What is Debt Settlement?

Written By Jeff Hindenach
Last updated December 1, 2020

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Personal Finance
January 17, 2017

Simple. Thrifty. Living.

With the holidays over and the leftovers gone, it’s time to deal with the outcome of all that shopping and gift giving — the bills. In the midst of the holiday season it’s easy to forget how expensive it can be, but when January rolls around, credit card bills are there to remind you. It can be even worse if you’ve already been racking up expenses and debt. In some instances, you may need to take serious steps to get out of debt. Fortunately, there are good debt relief companies out there that can help you settle your debt.

Simply put, debt settlement is the process of paying your creditors less than what you owe and having the entire debt erased off the books. But as easy as this may sound, accomplishing it can be complicated and difficult, and can have long-lasting implications.

If you’re going to have a hard time paying your bills, you should reach out to any debt settlement company you owe funds to before you become six months delinquent on the bill. If you don’t contact a debt settlement agent before this time, the company that holds the debt will generally write it off. This can have serious repercussions on your credit score.

The best debt settlement companies will negotiate with the firm that holds the debt on your behalf and will lower the obligation to an amount you can afford. To do this, the debt settlement company will need to review your complete financial statements. This means they will need to look over your bank statements, credit card balances, asset reports and any other documentation regarding what you might owe. From there, the debt settlement company will negotiate on your behalf to lower the rate.

The debt settlement company makes money by charging you a fee for their services. In general, that fee is a percentage of the amount by which they lower your debt load. Here is our Freedom Debt Relief review to give you a better idea of how debt relief services work. Or check out our Accredited Debt Relief reviews to compare the top services.

Debt settlement is not without cost. While debt settlement is not as bad as a straight default, the process can do serious damage to your credit score and can impair your ability to borrow money in the future. In addition, some debt settlement companies advise their clients to stop paying their bills during settlement negotiations. This practice can lead to late penalties, debt collection efforts and possibly lawsuits, all of which will increase the expense to you. Finally, any decrease in your debt load is taxable. If you have $1,000 in debt that you settle for $500, you have to report an additional $500 in taxable income on your next tax return.

Debt settlement is a last resort for people facing serious cash problems and it should not be entered into lightly. If not done properly, you could end up with more debt than you had at the beginning of the process. Before beginning any debt settlement process, consider working with a credit counselor. Credit counselors are generally non-profit organizations that can help you manage your finances and can negotiate on your behalf with creditors.

While you don’t get the immediate decrease in debt that you might achieve in a debt settlement, credit counseling can help you avoid a lot of the damaging effects that go along with a settlement. Additionally, credit counselors can ensure that your creditors won’t seek to collect on your debts while the counselors are helping to advise you and restructure your finances.

In short, you should really only proceed with debt settlement when credit counseling fails. Before you choose debt settlement as an option, make sure that the associated fees and penalties will be less money than the potential amount of forgiven debt.

About the Author

Jeff Hindenach

Jeff Hindenach is the co-founder of Simple. Thrifty. Living. He graduated from Bowling Green State University with a Bachelor's Degree in Journalism. He has a long history of financial journalism, with a background writing for newspapers such as the San Jose Mercury News and San Francisco Examiner, as well as writing on personal finance for The Huffington Post, New York Times, Business Insider, CNBC, Newsday and The Street. He believes in giving readers the tools they need to get out of debt.

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