If youâ€™re struggling with consumer debt and canâ€™t seem to dig your way out, youâ€™re not alone. In fact, you are one of many millions of Americans who deal with debt and its consequences in any given year.
Fact: The average adult with a credit card carried $6,348 in debt, paying an average APR of 15.54%. So far in 2018, we have also paid $104 billion in credit card interest and fees, which is 35% more than Americans paid five years ago.
With these figures in mind, itâ€™s no wonder so many of us continue to fall further and further behind.
The painful reality is that 70 million Americans were contacted about a debt in collections in 2017, which typically means their debt was in default for at least 180 days. Debt collectors call consumers to follow up on these debts over one billion times per year, with up to 15 calls made per account per day.
While consumers can sometimes figure out a way to pay debt off on their own, there are strategies that can expedite the process. Some opt to consolidate their debts with a new loan that offers better terms and a lower interest rate, for example. Others sign up for a debt management plan, which is a debt repayment plan operated by a third-party credit counselor.
Finally, some consumers opt to negotiate their debts down through a process known as debt settlement. This option comes with its own share of pros and cons, and risks for consumers.
Before you decide to settle your debts, understand how it works, what the consequences might be and who can help you manage the process. This guide was created to explain your options and offer all the information youâ€™ll need to decide for or against debt settlement.
Unlike debt management plans, which are often offered by nonprofit companies, debt settlement programs tend to be administered by for-profit organizations. With debt settlement, the company you work with aims to negotiate a â€śsettlementâ€ť with your creditors that is less than the amount you owe.
Since youâ€™re already behind on your debts before you begin this type of plan, the debt settlement company asks you to save a specific sum of cash each month in a dedicated savings account. You do maintain ownership over the funds you save as well as any interest that accrues in your account, though. Your debt settlement company may ask you to stop making payments on your debts during the negotiation process, resulting in you purposely putting yourself further in default.
The end goal of these programs is that once a settlement amount is reached, you would have saved enough cash to pay the lowered amount in full. Once the final lump sum payment is made, the accounts are considered satisfied.
While debt settlement is an imperfect solution to a complex problem, this strategy could be the best option for you. Hereâ€™s how you can decide if itâ€™s right for you:
While debt settlement can wipe away some of your debts if youâ€™re struggling to keep up with minimum payments, there are times when you should look more closely at potential alternatives. Those instances can include:
Here are the main ways consumers can settle their debts by working with a third party or handling negotiations on their own.
Mike Sullivan, a personal finance consultant with Take Charge America, a national nonprofit credit counseling and debt management agency that does not offer debt settlement services, said that consumers settling their own debts with collections agencies is very rare. This is partly because the process is complex, but also because it takes so long.
Still, here are the steps you need to take if you prefer to settle your debts on your own.
Working with an agency that offers debt settlement is an easier proposition for many consumers since the debt settlement firm will perform most of the steps involved on your behalf. However, youâ€™ll need to do some research and legwork upfront. The main steps required to work with a debt settlement company include:
While negotiating a settlement that is less than what you owe might sound advantageous, and it can be, debt settlement comes with both pros and cons. Here are the main advantages and disadvantages of this strategy:
If you can move through the debt settlement process successfully and put all your debts behind you, the time and energy spent could be worth it despite the potential downsides. Why? Because your debts could go away for good, granting you a chance at a fresh start to rebuild your finances.
As we noted already, you may find you are liable for income taxes on some of your forgiven debts. You should also be aware that your credit score may have taken a significant hit that will take months or years to recover from.
Make sure to get a copy of a debt settlement letter from each of your creditors so youâ€™ll have proof of the settlement and your payment if they try to collect in the future. Once you have this proof, you should also check your credit report to ensure settled debts are reported as â€śpaid off.â€ť
While the information weâ€™ve offered on debt settlement may have you excited about the prospect, you may also be worried about the long-term consequences. Perhaps you want to keep your credit score in good shape while you get out of debt, or maybe you donâ€™t like the idea of escaping full repayment of the debts you owe.
