Debt settlement is normally offered as an alternative to bankruptcy. You may read that debt settlement will provide a large reduction in the amount you owe your creditors and that you will be out of debt quickly. We want to provide you the straight goods on debt settlement; The Good, The Bad and The Ugly.
Debt Settlement is the process of requesting your creditors to do two things for you:
- Lower the amount you owe and
- Erase all outstanding debt off the books
This is what the debt settlement companies offer and here is how it works.
How Debt Settlement Works
The process starts with you contacting the debt settlement company and providing all of the information about the creditors that you currently owe money. The debt settlement provider will offer you an estimate of what it will cost for their service to settle your debt. If you accept the terms of the debt settlement company, you will stop paying all of your creditors and start a savings account with the debt settlement company. We would suggest that you try to secure a debt consolidation loan before considering debt settlement
The Money you Send will go into a Savings Account
The debt settlement company places your monthly payments into a savings account. Once the cash account has grown to an amount that will pay off a creditor the debt settlement company contacts your creditor or the collections companies and begins negotiating the settlement. The settlement is an amount lower than your full outstanding balance and they pay off one creditor or collector at a time.
If your creditors (or the collection agency that your debt was sent to) agree to a settlement amount, the settlement company pays the creditors and takes a fee for the work they negotiated. The fee will Depend on what you negotiated with the debt settlement provider. It could be a percentage or a flat fee for the entire package. We would recommend never to pay an upfront fee to anyone if you do decide to go this route.
OK Great, Now I'm Free and Clear of Debt Right?
Your debt is now paid off and your past creditors may or may not have agreed to the terms of the debt settlement company. Some creditors may decide not to settle and continue coming after you for payment, there is no guarantee that all of them will and a lawsuit may still be filed against you.
You have made all of your payments with the debt settlement company and they have received their fee.
Going back to where this all started, you stopped making payments to all of your creditors and started depositing all of your money with the debt settlement company. The first and most important part of your credit score is making your payments on time.
What Happened to Your Credit Score?
The FICO credit score values 35% of your total credit score on payment history. The debt settlement company had you stop making payments to your creditors and requested that you start sending payments to them instead. The debt settlement process breaks the primary rule of credit scoring and receiving credit.
The only way to get a creditor to settle debt is to stop paying them for a long period of time. Your creditor, after an extended period of time, will send your file to collections. This is what the debt settlement company counts on.
Every month that you do not pay is recorded with all three credit bureaus, your credit score would have dropped every month and the collection companies will be calling.
This debt settlement information is recorded and sits on your credit score for up to 7 years and available for everyone to review. It will say "Charged-Off Settled" or "Paid-Settled" on your credit report. When you pay off a loan or credit card, it normally reports as "Paid In Full" and this is what we all want on every credit report.
Now You're Looking for a New Loan Or Credit Card
Six months to a year after you have completed debt settlement with everyone, you may start looking for a new loan or credit card. With a debt settlement on your credit score, you become a high risk to deal with. The question lenders will have after viewing your credit report, will they do it again? Will they start raking up debt and go back to debt settlement again? Six months after debt settlement, your credit score will still be very low because the only way to build credit is to have credit. It will be very difficult to find a bad credit loan or personal loan or apply for a bad credit - credit card option. You may require a secured credit card to start rebuilding your credit score.
Ask the Debt Settlement Company About Taxes
When debt is settled with a debt settlement provider, the Internal Revenue Service (IRS) treats the amount settled as income. Your past creditors are required to provide a Form 1099-C for canceled debts and the IRS expects anyone with settled debt to report this on their tax return regardless if the creditors sent you a Form 1099-C. This becomes your responsibility to declare this profit on your tax return.
What Else Could You Try?
We are not here to criticize your decision on debt settlement. If you are even considering debt settlement, you are already in a very difficult financial position. We want to offer you a few ideas that you may not have considered yet.
What Else Could You Try?
Speak to a credit counseling service and request direction on how to communicate with your current creditors. They can provide you with the best way to move forward with an action plan. This link will provide reference groups that will get you started. Novita is also a great choice to start the process of getting back on track with your credit score. They offer a low-cost credit management program.
Call your creditors directly. Creditors appreciate a phone call any time and especially when you are in trouble financially. Let them know that you are going through a difficult time and that you and your family are struggling. Ask your creditor is they have a hardship program that you could learn more about. These programs are typically not advertised so a good start will be to ask for customer assistance, then request contact with their hardship program. This may provide an alternative to debt settlement.
Debt Settlement provider
If you do decide to go down the debt settlement path, National Debt Relief provides help and advice on debt settlement services, debt management, and debt negotiation. They have an excellent reputation in the debt settlement industry.
- Form 1099-C Cancellation of Debt IRS - Form 1099-C Cancellation of Debt IRS
- Vantage Scoring System - Vantage Scoring System acquired June 2018
- What Makes up my Fico Score - What Makes up my Fico Score myfico.com acquired May 2018
- Free Credit Report - Free Credit Report consumer.ftc.gov acquired may 2018
- The National Foundation for Credit Counselling - The National Foundation for Credit Counselling