You’ve probably heard commercials on the radio, or seen ads on the Internet: You can get rid of your debt, paying just pennies on the dollar for what you owe.
These types of offers are typically the result of debt settlement efforts. In some cases, the promises are true; there are some companies that can help you settle with your creditors so that you only pay between 30% and 80% of what you actually owe.
But before you jump into debt settlement, it’s important to understand how it works.
How Does Debt Settlement Work?
The theory behind debt settlement is fairly straightforward. You offer to pay your creditors a lump sum to clear off your debts. You might owe $5,000, but if the creditor is concerned that you will be unable to keep making the required monthly payments, and that you might end up defaulting altogether, the creditor might agree to take $3,000 right now. (It’s also worth noting that, in many cases, creditors have already received enough in interest to more than cover the original amount borrowed, especially if the obligation is a credit card or some other high interest consumer loan.)
The key, though, is that the creditor has to think that there is a small chance that you will actually pay the entire amount owed over time. This means that, in order for debt settlement to be most effective, you have to stop paying your bills. Debt settlement companies that handle these transactions on your behalf usually insist that you make payments into an account set up by the debt settlement company. These payments, less the administration fees charged by the settlement company, add up until a creditor agrees to a settlement.
As you might imagine, the fact that debt settlement works best after it’s become clear that you aren’t making regular payments means that your credit score is going to take a dive. Your missed payments are going to be reported to the credit bureaus, and that means that you will end up with negative information in the most important part of your credit score — your payment history.
This is something you need to be prepared for if you want to go the debt settlement route. If you don’t mind the dings to your credit, and you are most interested in getting out of debt by paying as little as possible, settlement can work on your behalf.
Watch Out for Scams
It’s possible for you to negotiate your own debt settlement with your creditors. However, many consumers prefer to have someone else take care of the heavy lifting. If you decide to go with a debt settlement company, you need to be on the alert for scams. Carefully vet the company, and make sure you get all of the terms in writing. While you will be expected to pay fees, be wary of large fees to be paid up front.
Carefully vet any company you decide to use for debt settlement. You don’t want to lose your hard-earned money AND destroy your credit.
With the right approach, it is possible to settle your debts. Just be aware of the possible consequences.