What is debt settlement?

Debt settlement allows a debtor to negotiate with a creditor to pay less than the amount owed for a debt. Debt settlement may also be referred to as credit settlement, debt negotiation or debt arbitration. Debt settlement is just one of many strategies to eliminate debts. It has financial risks and is not the right solution for all debtors.

How does debt settlement work?

Debt settlement allows a debt settlement company to contact a debtor's creditors and negotiate an acceptable settlement rate. The rate varies, but some settlements may allow the debtor to pay 40 to 60% of the total amount owed. If a creditor is willing to accept less than the full amount owed from the debtor it is because they believe if they do not settle they will receive nothing.

If you hire a debt settlement company they will charge you a monthly payment, which they will distribute to your creditors, minus the fee they charge.

Cons of debt settlement

Failing to pay your bills and resorting to any type of debt settlement or bankruptcy will have negative financial consequences. Debt settlement may lower your credit score because the lender is likely to report the debt as "settled for less than agreed" or "settlement accepted," damaging your credit reports for seven years. The creditor may also continue to report the payments as late until the account is charged off, sent to collections or is settled.

Debt settlement can also be expensive. For example, some debt settlement companies may charge up to 15% of the unsecured debt balance to provide the debt settlement service. They also may not be upfront about how much of the money they are charging is going to actually reduce the debt and how much is being deducted for their fees.

Finally, debt settlement companies may also refuse to work with certain customers, especially if they do not believe they have enough money to afford the program.

Benefits of debt settlement

Debt settlement can, under specific conditions, allow you to negotiate and pay a much lower payment for your debts. In fact, if creditors agree to work with the debt settlement company, in some cases your payments could be as much as 50% less than the original amount of debt owed, which will save you money.

Debt settlement vs. Bankruptcy

While debt settlement allows you to negotiate with creditors to pay less than the amount you owe for a debt, bankruptcy will allow you to either discharge unsecured debts or create a repayment plan to repay a portion of your debts to your creditors.

Like debt settlement, bankruptcy will also lower your credit score, and will remain on your credit report for 7 to 10 years. Consider also, not all debtors will qualify for Chapter 7 bankruptcy. In fact, if your income or disposable income is too high you will not be able to file Chapter 7 bankruptcy.

If you are considering bankruptcy or debt settlement, a consultation with an attorney experienced in both debt settlement and bankruptcy can answer your questions.