How Debt Settlement Works and Whether It’s Worth the Risks?

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Written By Michel Gerrald

Knowledge, Success, & Happiness.
My vision is to shift the mindset of success.

Cash in Hand Showing Debt Settlement

The debt settlement industry is being fueled by debt settlement, with the CAGR predicted to climb between 2021 and 2026. As a result, debtors must choose between bankruptcy, debt consolidation, and debt settlement.

What is Debt Settlement & How it Works?

Creditors will only offer you a debt settlement plan if they know you can’t pay back the full amount of your debt. You’ve most certainly missed payments on several accounts, and a settlement will allow you to minimize your overall obligation by depositing funds into a savings account.

When the account reaches a particular amount, the settlement company negotiates on your behalf with the creditor to try to convince them to agree to accept the lump sum in your savings account as payment for your debt.

For example, let’s say you owe $10,000 to credit card company ABC. You contact the company and explain that you are having trouble making payments. After some back-and-forth, you agree on a settlement plan where you will pay the credit card company $5,000 over the next 12 months. 

Is it worth it to settle debts?

Maybe. Most financial counsellors consider a settlement to be a last alternative because your credit score would suffer as a result. The debt reduction business will request that you stop making payments, and because late payments are a big element in evaluating your credit score, your score will plummet dramatically.

Expect to get denied for any of the following in the near future:

You’ll settle the loan, but you’ll have to rebuild your credit. However, debt settlement businesses may be able to lower your debt by up to 50% and assist you in becoming debt-free in three years.

When the negotiation period is over and your debt is paid off, the company that helped you settle your debt will charge you a fee for their services.

Debt settlement, Debt Consolidation, and bankruptcy are methods of dealing with overwhelming debt. But which one is better? Let’s find out!

Debt Consolidation vs. Bankruptcy:

Bankruptcy provides a clear road to debt relief, but you must apply for bankruptcy in court. Furthermore, you will have a 7 to 10-year impact on your credit score, making it nearly impossible to receive a loan or line of credit.

Lenders would rather you settle and get part of their money back than file for bankruptcy and get nothing.

If the settlement is done correctly, the impact on your credit will be severe, but it will last less time.

Debt Consolidation vs. Debt Settlement:

Consolidating your debts may be an alternative that has a significantly smaller influence on your credit score. Debt consolidation is simple: combine your debts into one loan with lower interest rates and pay it off over time.

The idea is to consolidate payments so that they are more manageable for you.

When your payments are modest, you’ll be able to settle your debt while also improving your credit. If you use credit less, the loan may enhance your credit and minimize your monthly bill.

However, unlike a settlement, debt consolidation does not reduce your overall debt commitments.

Key Takeaways:

Here are some key takeaways:

  1. Debt settlement is not right for everyone. If you can afford to make your payments, it’s probably not worth the risk of damaging your credit score.
  2. If you decide to settle your debt, make sure you get everything in writing from your creditor. This will protect you if they try to come after you for the full amount later on.
  3. Be prepared to pay taxes on the forgiven debt. The IRS considers this income, so you will need to report it on your tax return.

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