Is Debt Settlement a Good Idea?
Debt settlement can provide a lifeline for consumers struggling with debt.
When you pursue debt settlement – also called debt relief, debt negotiation or debt settlement – you are trying to get your creditors to agree to accept a lower payment than what you owe. One industry study found that consumers who pay bills successfully cut their debt burden by nearly half.
That may sound absurd. But debt settlement is not the best solution for everyone. And even if it seems like a good option in your situation, it’s important that you understand the potential risks and potential rewards.
Can debt settlement help you in your situation?
The basic idea about debt settlement is that creditors may be willing to negotiate and ultimately accept a lower amount to close the account. Usually, the process requires that you fall behind on your unsecured debt — think: credit cards and personal loans — and that you have an explanation for why you can’t pay. (You can’t pay off certain types of debt, including secured loans, federal student loans or tax debt.)
“Everyone’s financial situation is different. However, in general, debt settlement is often the right solution for someone in the midst of serious financial problems,” said Steve Boms, president of Allon Advocacy and legal director of the American Association for Debt Resolution. People who qualify for credit are often faced with a lot of unsecured debt and have experienced some hardship, such as a job loss, medical problem or divorce.
You can try to negotiate the debt yourself (see step-by-step guide). But this can be a long, stressful experience, so some consumers turn to for-profit debt service companies.
When you start working with a debt relief company, you will have a good consultation – some companies report that this call takes two hours – where you will pay your debts and finances. If you haven’t done so, the company may advise you to stop paying your debts.
Stopping payments is an option, although it is an important part of the process, as it helps you gain leverage for creditors to negotiate. But delinquents can (and likely will) damage your credit score, possibly lowering it by 100 points or more. This is why this solution is best for people who have already fallen behind on their payments or are on the verge of doing so.
Meanwhile, you’ll also need to make a deposit into a dedicated savings account. After making enough money, the company will reach out to the creditor, and if they reach an agreement, they will send the terms for you to review. Once approved, the company will pay the lender, collect their money and move on to the next account.
Is debt settlement good for consumers? Bottom line: It depends on who you ask. If successful, debt settlement can help consumers finally get a handle on their debt — and the debt relief industry will highlight the stories and statistics that prove it.
But for those unable to reach agreements with creditors, the increased delinquency associated with settlements could leave them worse off than they were when they first filed, consumer groups warn.
Should you work with a debt settlement company?
Although you can’t talk to debtors on your own, representatives of the credit assistance industry often emphasize that they can bring a lot of expertise to the negotiating table at a time when borrowers are frustrated.
There are a number of services offered to buyers for a fee, Boms said, noting that, for example, you don’t need to work with a realtor to buy a house. When you’re negotiating on your own, the lender’s only incentive is to get as much money out of you as possible regardless of what you owe others. But debt settlement companies get paid for every debt they successfully pay off.
In addition, the companies have experience working with tens of thousands of different consumers who have settled with the same creditors, he says. That helps them decide the best time to pay and the right or wrong payment amount.
“They have relationships with those borrowers to get you the best results, and they look at your entire portfolio of unsecured loans, not just one,” he says.
Boms thinks that much of the stigma attached to credit unions stems from the way the industry operated before federal regulations took effect in 2010. Now, due to regulations from the Federal Trade Commission, or FTC, these companies cannot charge upfront fees and consumers have the ability to authorize payment before they are charged. Consumers must receive clear disclosure of the program and maintain control of their savings account throughout the program, according to FTC guidelines.
Those rules helped align incentives — “companies only have a revenue event if they’re successful on your behalf,” Boms said.
Still, consumer advocacy groups like the National Consumer Law Center and government agencies like the Consumer Financial Protection Bureau stress that credit relief can be dangerous.
If you stop paying your creditors, that will create late fees and interest charges, meaning your debt will continue to grow while you wait to see if your creditors will negotiate. On average, account balances increase by $494, or 12% of the original amount, according to industry figures.
That’s not a problem if you can access enough balances for your accounts that you can walk away with some savings. And many customers of debt settlement companies do this: About 6 out of 10 customers between 2011 and 2020 were able to pay their registered debts, and 23% reached compensation for all their debts, according to a report commissioned by the American Association of Debt Resolution (AADR), which is an industry trade group.
But the same report shows that a quarter of customers have not been able to access compensation on any of their registered accounts, and it is unclear how much those particular balances may increase during the negotiation efforts.
What are some other options to get rid of debt?
If you are able to pay off your debt, you are probably better off pursuing another strategy to get a handle on your debt. If you need some help with budgeting, for example, you can talk to a credit counseling organization that offers debt management programs. These come with a small monthly fee. If you switch, you’ll get a reduced interest rate and one monthly payment. Or if your credit is relatively strong, you may want to consider debt consolidation as a way to simplify your debt and save on interest.
If, on the other hand, you don’t have enough income to build up negotiation capital, then debt settlement may also not be appropriate. Instead, you may want to consider filing for bankruptcy.
Finally, if you decide to work with a debt relief company, remember that even though you may be stressed about your finances, you shouldn’t make knee-jerk decisions. Make sure the company you are considering registering with is accredited by the AADR and check online review sites.
You should be presented with full disclosure and an overview of the process that explains what to expect. Then you can (and should) keep asking questions until you have a clear picture of how much you can afford to pay, what you will owe the company, how long the process will take and what resources, if any, are available if you are sued by creditors. Some companies offer legal support and include it in their fee, while others may charge for it.
More from Mali:
Here’s What Happens When You Work With A Debt Relief Company
Will Debt Relief Really Improve Your Credit Score?
5 Questions to Ask Before Signing Up with a Debt Relief Company
