Is debt settlement a good option? What are its pitfalls and alternatives?

Debt settlement is a viable option when you are struggling to repay huge balances on your credit cards and personal loans. It can help solve your debt problems fast. However, you need to be aware of certain pitfalls before resorting to this option.

Here’s how debt settlement works, its pitfalls, and the alternatives to this debt relief option.

Debt settlement – How it works

Debt settlement or debt negotiation is a debt relief option through which you get rid of your dues by paying less than what you owe to your creditors. You can opt for professional help or a DIY settlement option.

If you opt to settle your debts yourself, you will have to negotiate with your creditors to reduce the outstanding debt amount.

If you use a debt settlement company, professional debt negotiators will try to convince your creditors to reduce the outstanding balance as much as possible. They will also analyze your financial situation and ask you to make an affordable payment to the settlement company every month. Once you accumulate a substantial amount, the company will use the saved amount to pay a lump sum to a creditor, and you will get rid of that debt. Likewise, you repay debt one after another. However, when using professional help, hiring a good debt settlement company is essential.

What are the risks of debt settlement?

There are certain risks associated with debt settlement. You need to be aware of these before resorting to this debt help option.

Debt amount can increase

A debt settlement company can ask you to stop making payments to your creditors for the time being. However, while doing so, you can incur additional charges and penalties that will increase your outstanding debt balance. It may add up to hundreds or thousands of dollars to the balance.

Credit score can reduce

When you can’t repay your credit card debt and the outstanding balance on your personal loans, you already become delinquent on your accounts. You will also stop making payments to your creditors and offer a lump sum once you save the required amount. The delinquent accounts and settled accounts will remain on your credit reports for seven years. As a result, it will affect your credit score negatively. However, its effect will reduce with time once you start adding positive items to your credit reports.

Forgiven debt can be taxable

You save a significant amount by opting for debt settlement. However, you may have to pay tax on the forgiven debt amount. This is because the IRS (Internal Revenue Service) considers forgiven debt as the debtor’s income. You should consult a tax professional to inquire about additional tax obligations, if any.

Professional fee

You will have to pay a fee to the settlement company, along with paying back the debt balance. However, make sure that you don’t pay any upfront fee before they negotiate with your creditors. A debt settlement company may charge about 25% of the eliminated debt amount. You could save this amount if you settle yourself. But, again, a settlement company can negotiate with your creditors in a better way.

You can avoid certain pitfalls by opting for other debt relief measures beforehand.

What are the alternatives to debt settlement?

You can opt for these options as an alternative to debt settlement.

Consolidate debts through professional help

If handling multiple debts is your primary concern, then you can enroll in a consolidation program. By doing so, you can make single monthly payments towards paying off your multiple bills. Therefore, it becomes easier to manage your debts. A consolidation company can negotiate with your creditors to reduce the interest rates on your accounts. You have to pay an agreed-upon monthly amount to the consolidation company, who will distribute the payments to your creditors on your behalf.

Opt for a balance transfer

This option makes it easier since you don’t have to make interest payments for a few months if you can take out a 0% balance transfer card. Even if not a 0% card, a card with much lower interest can also help you repay debts faster. You can shift your debt to such a card and repay the balance within the introductory period of the balance transfer card. Usually, the interest-free period lasts for as long as 18 months.

Take out a consolidation loan

A consolidation loan is like a personal loan you can use to repay your existing balances. Then, you will make monthly payments to repay your new loan. The interest rate on a personal loan is relatively lower than that of credit cards. If your credit score is good, you may be able to take out a consolidation loan at reasonable terms and conditions.

File for bankruptcy

Though it is considered the last resort to get rid of debts, it can help give you a fresh start. Most of your unsecured debts will be discharged through bankruptcy. Depending on whether you file Chapter 7 or Chapter 13 bankruptcy, it will take four months to five years to get discharged from debts.

It depends on you whether you can reduce the adverse effects of debt settlement and choose this option to get rid of your debts. However, while opting for debt settlement, make sure you hire a reliable and experienced debt settlement company. Also, while opting for settlement, make sure you manage your finances such that you can make the payments on time and get rid of debts quickly.

About the Author: Lyle Solomon has considerable litigation experience as well as substantial hands-on knowledge and expertise in legal analysis and writing. Since 2003, he has been a member of the State Bar of California. In 1998, he graduated from the University of the Pacific’s McGeorge School of Law in Sacramento, California, and now serves as a principal attorney for the Oak View Law Group in California.

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