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In a NutshellIf you’re struggling to pay a debt and your account is in default, you can try to negotiate a debt settlement agreement with your creditor. If a creditor does agree to negotiate a debt settlement agreement, it's important to get the details right before signing a binding contract. This article will explore when to consider a debt settlement agreement, how long the process takes, how it affects your credit score, and what an agreement should contain.
Handling debt is an important part of personal finance. If you’re struggling to pay a debt and your account is in default, you can try to negotiate a debt settlement agreement with your creditor. These agreements can be difficult to get though. Many creditors, such as some credit card companies, don’t allow their borrowers to negotiate their debts, and the odds of convincing them otherwise are low.
But it can still be done. In fact, a report published by the Consumer Financial Protection Bureau shows that the number of approved debt settlement agreements has steadily risen since 2016. This should be encouraging if you have one or more debts that you would like to try to negotiate with your creditors. This article will explore when to consider a debt settlement agreement, how long the process takes, how it affects your credit score, and what an agreement should contain.
A debt settlement agreement is when you, or a debt settlement company working on your behalf, negotiate with a creditor to reach an agreement on a payoff amount for your debt. A debt settlement agreement is a binding contract that either you or the creditor drafts. This contract states that you, the debtor, will pay your creditor a lesser amount than what you owe on a debt. The payoff may be an upfront lump-sum payment or a series of payments.
Most debt settlement agreements allow borrowers to pay 40%-60% of what they originally owed. Once the creditor agrees to a debt settlement amount, they’ll forgive the remainder of the debt. If you can come up with a lump-sum payment, you may have better odds of settling with your creditor than if you need a monthly payment plan.
Debt settlement agreements can only be created for unsecured debt, such as credit card debt, personal loans, department store charge cards, or medical bills. They cannot be used with secured loans such as mortgages, car loans, or federally subsidized student loans. Some creditors won’t be open to any settlement offers, but others would rather get something than nothing. Also, while you can hire a debt settlement company to negotiate on your behalf, some lenders will not negotiate with a third party.
If you directly negotiate a lump-sum payment with your lender, then your settlement will happen fairly quickly. If you are making payments, then your settlement will take longer. But if you hire a debt settlement company to negotiate on your behalf, then it may take as long as two to four years before the settlement happens.
Most debt settlement companies require you to make monthly payments into a savings account they manage so they can eventually negotiate a lump-sum settlement with your creditors. It takes a while for your monthly payments to add up to enough to make these lump-sum payments. In the meantime, the company may ask or require you to stop making payments to the creditor, which has serious negative consequences on your credit score.
If you have old unsecured debts that are within a year of the statute of limitations, then you may be better off simply letting them age off of your credit report. Most creditors will stop all collection efforts once a debt has been on the books for more than seven years.
Debt settlement is almost never good for your credit score. By the time you get to a settlement, your creditors will have reported missed payments to the three major credit bureaus. This can cause your score to drop dramatically. Your creditor may also charge off your account or send it to collections in the meantime. This will further damage your credit score and make it that much harder to get new credit in the near future. You may also still be subject to collection efforts such as phone calls, written notices, or even lawsuits while you are negotiating your settlement.
For these reasons, it may be best to research other debt relief options before deciding on debt settlement. A debt management plan or debt consolidation loan may be a better idea. You can also try consumer credit counseling or even bankruptcy in some cases.
If your accounts are already several months past due or have been sent to collections, you’ve probably already seen your credit score drop as a result. Since the damage has been done, it might make sense to consider debt settlement in this case. After a debt settlement, most accounts will be reported as settled on your credit report. This doesn’t look great but it is better than having an open collections account.
You can hire a debt settlement company to negotiate with your original creditors for you if you don’t feel comfortable speaking with your lenders yourself or you’re too busy to do so. But debt settlement companies can be expensive. It’s not uncommon for them to charge you 15% or more of the amount of debt that is forgiven. They may also be better at bargaining than you are because they do it for a living, so you’ll have to weigh the pros and cons. You should also consider the tax implications for debt that your creditors forgive. Forgiven debt over $600 is considered taxable income.
Since scams and fraud are common in this industry, be sure to do your homework on any firm that you’re thinking of hiring. You can use the Better Business Bureau (BBB), the Consumer Financial Protection Bureau (CFPB), the Federal Trade Commission (FTC), and your state attorney general’s office to research companies. See whether the firm that you are considering has had any complaints lodged against them or disciplinary history. You can also look online to see what kind of reviews other customers have given them.
Remember: No debt settlement company can do anything for you that you can’t do for yourself. And some debt collection agencies will not bargain with a debt settlement company under any circumstances. You can potentially save money by negotiating with creditors yourself, but you’ll need to be comfortable and confident in your skills.