once the creditor agrees to accept a settlement, and that agreed upon amount is received by the creditor, they will end efforts to collect the original amount. However, if the amount of the forgiven debt totals $600 or more, you will generally owe income taxes on the forgiven amount.

• Review the company’s record with the Better Business Bureau as well as their state Attorney General or Commissioner of Banking.
• Select a company that is affiliated with an industry trade association which holds members accountable through accreditation.
• Confirm that the account holding your deposits is FDIC-insured.
• Obtain all disclosures in writing, including a good faith estimate of costs associated with the settlement.
• Inquire about refunds of any money on deposit should you wish to drop out of the program.
• Be cautious about promises or guarantees that seem unrealistic.
• Debt settlement is a process through which your creditor agrees to accept less than the full amount owed, yet considers the balance as paid. Settlement companies often advertise that they can negotiate reductions of 50 percent or more in the debt you owe. They then set up a repayment plan that typically takes between two and four years.
• Settlement companies charge significant fees. Different settlement companies have different fee structures, but there are two basic approaches. In one model, the settlement company’s fee will be a percentage of your total debt. The fees in that model typically range from 13-20 percent. Another option the settlement company may offer is to base their fee on the amount of debt reduction they can negotiate. Fees under this model can be as high as 35 percent. In addition, many settlement companies also charge a monthly fee that can range from about $19 – $89 a month for the entire program. Either way, it is not uncommon for settlement fees to total thousands of dollars.
• Some debt settlement companies front load their fees. In other words, they collect a large part of their fee before you receive any benefit. Much of the money you initially deposit goes to pay the settlement company to satisfy its fees. It can be months after you start the settlement program until your creditor receives any payment.
• A settlement company may suggest that you stop paying your creditors and instead begin making deposits into a special third-party account. The settlement company will attempt to negotiate a settlement offer with your creditor once enough money relative to the debt is on deposit. This may take six months or more, although the exact length of time will vary with circumstances. During this time, the balance on your debt can continue to grow if interest and various penalty fees continue to be charged by your creditor. As a result, you may owe more than when you started and your credit may suffer because of your failure to make any payments on your debt. Even worse, legal actions such as wage garnishment or a judgment may be filed against you during this time.
• Debts paid off through settlement will generally show “Paid by Settlement” on a consumer’s credit report. If you later apply for new loans or credit, when reviewing your credit report the prospective lender(s) will see that a previous debt was paid by settlement, indicating that your repayment did not cover the total debt that you owed, but that your creditor accepted a lesser amount.
• The credit score is based on information contained in the credit report, with the highest consideration given to how you repay your debts. If you’re not repaying the creditor or have missed payments, it will show on your credit report and potentially lower your credit score significantly.
• The consumer may be responsible for taxes on the forgiven debt. If the forgiven debt totals $600 or more, you will generally owe income taxes on the amount forgiven, substantially reducing the total savings from debt settlement.