Debt settlement could seem an option that is too good to be true. In fact it could seem the perfect way to get out of your debt, while avoiding bankruptcy. While everyone talks about how it makes life easy, no one actually elaborate the effect of debt settlement on your credit.
How debt settlement works?
Before we move any further, let us understand how debt settlement works.
When you think you can no longer afford to make the monthly payments on your debts, the first thing you do is get in touch with a debt settlement company. Nowadays many such companies collect details about borrowers through debt settlement leads and get in touch with them directly. If you do get a call like this it can make your job easier.
Once you are in touch with the debt settlement company, you will have to explain your situation to them and give them the names of your creditors with the details of the debts you owe. You then get a quote from the debt settlement company to get your debt reduced, with a new monthly payment which is much lower. This amount needs to be paid not to your creditors but to the debt settler.
After the final confirmation, the debt settlement company will ask you to stop making payments to your creditors. This is to make your creditors agree to the settlement at the time of the negotiations. Typically this doesn’t happen until your accounts with your creditors become past due. This is so that the creditors start realizing that they may not get any money back if they don’t agree for the settlement. However, these skipped payments will have a long term effect on your credit score.
Meanwhile the monthly payments that you make to the debt settlement company would get accumulated until they reach a certain limit. It is then that the debt settlement company starts making the calls to your creditors to negotiate settlement. The settlement amount would usually be much lower than what you actually owe.
Once the creditor agrees to settle the debt for the amount suggested, the debt settlement company will pay the amount to the creditor and then assess a settlement fee. This could be either a percentage of the cancelled portion of the debt or a flat fee.
Effects of Debt Settlement on Credit
On the face of it debt settlement might actually sound good. You are paying the debt settlement company, who in turn will pay your creditors. So everyone gets paid at the end and life will move on as normally as possible. But it doesn’t work that way.
Do you remember you had stopped making payments to your creditor? Well yes, you were making payments to the debt settlement company; but your creditor had no idea about this. As far as he was concerned the payments were getting delayed. So, the creditor must have done his duty of reporting late payments to the credit bureaus, thereby reducing your credit score.
Although the creditor does get paid the settlement amount at the end, the effect of your late payments would remain on your credit report for seven whole years. During this time you may find it difficult to obtain new credit cards, good insurance rates or even better placements, should you happen to lose your job. To add to this, you may have to pay taxes on the forgiven part of your debt.
The only way to make good the negative effect of debt settlement on your credit report is to negotiate “Pay For Delete.” For this, you may have to pay back the unpaid amount and work out with your creditor or your debt collection agency to delete the negative entry from your credit report.
If you are more or less current on your monthly payments and wish to maintain a healthy credit score, debt settlement may not be for you. However, if you are in a situation where you are no longer able to afford those monthly payments you can consider this option, but only to avoid bankruptcy.
So, before you say ‘Yes’ to the debt settlement company that came to you through debt settlement leads, make sure you have weighed your options and considered what you are getting into. It is always better to be safe than sorry.
