How To: Debt Settlement Programs

(February 2025)

How To- Debt Settlement Programs

In This Article

Do you have a feeling of frustration with high credit card or loan balances? Debt settlement programs provide relief. But are these services an effective debt solution, or do they leave consumers deeper in debt?

Debt settlement companies renegotiate, settle, or alter the terms of your debt balances with creditors. However, dealing with these companies poses considerable risks that you should weigh carefully before signing up. 

The debt settlement process typically involves stopping payments to creditors so accounts become delinquent, which prompts creditors to negotiate a lesser settlement. However, halting payments can severely damage your credit, result in late fees and interest charges, and lead to potential lawsuits while you save up for settlements. 

There’s no guarantee a company will settle all your debts – leaving you still owing money, now at higher amounts with worse credit.

While companies like National Debt Relief market themselves as reliable providers, debt settlement carries inherent risks, with no assurance of settling all obligations or ending up better off. Make sure you fully understand the credit impacts, fees, and likelihood of all debts getting settled before pursuing this path.

SUMMARY

1. Understand what debt settlement is

2. Review your finances

3. Weigh all the pros and cons 

4. Review complaint records thoroughly

5. Beware of the tax consequences

6. Choose a debt settlement company

7. Enroll in the program

8. Communicate regularly

Recap

1. Understand What Debt Settlement is

To apply for a debt settlement program, ask yourself, what is a debt settlement program all about? To understand this program, here is an explanation. Debt settlement involves negotiating with creditors or third-party debt collectors to try to pay off your unsecured debts like credit cards or medical bills for less than the full outstanding balance. 

For example, if you owe $10,000 across multiple credit cards, the debt settlement company contacts the creditors to try to reach an agreement to accept a smaller lump sum payment, say $6,000, and consider a waiver for the remaining $4,000.

This provides substantial savings, with settlements erasing 50% or more of your debts in some cases. However, debt settlement companies charge fees for their services, either a percentage of debt enrolment or a monthly fee. These fees can total 15-25% of the debt amount.

Additionally, when you sign up for debt settlement, you’ll typically stop making monthly payments to your creditors. But halting payments also means accounts become delinquent, triggering late fees, penalty rates, and extra interest charges.

2. Review Your Finances

To pursue a debt settlement, carefully review your complete financial situation to determine if it’s the right debt relief option for you. 

Debt settlement works best for unsecured debt like credit cards, payday loans, medical debt, and personal loans where creditors have no lien rights on property. Secured debts like mortgages generally don’t qualify.

You also need sufficient income to set aside monthly savings that will fund eventual settlement offers.

Examine the potential credit impacts. Your scores will take an initial hit when accounts become delinquent and get sent to collections during settlement. However, credit improvement is possible in the long run after eliminating debts.

Get a free consultation with a nonprofit credit counseling agency before debt settlement through credit unions, military personal financial managers, U.S. Cooperative Extension Service branches, and others. Your financial institution or local consumer protection agency also may be able to refer you to a credit counselor.

3. Weigh All The Pros and Cons

To decide on adopting a debt settlement program, weigh all the potential advantages and drawbacks.

On the positive side, debt settlement provides an opportunity to resolve unsecured debts for fractions of the true debt amount. If you negotiate well, settlements eliminate 50% or more of your balances. This produces significant savings.

However, enrollment fees and monthly service fees apply. These total 15-25% typically and reduce your net savings.

In addition, there is no guarantee all your debts will clear successfully. You may still owe balances if some creditors refuse to negotiate a deal. 

Any savings from debt settlement can be eroded by rising balances on accounts not without settlement yet due to accumulating late fees, interest, and penalties while enrolling in the program.

Essentially the process involves defaulting on debts to force creditors to negotiate which can worsen finances if not all debts get a resolution.

Consider all these factors carefully depending on your specific debts and budget. Debt settlement sounds appealing but results vary widely.

4. Review Complaint Records Thoroughly

To avoid regrets after opting for a debt settlement program, check complaint sites for any concerning trends of customer issues or lack of responsiveness. Look up the company’s Better Business Bureau (BBB) rating to catch concerning complaint patterns. Search online for the company name plus words like “scam” or “complaint” to uncover issues.

5. Beware of The Tax Consequences

To have a smooth experience while using the debt settlement program, beware of the tax consequences. The IRS considers any forgiven debt above $600 as taxable income.

For example, you settle a $10,000 credit card balance for $4,000. That eliminates $6,000 of debt. But unless an exception applies, the IRS will treat that $6,000 cancellation as income you have to pay taxes on.

Depending on your tax bracket, state taxes, etc., the bill on forgiven debt income could reduce your net savings from the settlement substantially.

Some exceptions do exist. For instance, if you are insolvent and liabilities exceed assets, there can be an exclusion of debt cancellation.

Work with a tax professional to understand if any IRS exceptions apply to your situation. And be sure to set aside a portion of settlement savings to cover potential taxes.

The last thing you want is to settle debts at a discount only to then face a big tax bill you didn’t anticipate.

6. Choose a Debt Settlement Company

To choose a debt settlement company, look for a company that has experience in the field. You want professionals who know what they’re doing to assist you in navigating the process. Transparency is also crucial!

You don’t want any surprises along the way. It’s always a good idea to ask for recommendations from friends and family. If you have a financial advisor, don’t hesitate to reach out to them as well. 

While you’re at it, take some time to check online reviews. Hearing about other people’s experiences provides you with a better understanding of each company’s track record and reputation in the industry. 

Have you heard of debt settlement scams? There are a few red flags to watch out for:

  • Avoid any company that asks for upfront fees before settling your debts or creating a debt management plan.
  • Be cautious of any company that guarantees to settle all of your debts or promises fast loan forgiveness. 
  • To enroll you, legitimate companies always review your financial situation.
  • Watch out for organizations that claim to be part of a “new government program.” 
  • Consider it a warning sign if a company advises you to stop communicating with your creditors.

Note: If you come across any suspicious debt settlement or debt relief organizations, report them to the Federal Trade Commission (FTC) at ReportFraud.ftc.gov. You can also contact your state attorney general or your local consumer affairs office.

7. Enroll in The Program

To enroll in a debt settlement program, contact the company for its eligibility requirements and enrollment processes. Once you enroll, it’s time to adjust your payment strategy. Instead of making payments directly to your creditors, start depositing monthly savings into a dedicated account.

Keep in mind that the debt settlement process can take time. It often takes two to four years to complete, and during that time, you may incur additional interest and fees from your creditors. 

This is because debt settlement companies typically advise you to stop making payments to your creditors while you work with them. 

8. Communicate Regularly

To stay up-to-date during the program, maintain regular communication with the debt settlement company. Stay in touch with them to receive updates on the progress of your negotiations. Ensure that they are actively working on your behalf to negotiate your debts.

Do not hesitate to ask questions along the way if you have any concerns or need clarification.

It’s important to remember that settling your debts is just the beginning. Focus on rebuilding your credit by making timely payments and keeping your balances low in the future.

Recap

Debt settlement programs involve negotiating with creditors to pay off unsecured debts for less than the full amount owed. While this can lead to savings, it can also damage your credit and there is no guarantee all debts will be settled. It is important to review your financial situation and consider alternatives before enrolling. Choose a reputable company, communicate regularly, and be aware of potential tax consequences. Rebuilding credit after settlement is crucial.

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