It sounds like a good deal, but because payments aren’t made directly to the creditor for months, debt settlement destroys your credit. It can actually take two to four years to complete. Settlement companies can’t charge upfront fees, but it’s still costly. Debt settlement should be used as a last resort in eliminating debt.
1. High Fees
The debt settlement company’s high fees are usually specified in the enrollment contract and can range from 15% to 25% of the reduced debt amount. By the time these fees and future interest are added to your balance, any savings from the agreed settlement could be wiped out.
2. Credit Score Reduction
A debt settlement, with a company or creditor, will negatively impact your credit score. Payments previously made to the lender will now be paid to the settlement company. If not already, your credit account will become delinquent and charged off by the lender. The settlement may then be reported by the creditor to the credit bureaus. This will stay on your credit report for seven years. It will affect your future loan terms, credit availability, employment opportunities and more.
3. Tax Implications
In the end, because it’s considered taxable income, you’ll owe tax on the forgiven debt. If a creditor agrees to settle your debt in exchange for a reduced amount, you may still be responsible for paying taxes on a debt reduction of $600 or more. The creditor is then required to notify the IRS. For example, if you owe $10,000 and the creditor settles with you for a one-time payment of $7,500, the forgiven amount, $2,500, is considered taxable income.
Before you jump into a debt settlement program, find as much information as you can about the company. The decision involves a lot of money that could go toward reducing debt, so you need to find the right organization to work with. Your state’s Attorney General or local consumer protection agency can tell you if they’ve received consumer complaints about the company you’re considering choosing. Your Attorneys General can also tell you if the company is required to be licensed in your state and whether it actually is. To find information on either website, enter the company name with the word “complaints” into the search engine. That will pull up what others have said, news or lawsuits against them.
The company can only charge a portion of their full fee, for each debt it settles. They are legally required to give you specific information about the program before you sign up with them. The company must inform you of the cost and terms, how long it will take to get the creditors to settle, the amount of money that needs saved before they make an offer to the creditors and the possible damage it could cause to your credit report and credit score. They should also remind you that creditors could sue or turn you over to collections. As well, the creditors may charge additional fees and interest, which will increase the balance on your accounts. Lastly, if the company has saved your money from payments you’ve made and its earned interest, the company should communicate that you may withdraw, without penalty, the money at any time.
You Have Rights
You have legal rights when it comes to outright harassment from creditors or loan companies through the Fair Debt Collection Practices Act.
- Call you before 8 a.m. or after 9 p.m.
- Yell, swear or use crude language.
- Threaten you with arrest, bodily harm, firing, deportation, public shaming or anything else.
- Do anything that could be considered harassment, such as phoning incessantly or making hang-up-calls.
Working with a debt settlement company is just one option for dealing with debt. There’s also the option of working with a debt management company, negotiating directly with your creditors or bankruptcy.
Debt Management/Credit Counseling
This is the best option when dealing with unsecured debt. Debt Management/Credit Counseling is a plan you enroll in, where a company negotiates with creditors on your behalf. They negotiate lower monthly payments, reduced interest rates and roll several debts into one monthly payment. Typically the plan is structured to last three to five years. The goal is paying off your debt entirely. Trinity is a debt management company and we’d love to work with you. You can reach us at 1-800-758-3844 or you can fill out an online application
Declaring bankruptcy has serious consequences. You can lose property and even have to give up possessions for sale in order to repay creditors. Bankruptcy also damages your credit. It can affect how future lenders view you and they may decline extending you credit in the future. Filing for bankruptcy under Chapter 13 allows people with a steady income to keep property, like a mortgaged house or a car that they might otherwise lose through the Chapter 7 bankruptcy process. In Chapter 13, the court approves a repayment plan that allows you to pay towards your debts over three to five years, without surrendering any property. After you have made all the payments under the plan, your debts are discharged. As part of the Chapter 13 process, you will have to pay a lawyer and you must get credit counseling from a government-approved organization within six months before you file for any bankruptcy relief. Bankruptcy will stay on your credit report for 7-10 years.
Work with the Credit Card Company Directly
Rather than pay a company to work with creditors on your behalf, you can try and do it yourself. You can find the creditors telephone number on your card or monthly statement.
If you haven’t made payments toward your debt for 180 days, your creditor will write it off as a loss; your credit score will take a big hit and you’ll still owe the debt. Creditors are often still willing to negotiate with you even after they write your debt off as a loss. Keep good records of your debts, so when you do reach them, you can explain your situation. Your goal is to work out a modified plan that reduces your payments to a level you can manage.
The Bottom Line
If it sounds too good to be true, it probably is. Be smart: Don’t fall victim to misleading claims or pay money for something that will hurt you later. Never sign anything you don’t fully understand. If you want to maintain a good credit score and you’re just one or two months behind or current on your accounts, debt settlement is not for you.
Consider Trinity, a debt management company. We’ll help you reduce monthly payments and lower interest rates.