In any case, there are several alternatives to debt settlement you can consider. Your options include:
Debt management plans are debt repayment plans administered by third-party credit counselors who work for nonprofit agencies. These credit counselors call your creditors and negotiate more favorable terms on your behalf, including lower interest rates and reduced or waived fees. Once creditors agree to these concessions, consumers begin making a single monthly payment to the nonprofit agency overseeing their debt management plan. The nonprofit agency then distributes funds to their creditors on their behalf, taking care of the grunt work for them.
Debt management plans can take up to 48 months or longer to complete. Consumers are also asked to stop using credit cards and get on a budget or spending plan during the process. Ultimately, the goal of debt management plans is helping consumers escape high interest and fees, pay down their debt over time and learn positive money habits along the way.
Debt consolidation is another option to consider if you are financially unable to repay your debts. With debt consolidation, you will replace your existing loans with a new loan with better terms and a lower interest rate. The goals of debt consolidation can include lowering your monthly payment, saving money on interest and simplifying your finances with a single loan instead of several.
Bankruptcy is another last resort option to consider if you have considerable amounts of debt you canâ€™t seem to handle on your own. However, itâ€™s important to note there are two main types of bankruptcy to consider:
Advantages and disadvantages of bankruptcy include:
As you continue researching ways to pay off your debt for good, it helps to educate yourself on debt settlement and its alternatives. This list of frequently asked questions could help you with your decision.
The FTC states that debt settlement companies are required to disclose certain information upfront such as the fees they charge, how long it will take to get results, how much you need to save before they can settle your debts and the consequences you will face when you stop making payments to your creditors. You should also be notified that the money you save â€” including interest â€” is yours and that the account you use for savings is not affiliated with the debt settlement company. You also have the right to withdraw your funds at any time for any reason without penalty.
Fees charged by debt settlement companies can vary based on how many of your debts they settle and the percentage they agree to charge upfront. However, many debt settlement companies charge 18% to 25% of their debts handled through the program. This could add up to thousands of dollars in fees once the program is complete.
Because debt settlement companies ask you to stop making payments on your debts and save up to settle them instead, your credit score will take a hit. Considering that your payment history makes up 35% of your FICO score, it should be no surprise that letting all your accounts go into default would damage your credit score.
While the answer is different for everyone, debt settlement is best for consumers with considerable unsecured debts they canâ€™t seem to pay off on their own. These programs are often the last resort for consumers who struggle to keep up with minimum monthly payments and know they need help from a third party to avoid bankruptcy.
Debt settlement can take 36 months or longer to complete depending on how much debt you owe, how long your creditors take to negotiate and how long it takes you to save up the money you need to settle. Longer timelines are typically reserved for individuals with considerable debt and many creditors.
While you can settle your debts on your own, itâ€™s not very common. Not only will you need to communicate back and forth with each creditor for many months, but youâ€™ll have to negotiate with them to repay less than you owe. Many consumers donâ€™t have the knowledge or confidence to negotiate on their own behalf, so they turn to debt settlement companies or nonprofit credit counseling agencies for help.
Typically, unsecured debts qualify for debt settlement. This can include credit card debt, unsecured personal loans, some private student loan debt, medical bills, auto repossessions, cell phone and utility bills from past providers and department and store charge card debt.
Debts that donâ€™t work with debt settlement typically include secured debts. Common debts that donâ€™t qualify are car loans, mortgage loans, federal student loans, utility bills from current providers, overdue taxes, gambling debts and debts resulting from lawsuits.
Debt consolidation involves getting a new loan with a lower interest rate and better terms with the goal of combining old, higher interest debts into a single new debt. Common financial products used in debt consolidation include personal loans, home equity loans, home equity lines of credit (HELOCs) and balance transfer credit cards.
Debt settlement is a long-term process that involves having a third-party debt settlement company settle debts on your behalf while you save the cash for your settlement instead of making payments on your debts. With debt settlement, you may be able to repay less than the amounts you owe.
A debt management plan is a third-party debt repayment plan that is typically administered by a nonprofit credit counseling agency. With a debt management plan, the credit counseling agency will negotiate with your creditors to lower your interest rate and remove late fees or over-the-limit fees from your account. During the program, youâ€™ll make a single monthly payment to the nonprofit credit counseling agency who will disburse the funds on your behalf.
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