Maybe you’ve seen an ad on television or on the web which tells you that you can “settle your debts for pennies on the dollar.” Maybe a collection company has sent you a letter offering to settle your debt for less than the amount that’s owed.
It may sound like a great deal. But you should proceed carefully. Settling debts comes with a lot of potential pitfalls. It can be a weapon in your arsenal to get out of debt, but it should be employed with extreme care. Often, it just creates more problems and doesn’t do anything to solve your long-term financial situation.
Which debts can be settled successfully?
Debt settlement only tends to be an option when:
- The debt has already passed on to a collection agency. It’s almost impossible to settle debts with a first-party creditor.
- The debt is unsecured.
- The debt is old. Collection agencies are losing hope they’ll ever be able to collect the debt.
- You have money in hand the day you go to settle the debt, and can pay it right away.
Obviously, if you’ve received a debt settlement offer you can choose to accept the offer whether the debt is old or not. You’ll still have to pay right away if you do. And if you’re receiving the offer on behalf of a secured debt, like a house or a car, then something’s very wrong. That doesn’t happen, so someone may be setting you up for a scam.
Do you need a debt settlement firm?
No.
If the debt is likely to be settled you can negotiate that settlement directly with whomever is pursuing you for that debt. Many so-called debt-settlement firms are scammers who are out to make your situation worse.
There are tell-tale signs you’re dealing with a debt relief scammer. The Washington Post covered some of those here.
See also: Are You About to Become the Victim of a Debt Collection Scam?
Credit counseling scams and schemes are closely related to debt settlement schemes. Make sure you are thoroughly educated about both before you place your financial life into the hands of one of these firms.
How can you negotiate a debt settlement?
It can be as simple as calling up the collection agency and making an offer, if you have some sense of what they’ll typically accept.
Unless they’ve sent you a settlement offer, which could be as low as 40%, a collection company will generally only want to settle for about 60% to 80% of the debt. You’re not going to get a settlement agreement if you go in pitching 20%. Keep in mind they might pitch 90% to see if you can get them to accept it. You could pitch 0% to see if they’ll bite.
Expect to land somewhere in the middle.
Keep in mind some collection agencies will start asking a bunch of questions about your income and assets. They aren’t gathering this information because they have to. They’re gathering it to use against you in a potential lawsuit if negotiations break down. Play your cards close to your chest and don’t give them any extraneous information.
If you’re going to do this, make sure you get the settlement offer in writing. Make sure, once it’s paid, you get a letter acknowledging the debt has been paid. Companies have been known to go after people for settled debts. You want to be able to prove the debt has already been taken care of.
What happens to your credit report when you settle a debt?
Settling a debt is not consequence-free. It will lower your credit score. Bankruptcy, by contrast, typically raises it.
It doesn’t even guarantee creditors won’t come after you later. Even if you have proof of settlement, you’ll still have to go through the hassle of producing the proof every time the debt rolls over to some new company.
The only thing it’s good for is ending your legal obligation to pay another cent on that debt.
There’s a reason Nerd Wallet points out settling debts is usually a bad alternative to bankruptcy.
How to Figure Out if Debt Settlement Will Help You
Do you have a single debt, maybe one you don’t even agree with, which is held by a single collection agency? If that’s all it will take to put an end to your debt situation and you don’t anticipate needing a new loan for some time, debt settlement might make sense.
If you’re drowning in debt, settling just means you’re delaying the inevitable and spending money you probably should be spending on bankruptcy, and starting over. It is not a smart solution for most people.
Not sure what to do?
We offer free consultations. Gather up your financial information and schedule a sit-down with us. We can tell you if continuing to throw good money after bad makes sense…or if it is time for you to take advantage of bankruptcy protection so you can enjoy a fresh financial start once and for all.