Debt Settlement: A Comprehensive Guide to Resolving Your Debts

When it comes to getting a handle on your debt payments, there are options to help you do so. Debt settlement is a process of negotiating with your creditors, either by yourself or with the help of a representative.

Let’s take a closer look at exactly what debt settlement is and how it works. 

What Is Debt Settlement?

Definition and Overview

Debt settlement is a type of debt relief where you work with your creditors to lower the amount you owe on your debt. Some people hire a debt settlement or debt resolution company to negotiate on their behalf. If your creditors agree to forgive or cancel part of your debts, you’ll work with them or the debt settlement company on a new repayment plan. 

There are other debt relief options available, like debt consolidation, where you take out a new loan to pay off your old ones. Ideally, it’ll help you streamline payments and lower monthly payments. 

How Does Debt Settlement Work?

How debt settlement works is by first presenting your case to creditors and attempting to come to an agreement about what you owe. 

The Process of Debt Settlement

A key part of the debt settlement process is debt negotiation, where you or the debt settlement company you work with will attempt to reduce the amount you owe and settle the debt for less. Creditors are more willing to negotiate with you if they know that you’re having a financial hardship that makes it difficult or impossible to repay the full amount you owe. From their perspective, it’s better to get something than nothing. 

During negotiation, you’ll most likely have to plead your case and explain the financial hardship you’re facing that makes it difficult to repay the loan.

Anyone can try to negotiate their own debts. The process can be time-consuming, stressful, and even overwhelming. You’ll almost certainly have to go through several rounds of communication with each creditor. You’d need to contact each lender, negotiate with them to reduce what you owe, and get a written agreement that outlines the terms of your negotiation. 

Even working with a debt settlement company is not a guarantee that creditors will agree to settle your debt. Some other common pitfalls of debt settlement are a negative impact on your credit score (although you’ll have time to improve it) and the possibility of having to pay taxes on the forgiven debt (if you’re not insolvent when you settle the debt). 

Eligibility for Debt Settlement

In most cases, those who are eligible for debt settlement are borrowers who can prove they’re really struggling to make debt payments. The types of debts usually eligible for debt settlement are unsecured debts.

Examples include:

• Credit card debt

• Department store charge card debt

• Personal loan debt

• Medical debt

• Some private student loan debt

Secured debt like mortgages and car loans are not eligible for debt settlement. 

If you’re a small-business owner and used personal credit cards for business expenses, debt from those cards could be enrolled in a debt settlement program. But a debt settlement company typically can’t help with business debts.

Pros and Cons of Debt Settlement

Advantages of Debt Settlement

• May owe less on your debts: Debt settlement works to lower the amount you owe so you could get some relief and not fall further behind on payments.

• Could streamline debt payments: One main advantage to debt settlement is the ability to streamline multiple debt payments into one. Instead of paying your creditors individually, a debt settlement company usually sets up a dedicated account where you make a single affordable monthly deposit. 

• Costs less than alternatives: Yes, there may be fees associated with working with a debt settlement company. However, you could end up paying less than what you would have owed on your debts without negotiating them. 

• Could be a better option than bankruptcy: Debt settlement programs may provide more favorable repayment options compared to bankruptcy filings. Also, debt settlement is private. Bankruptcy is a public record.

Disadvantages and Risks of Debt Settlement

• Impact on your credit score: The debt settlement process involves setting aside money for settlement offers. Many people can’t afford to this and also make their debt payments, so they choose to stop making debt payments (they may already be behind on their bills). Missing payments is almost always harmful to your credit score. But it also demonstrates that you’re struggling financially.

• Creditor or collection agency calls: If your debt goes into collections, debt collectors may try to contact you. 

• Potential legal action: Some creditors may threaten or actually take legal action to get you to repay your debt. It’s important to know your legal rights as you go through the debt negotiation process. 

At Freedom Debt Relief, if a creditor takes legal action against you for an enrolled debt, we may engage a Legal Partner Network attorney who will attempt to negotiate a settlement. This service is free for qualifying clients who have made their monthly deposits on time. The offer does not apply to legal action taken before you enrolled, or to legal action taken on debts that are not enrolled.

• Possible taxes owed: If creditors are willing to lower the amount of debt you pay, that could have tax implications. That means you may have to pay taxes on the amount of debt canceled or forgiven. If you are insolvent when you settle the debt (meaning your debts are worth more than your assets), you may be exempt from federal income taxes on the forgiven debt.

While you could get some financial relief by settling for less than what you owe, knowing the risks is just as crucial. Speaking with a reputable debt settlement company could help you get a deeper understanding of whether the benefits of debt settlement outweigh the risks. 

How to Choose a Reputable Debt Settlement Company

When you evaluate debt settlement companies, it’s important to know how they operate. And as an increasing number of consumers accumulate debt, more debt settlement companies are cropping up to take advantage of the opportunity. Unfortunately, not all have the history and experience to get the best results for clients. 

