Credit card debt can feel overwhelming. Many Americans struggle with high interest rates, late fees, and missed payments. If you find yourself deep in credit card debt, debt settlement may seem like an attractive option. However, debt settlement is a complex process with major drawbacks. This article from the financial experts at Delancey Street will explain how debt settlement works, provide tips for negotiating with creditors yourself, and discuss alternatives like credit counseling or bankruptcy.
How Does Debt Settlement Work?
Debt settlement involves negotiating directly with creditors to pay a lump sum that is less than the total amount owed, in exchange for forgiving the remaining balance. For example, if you owe $20,000 across multiple credit cards, a debt settlement company may negotiate to pay $10,000 to settle the accounts completely.The first step is to stop making payments on the accounts you want to settle. This signals to creditors that you cannot afford the full balance. Be aware that stopping payments will incur late fees and penalty interest, further increasing your debt. Debt settlement companies then negotiate lump sum settlements on your behalf. This can take months or even years to accomplish.Once a settlement is reached, the creditor forgives the remaining balance. However, the account will be closed, and the settlement can stay on your credit report for up to 7 years. Debt settlement can seriously damage your credit score.
Tips for Negotiating Debt Settlement Yourself
You can attempt to negotiate debt settlement directly with creditors without using a debt settlement company. Here are some tips:
- Research company policies. Creditors have different rules regarding settlements. Learn their policies before reaching out.
- Wait for delinquency. Creditors are more likely to negotiate if you are at least 90 days late on payments. Allow accounts to become delinquent before contacting the creditor.
- Start low. Offer 25-30% of the balance as a first offer. Expect counters, but start the negotiation at a favorable amount.
- Get agreements in writing. Verbal agreements can still go to collections. Formalize any settlement offer in writing before paying.
- Settle small debts first. This allows you to free up cash flow to put towards larger balances. Knock out small debts one by one.
- Avoid account use. Don’t make new charges on accounts you are trying to settle, as this reduces your leverage.
Negotiating directly with creditors takes persistence, but can help you avoid expensive debt settlement fees. Be prepared for the process to take 6 months or longer.
The Downsides of Debt Settlement
While debt settlement may seem like an easy fix, it comes with major drawbacks:
- Damaged credit. Missed payments and settled accounts cause significant damage to your credit score that can last for years.
- Tax consequences. The IRS may count forgiven debt as taxable income. Consult a tax professional to understand the implications.
- Collections calls continue. You are still responsible for debt during the settlement process. Collectors can still contact and sue you during negotiations.
- Possible lawsuits. Creditors may sue if you become delinquent on payments during the settlement process.
- No guarantees. There is no guarantee creditors will accept a low settlement offer or work with debt settlement companies.
For these reasons, debt settlement should only be considered as an absolute last resort if other options will not work.
Alternatives to Debt Settlement
Here are some alternatives to consider before pursuing debt settlement:
- Credit counseling. Reputable credit counseling agencies can help you consolidate debt into a single payment and negotiate lower interest rates. This is often a better first step.
- Debt management plans. A DMP provided by a credit counselor allows you to repay debt through one monthly payment over 3-5 years. The counselor negotiates for lower interest rates.
- Balance transfer cards. Transferring high-interest credit card balances to a 0% APR card can provide temporary relief and allow you to pay down principal.
- Bankruptcy. Filing for Chapter 7 bankruptcy eliminates eligible debt completely. While damaging to your credit, it provides a fresh start. Consult with a bankruptcy attorney.
- Debt consolidation loans. Taking out a personal loan at a lower interest rate can simplify payments. Be cautious of predatory lenders.
Debt settlement seems like an easy fix, but can seriously impact your finances and credit for years. Explore all alternatives before considering settlement offers, and negotiate cautiously with creditors yourself to avoid expensive settlement fees. If you are overwhelmed by high interest credit card debt, meet with a credit counseling agency to discuss your full range of options. With persistence and the right approach, you can take control of your credit card debt.