Is debt settlement right for you? This article is meant to help you decide if debt settlement is the best option.
What is debt settlement?
Debt settlement is basically what it sounds like. You and your creditor(s) agree that you only have to pay a portion of what is owed. This usually only occurs after you’ve missed payments, your credit scores have been shredded, and they know they’re unlikely to get the whole balance back.
On average most people end up only paying 40%-50% of what they originally owed after the debt settlement process is complete.
Are there drawbacks to debt settlement?
Are there drawbacks to debt settlement? Like almost anything except for breathing the answer is yes.
Damage to your credit. Debt settlement can drop your credit score significantly. However, most people who are at the point where debt settlement is needed are already dealing with less than perfect credit.
Also after the debt consolidation process it is recommended you go through credit repair to get your credit back on track.
The forgiven amount might count as taxable income. There is a chance that the forgiven debt might be considered as taxable income by the IRS. However with the new tax law significantly increasing the standard deduction that won’t affect most people.
Alternatives to debt settlement
Before we get into whether debt settlement is the right option for you lets explore the alternatives to debt settlement shall we?
Debt consolidation loans
A debt consolidation loan is where you take out a loan and pay off your debts with that loan thus turning multiple payments into one single payment.
That may sound good but there are some significant draw backs to these types of loans.
The interest rates are usually very high. By the time most people are at the point where they need a debt consolidation loan their credit usually isn’t in mint condition. As a result the lenders will charge very high interest rates; many times above 30%!
Many loans even have instant interest. That means you have to pay the total annual interest no matter how soon you pay back the loan.
In many cases you’d be better off just leaving your debt unconsolidated rather than getting a high interest rate debt consolidation loan.
Getting approved for the amount needed is difficult. If you’re $10,000 in debt or over it won’t be easy to get someone to give you an unsecured loan for the amount needed. Many lenders will require some sort of collateral on top of charging you exorbitant interest rates.
Most people who get these loans put their vehicles on the line–assuming the car is worth more than $10,000–and then end up losing their car when they can’t keep up with the high payments.
The subprime lending market is harsh. Most people who owe more than $10,000 in unsecured debt and are behind or about to fall behind on their payments are considered subprime by lenders. That means lenders in these markets know a large percentage (upwards of 50%) will default on their loans.
In order to cover those losses they must charge everyone else high interest rates and use strong arm tactics to ensure repayment.
Strong arm tactics such as:
Requiring Bi-weekly or even weekly payments
Giving them direct access to your checking account so they can withdraw funds directly without your knowledge or consent…okay technically you do give them consent but its buried in the terms and conditions that no one reads
Making you put your car or home as collateral. Most people would put their car as collateral and then lose their cars when they fall behind on their payments which in turn cripples their ability even further to earn a living.
Bankruptcy is a better solution than debt consolidation loans but it’s not without its drawbacks.
Qualifying for chapter 7 bankruptcy. The bankruptcy laws changed in the early 2000’s making it significantly more difficult for most people to file for bankruptcy than it used to be. The new bankruptcy law created an ‘assumption of abuse’ for bankruptcy filers. In other words the courts default position is to be that you are trying to commit fraud by filing for bankruptcy.
Most Americans no longer qualify for chapter 7 bankruptcy.
Chapter 13 bankruptcy takes 3-5 years. That means you’ll have those creditors hanging over your head for that period of time. Debt settlement, on the other hand, only takes 12-48 months on average.
During those 3-5 years you’ll be financially under the control of a judge or magistrate. All significant financial decisions will have to be approved by him or her.
A family member filed for chapter 13 bankruptcy and needed a car; badly. However since he was under chapter 13 bankruptcy he had to get the purchase approved by a judge. It took him over a month to get thumbs up all the while he was without good transportation.
Bankruptcy is expensive. The average bankruptcy attorney can charge anywhere from $1500 to over $5000 depending upon the complexity of your case.
Oh and most of them want their money upfront or a significant deposit first.
Bankruptcy could cost your you home. Contrary to popular belief you can lose your house if you file for chapter 7.
…it’s likely that a debtor will lose the home in a Chapter 7 bankruptcy if there’s significant equity that the trustee can use to pay creditors.
-Nolo Law Firm
By law the bankruptcy court is obligated to take whatever non-exempt assets you have in order repay your debts.
Bankruptcy ruins your credit for 10 years. Having a bankruptcy on your credit report automatically shuts the door to most lenders. For the next 7-10 years you will be considered a subprime borrower which means you’ll pay extortion level interest rates on all borrowed money and that’s if you can get anyone to lend you money at all.
‘Non-profit’ credit counseling
Most of these are scams and most of the ‘non-profit’ organizations were shut down for abusing their non-profit status in the early 2000’s.
Typically the ‘counselor’ will negotiate with your creditors and try to get your interest rates reduced. However, since interest rates are still at historic lows chances are that won’t happen.
In addition they charge you a monthly fee (sometimes as high as $79 a month) and you are required to pay 2% each month. On top of all that your credit will still be ruined since a lot of lenders consider this equivalent to a chapter 13 bankruptcy!
