Have you ever maxed out a credit card? Have you ever forgotten about a credit card bill for so long that the card was cancelled? If so, you may have been the recipient of a few phone calls. First, the issuing bank will call you to remind you you’ve got a past due balance. Then, the debt collectors will call.
Often, when debt collectors call, they offer something called a debt settlement program. But is this something you should take advantage of? Let’s look at debt settlement programs and how they can affect your debt and your credit.
What is Debt Settlement?
If you find yourself up to your ears in debt, you may be considering a debt settlement program. Never heard of this option? No problem. Here’s a summary of what debt settlement programs do.
Let’s assume that you’ve got a few maxed out credit cards and a hospital bill. You were out of work recently because of an injury, and the bills just keep piling up. Before long, the bank cancels your credit card and the hospital billing office keeps calling your employer.
You need a solution, and fast. One option is to hire a debt settlement company. Debt settlement programs are offered by for-profit companies. The service isn’t free, but can significantly reduce your bills.
What happens is the debt settlement company works with your creditors to negotiate a lump sum that you can pay. That sum is usually much less than the actual amount you owe – sometimes pennies on the dollar. Once you pay this lump sum, your debt is resolved.
Sounds like a good deal, right?
Well, there are pros and cons to debt settlement companies, so before you sign the paperwork, you’ll need to be aware of what these companies can – and can’t – do.
How Does Debt Settlement Work?
When you sign up with a debt settlement company, you’ll be required to put a specific amount of money into a savings account monthly. This savings account works like an escrow account, and the money is eventually used to pay off your debt … eventually.
Meanwhile, as you’re depositing money into this account, the debt settlement company will be in contact with your creditors. The company will presumably work with these creditors to negotiate a settlement amount for you. Again, this is usually much less than the amount you actually owe.
However, there are risks to debt settlement. Before you consider hiring one of these firms, it’s important that you know what a debt settlement program is unable to do for you.
Risks of Debt Settlement
We’ll keep this simple. There are several things you should consider before hiring a debt settlement company.
- The debt settlement company has no obligation to actually settle a debt. In other words, you could put money into an escrow account – sometimes for as long as three years – without any actual settlement agreement being reached.
- Most debt settlement companies will strongly urge you not to pay down your debts while negotiations are in process. This is usually because of the statute of limitations on old debts. However, if an agreement is not reached, your escrow payment may have been better spent paying down actual debt.
- The non-payment of those outstanding debts could further negatively impact your credit score.
- The monthly payment you’re required to make to the escrow account may or may not be sustainable for you. In some cases, if you leave the debt settlement program before the program is over, you may forfeit that money.
Put simply, it’s critical that you think carefully before you decide to hire a debt settlement company. In some cases, it’s easier to negotiate directly with your creditors.
How to Negotiate a Debt Settlement
There’s only one way to negotiate a debt settlement without risk of losing your money: call your creditor. And be sure to do so before your bill is sent to collections.
When you call your creditor, you’ll need to have a few key pieces of information. First, you’ll need to know the total amount of your outstanding debt, including principal, interest and fees. Secondly, you’ll need to know what you can afford to pay. Third, you’ll need to have a record of your payment history with the company.
If you’ve always had a good payment history with the creditor, there’s a good chance you can convince them to allow you to make small monthly payments on your account. Ask them to allow you to make these payments over the course of, say, a year with no additional interest added.
If you don’t have a great payment record, you’ll need to know what you can afford to pay as a lump sum. Imagine you owe a credit card $1,000. You may be able to negotiate a lump sum settlement of, say, $350.
Negotiating a debt settlement really is quite simple. Keep in mind, however, that not all creditors will (or are legally able to) allow settlements. There’s really only one way to find out: pick up the phone and ask!
Will Debt Settlement Affect My Credit?
In short, yes. In most cases, even when your debt is settled, it will still negatively impact your score. At the very minimum, a settlement will usually disallow you from opening a line of credit with that company in the future. For example, a credit card with USAA which has been settled will eventually disappear from your credit report. However, you’ll not be able to open a line of credit with USAA ever again.
Debt settlement, however, can also positively impact your credit. In many instances, a creditor will agree to wipe the debt from your credit report once a settlement agreement is met. This, of course, will only serve to improve your credit score.
Before you consider a debt settlement program, look at the risks and benefits. In some situations, it’s in your best interest to simply call your creditor. In short, the creditor wants to be repaid, and is usually willing to work with you to ensure that happens.