Red Flags to Watch Out for

Here are some red flags to look for when choosing a debt settlement company:

• No customer reviews: Most reputable debt resolution companies will have an online presence. If you’re unable to find any reviews for the company, such as from the Better Business Bureau, or speak to anyone who has worked with them, you may want to steer clear.

• No clear negotiation process: A good company should be able to explain clearly and exactly how it’ll help you negotiate debts and the ways it’ll keep you informed throughout the process. 

• Unclear fees: Some companies may charge a fee up front or be unclear about what the fees they charge. Stay away from any company that charges upfront fees, avoids talking about fees, or won’t detail its fees before you sign a contract.

• Untrained counselors: You want to be sure the debt counselor you work with is experienced and trained in negotiating with creditors. Consider looking for debt settlement companies that are members of the American Association for Debt Resolution (AADR). This organization enforces a strict code of conduct for its members, and companies can only join if they comply with the industry’s Federal Trade Commission regulations. Not being an AADR member is one sign of a company that may not be reputable.

Key Questions to Ask Before Signing Up

Before working with a debt settlement company, take the time to speak to each one to assess whether it provides the level of integrity, experience, savings, and customer service you expect and deserve. To choose the debt settlement company that could best help you eliminate your credit card and other debt, ask these key questions:

• How much will the program cost each month?

• What are the program’s negotiation fees?

• How many creditors have you settled debts with?

• How will you keep me informed during the debt negotiation process?

• Where can I read client reviews from real clients?

Trust your instincts when evaluating a debt settlement plan. If your gut feeling about a debt settlement company is negative, chances are that company is not the best fit for you.

Common Myths and Misconceptions About Debt Settlement

Myth: Debt Settlement Is an Easy Way Out

Debt settlement isn’t a quick fix, and it won’t be an easy process. It could take longer than you think. Plus, it requires that you make a solid plan and commit to settling debts, which could take time and work. Ditch the idea that debt settlement is a simple or quick fix. It requires commitment and planning. 

Myth: All Debts Can Be Settled

You may not be able to settle all of your  debts, particularly secured ones like auto loans and mortgages, or debts you owe to the government. If you have unsecured debts you want to settle, you might be able to, but first think carefully whether it’s worth it to go through the effort. 

Steps to Take After Completing a Debt Settlement

Hopefully, settling your debts helps you regain strong financial footing. Clearing at least some of your debts could put you in a better position to manage your finances going forward.

Rebuild Your Credit

After completing the debt settlement process, your credit score may be much lower than you’d like. Here are some ways you could work on improving your score:

• Check your credit reports and dispute any errors you find.

• Make consistent on-time payments on all your debts.

• Avoid applying for loans or credit cards until you really need to.

• Avoid carrying credit card balances. 

Avoid Future Debt Challenges

Working to ensure you avoid taking on more debt than necessary could prevent you from going back to square one. 

Some strategies to avoid unnecessary debt include building an emergency fund that you could tap into when unexpected expenses arise. Ideally, you’ll set this money aside in a separate account when you need it. This could be easier now that you have experience setting aside money in your dedicated debt settlement account. Set a goal of how much you want to save—it’s OK to start small.

You might also seek additional financial advice, such as how to budget with the income you’ve got so that you can better manage expenses. 

Is Debt Settlement Right For You?

Who Should Consider Debt Settlement?

Debt settlement is not the best debt solution for everyone. It’s for people who can’t afford to fully repay their debts.

Those who aren’t in deep financial trouble usually have less drastic options available—like DIY debt payoff strategies or debt consolidation. 

Consumers with high credit card debt and few assets, and people facing lawsuits may find bankruptcy to be the best choice. Chapter 7 can wipe out your unsecured debts if you qualify, and bankruptcy puts a temporary hold on any debt lawsuits that have been filed. 

Debt settlement requires you to have a strong commitment to getting out of debt, learn how to budget and live within your means, and be comfortable with having your credit score impacted. But it could help many people resolve their debt and get on solid financial ground.

Generally speaking, for those who don’t qualify for Chapter 7 bankruptcy or who own assets they might lose in a bankruptcy, trying to settle the debt yourself or with a debt settlement company could be a smart financial move. 

If you’re on the fence, you could contact a bankruptcy attorney or a debt consultant at a debt settlement company who’s trained to answer your questions and help you compare options.

Alternatives to Consider

Some options to consider instead of debt settlement include:

• Debt consolidation: If you can qualify for one, taking out a debt consolidation loan could help you lower your monthly payments. A longer repayment term or lower interest rate could help you get breathing room in your budget.  

• Credit counseling: There are many nonprofit credit counseling agencies that could look over your financial situation and help you come up with a strategy to pay down your debt. You won’t get any debt forgiveness, but you could get other kinds of help.