More often than not, financial struggles lead to poor decision making. If you are seeking to minimize your debt, it’s important to first understand how debt settlement works. Many debt settlement companies offer to reduce your debt by negotiating with your creditors but they don’t really explain how it will impact your credit score in the long run. Let’s evaluate some of the pros and cons of debt settlement to help you determine if this option is right for you.

How Does Debt Settlement Work?

Debt settlement is the process of offering a large, one-time payment toward an existing debt in return for the forgiveness of the remaining balance. This can be done by hiring a debt settlement company that takes your monthly payments and puts them into a savings account. Once the account has grown to a certain number, your debt settler uses the funds to leverage negotiations with the creditor. If your creditor agrees with the settlement amount, which is normally lower than your pending balance, your debt settler pays the creditor and collects a flat fee or a percentage of the debt that was canceled.

Sometimes creditors willingly choose to forgive a substantial portion of the balance because they may either be strapped for cash themselves or fear you won’t be able to pay off the entire balance. Not surprisingly, lenders don’t openly advertise debt settlement but they are often willing to use this option as a last resort. If you are behind on your payments to the point that you are ready to declare bankruptcy, your lender may be willing to take what it can get and agree to settle your debt. So the main benefit of approaching debt settlement is in your ability to significantly reduce the remaining balance.

But is it always the right choice? Let’s explore debt settlement process in greater detail to determine its impact on your credit rating and your overall financial posture.

Your Accounts Become Past Due

Debt settlement typically takes place when your payments are several months past due. That means that you have to stop making payments on your accounts if you want to pursue debt settlement. It also means that your late payments get reported to the credit bureaus and your credit score eventually drops to the point where you won’t be able to afford new credit cards or loans.

Even if the debt settlement company settles your debt successfully, the delinquent information can stay on your record for up to seven years. Your account will gain a status of “Charged-Off Settled” or “Paid-Settled” which is not nearly as good as a “Paid in Full” status.

You Could Owe Taxes on Settled Debt

The Federal Government considers the forgiven debt amount an income and requires you to pay taxes on it. You will owe more money to the IRS and will probably get a smaller refund check if any. Not many people know that even if they don’t receive a Form 1099-C for reporting canceled debts from their creditor, the IRS will still expect them to list their debt on their tax return.

Short-Term Debt Settlement Interrupts Your Cash Flow

If you are looking to settle your debt short-term, you’ll have to come up with a substantial amount of cash at one time – because this is what makes the debt settlement attractive to your lenders. Instead of getting minimum monthly payments, they are receiving a larger payment installment. To you, it means that you will have to ensure you have enough money saved to pay your lender and to sustain your daily life in the meantime.

You Can Only Settle Unsecured Loans

If you are settling unsecured debts such as credit cards, medical bills or personal loans, debt settlement is a good option for you. However, mortgages, homeowner’s equity or auto loans are hard to settle due to collateral involvement. The lender may not agree to the settlement if they think the collateral property can be seized and resold for more than the proposed settlement amount.

Still on the fence about pursuing debt settlement? Let us help! If debt settlement seems like a good option, we can help you handle the settlements and possibly save you thousands of dollars in the long run. Give us a call today or email us for more information. We’re ready to help!