Should I settle my debts myself or use a debt settlement company?
The thing about these scenarios is its highly unlikely a creditor will agree to a 50% haircut right off the bat.
You can settle yourself but it may be difficult. Remember these creditors have a lot more experience than you. They do this everyday you’ll hopefully only have to do this once or twice in your life.
A reputable debt settlement company will give you a professional counselor that is on your side to get the best deal for you.
In addition debt settlement companies aren’t allowed by law to charge upfront fees.
Get a company that charges based on the amount of debt eliminated. This will give them an incentive to get rid of as much debt as possible.
Are debt settlement companies a scam?
No, contrary to popular belief dishonest companies don’t stay around that long. Debt settlement companies are for profit organizations set up to help customers in exchange for a profit. If they–as any business–weren’t providing value they wouldn’t be around very long. Enron anyone?
In other words if both sides don’t benefit the transaction doesn’t occur. Period. National Debt Relief has an A+ BBB rating. I seriously doubt they would have that if they were a scam or cheating customers.
Can I buy a house after settling my debts?
Yes, if you have a good payment history and get a credit repair you can buy a house within 1-3 years after the debt settlement process is complete.
When is debt settlement the right option?
When you should settle your debts truly depends on your particular situation. There is no uniform answer. The best way to know if you should settle is to call 855-224-0820 and speak to a debt specialist.
Let’s look at these scenarios to see when settling is and isn’t appropriate.
Scenario 1: Mary
Mary is a single mother of two who earns $30,000 per year as a secretary and is renting in California. She owes $20,000 in debt (not counting her student loans) and is behind on her payments. Her credit is already shot and she is pretty much judgment proof–meaning its not worth her creditors time to sue her.
Mary is currently in school to be a nurse and graduates in two years. She wants to to buy a home for her and her two children shortly after she graduates and gets a job.
She has consulted a reputable debt settlement company that has said they can settle her debts for 50 cents on the dollar ($25,000).
In this scenario I would advise Mary to settle and instead of filing for chapter 7 bankruptcy.
1. If she files for bankruptcy she may not be able to buy a home for the next 7-10 years.
2. She may not get a discharge. Her creditors may argue that while she is indigent now after she graduates from nursing school she will have more means to pay back her debts. A judge may throw out her case.
3. The settlement process takes anywhere from 12-48 months instead of the 3-5 years that a chapter 13 bankruptcy would take. After which she can get a credit repair and still qualify for a home loan after she graduates.
4. It would cost her $2000 to hire an attorney who would most likely want his or her money upfront. She simply doesn’t have $2000 sitting around.
Scenario 2: Steve & Joan
Steve is married and together he and his wife Joan make about $75,000 per year, they both live in California, and own two homes a primary residence and a rental. They have mortgages on both of them and very little unprotected equity in the rental but a lot in their primary residence. They owe about $90,000 in unsecured debt and $550,000 on their mortgages .
Their renters haven’t been paying, they had a death in the family, and they’ve had many unforeseen expenses. Unfortunately, they’re behind on their payments and have been for two years. Their credit is also shot.
They consulted a reputable debt settlement company that has said they can settle their debts for 50 cents on the dollar ($45,000).
In this scenario I would advise Steve & Joan to settle.
- They don’t qualify for chapter 7 bankruptcy since their income is above the California state median for 2 people which is $32,827
- They may qualify for chapter 13 but they would take 3-5 years to complete
- Even if they did qualify for chapter 7 bankruptcy they would definitely lose their rental even though there isn’t that much equity and possibly their primary home as well because it has so much unprotected equity
Frankly in this scenario if they were offered a 50% settlement I would advise them to take that offer and run!
Scenario 3: Katelyn
Katelyn is single and earns $50,000 a year. She is renting but wants to buy a house in Texas in two years. She owes $24,000 in student loans and has $30,000 in credit card debt. Katelyn went on some shopping sprees and used her credit card to make up for expenses not covered by her student loans.
She was able to make her payments until a year ago when she had to pay for her mother’s medical expenses and burial. Unfortunately she is behind on her payments and her creditors are threatening to sue her.
She consulted a reputable debt settlement company that has said they can settle her debts for 50 cents on the dollar ($15,000).
In this scenario I would advise Katelyn to settle.
- She’s not eligible for chapter 7 bankruptcy since her income is well above the Texas median income for one person.
- A chapter 13 bankruptcy would take 3-5 years to complete during which time she couldn’t buy a house.
- After her settlement she can get a credit repair and buy a home after 1 year
Scenario 4: Kyle
Kyle is a single college graduate that’s making $30,000 in an entry level job and owes $10,000 in credit card debt. His dream is to quit is job and travel around the world for the next 5 years. His biggest asset is his car which he’s planning on selling to help pay for his world wide adventure.
He consulted a reputable debt settlement company that has said they can settle his debts for 50 cents on the dollar ($5,000).
In this scenario I would advise Kyle not to settle.
- He probably qualifies for chapter 7 bankruptcy
- Since he’s not planning to buy a home or anything significant within the next 5 years it wouldn’t be a big deal that his credit is ruined
- He’s got nothing to lose
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