If you are struggling to pay off a lot of debt, you may be considering debt settlement. Debt settlement companies offer to reduce how much you owe by negotiating with your creditors to settle your debt for a much smaller amount.
Say, for example, that you have a $10,000 balance on your credit card. With good negotiation and a little bit of luck, your credit card company might agree to accept $6,000 as payment in full, forgiving the remainder of your debt.
As the adage goes, if it sounds too good to be true—it probably is. When you’re in deep financial trouble, it’s easy to focus on the potential upsides without giving serious consideration to the downsides. We want you to make the best choice for your financial future, so we’ve outlined the pros and cons of debt settlement in this article.
Benefits of Debt Settlement
The most obvious benefit of debt settlement is that you will pay a fraction of what you owe to become debt-free. When debt settlement goes well, it can be a fast and relatively painless way to get out of debt at a reduced cost.
Downsides of Debt Settlement
However, not everyone is a good candidate for debt settlement. Even for good candidates, there is no guarantee it will work. There are several potential pitfalls of debt settlement that you should be aware of:
Creditors Aren’t Required to Negotiate
There’s a real possibility that your debt settlement company won’t be able to reduce your debts. Your creditors might not budge at the negotiation table, and some creditors won’t negotiate at all.
It’s Only for Certain Unsecured Debts
Debt settlement companies only work on unsecured debts such as credit cards. Secured debts, such as mortgages and car loans, are not eligible for debt settlement. Most debt settlement companies will not work with student loans, either.
Debt Settlement Companies Pocket Huge Fees
One big downside is that debt settlement costs money. Debt settlement companies may charge 15% to 25% in fees. For that $10,000 credit card balance, 25% is $2,500. If you pay $6,000 to settle your debt and $2,500 in fees, you’ve now paid $8,500 to settle your debt—not nearly as good a deal as it seemed.
Debt Settlement Hurts Your Credit Score
You might think that settling a debt will leave you with a clean and clear credit report, but that is not the case. When you pay off a debt using debt settlement, your creditor will report to the credit bureaus that the debt was “settled for less than agreed.”
What’s more, because debt settlement companies will generally advise you to stop making payments on your debts, creditors will continue to report late payment status updates, which hurt your credit score.
The IRS Can Tax You
Even if you get a great deal in your debt settlement, you may not be out of the woods just yet. If your settlement reduces your debt by more than $600, your creditor is required by law to notify the IRS.
For example, if your $10,000 in credit card debt is reduced to $6,000, the $4,000 you “saved” may now be considered taxable income. This could lead to an unpleasant surprise when tax time comes around!
Creditors May Make Harassing Phone Calls
While you’re not making payments on your debt, your creditors are free to make harassing phone calls. They may even take legal action, threatening to garnish your wages or send your debt to collection.
There’s Another Option
If you’re struggling to pay your debts, bankruptcy may give you the fresh start you’re looking for. As soon as you file for bankruptcy, creditors are not allowed to call you anymore, and you can begin rebuilding your credit immediately.
There are no surprises when it comes to the cost of bankruptcy. Unlike debt settlement, bankruptcy can protect your home from foreclosure and your car from repossession.
Our experienced attorneys will help you decide if bankruptcy is the right option for you. For a free, no-obligation bankruptcy consultation, contact Benson Law Firms today.
