Debt settlement is when the borrower resolves outstanding debt with the creditor. It can bring relief to those drowning in debt; however, understanding the implications and consequences of debt settlement is imperative before entering into an agreement with an external company or creditor. Debt settlement has both drawbacks and benefits:
Pros for Debt Settlement
The bottom line benefit is that your debt will be reduced and resolved to a lesser amount. The goal of debt settlement is to allow borrowers to satisfy a debt in full, but by paying a lesser amount. This approach allows the borrower to reduce the number of collection agency calls, save money and lessen the impact on her credit score. The benefits include:
- Quicker turnaround time: Once you've come to an agreement with the creditor, your debt is considered "paid off." The debt settlement process typically takes several months instead of possibly several years, which is what you could experience with credit counseling or using home equity loans.
- Complete loan pay off: Your full amount won't continue to turn up on subsequent invoices from your creditor (settlement means it's a done deal).
- Decent savings: Typically, you can save between 40 percent to 60 percent with debt settlement--creditor savings will vary.
- Bank money for payments: Some creditors will allow you to bank your payments in an escrow account. Once you accumulate the full amount, you will use the cash to pay off the settlement total.
- Stop bankruptcy proceedings: If debt is the reason you are facing bankruptcy, debt settlement can prevent that train from leaving the station.
Cons for Debt Settlement
While debt settlement erases nagging debt, there is a dark side to this approach. One of the major downfalls is that debt settlement opens the door for unethical companies to pounce on unsuspecting borrowers. Also, debt settlement is an aggressive business, making it a process that isn't for everyone. Other drawbacks include:
- Complicated fee structure: Creditors or debt settlement companies will impose fees for performing this service, however, sometimes fees are not disclosed in a clear, concise manner.
- Payments and fees demands may be different: Some companies require a lump sum whereas others want payment in installments. If you are required to make one lump sum payment, you will need to be disciplined enough to save the money.
- Taxes will be imposed on savings: Even though you've settled, you must still pay taxes on the difference. A tax advisor can assist you with the impact.
- Credit score will be negatively impacted: Regardless of your approach, your credit score will be lowered if you don't pay the debt per your original agreement.
- Creditor calls may continue: Debt settlement can reduce the number of calls, but until the debt truly paid off, the calls may continue.
Debt settlement has both positive and negative consequences. Conduct due diligence and research debt settlement companies before entering into any agreement.
Gina Ragusa is a freelance writer and mom from sunny (and sometimes not) South Florida. Her 15 year experience ranges from writing about banking to tattoo parlors. Read more about her adventures at http://blog.wahm.com/