Debt Settlement Pros and Cons: Is It Right For You?

debt settlement pros and cons

If you’re struggling with debt, you may be considering a number of debt relief options. Debt settlement is a common method for those with significant amounts of debt.

However, scam companies have often given debt settlement a bad reputation. Understanding the pros and cons of the debt settlement process can help you decide whether it’s the right option for you in your journey to financial freedom.

How does debt settlement work?

Debt settlement is the process of negotiating your debt for less than you owe. Often, the borrower pays the negotiated settlement to the creditor in a lump sum. This process can only occur when you are delinquent on your debt. Because you haven’t been making payments, creditors will be more likely to negotiate a settlement if they feel that they would otherwise not recoup any of your debt. Creditors will also be more likely to come to an agreement if you can exhibit that you are facing a hardship. A settlement is intended to be generally favorable to both parties. You can choose to negotiate with the creditor yourself or you can work with a debt professional.

If you do decide to work with a debt professional, you will likely make a monthly payment into their office. This payment will be used to accumulate funds to pay off your settlements. The debt settlement company will contact creditors on your behalf to negotiate an agreement for you. This process can take anywhere from a few months to a few years, depending on the amount of debt you owe and to how many different creditors. Like with any form of debt relief, it’s important to understand the pros and cons of debt settlement.

Pros of Debt Settlement

Lowering Your Debt

The most obvious advantage to debt settlement is that you will be paying less than you owe. This, of course, can help you get out of debt more quickly than you would have if you were simply trying to make payments on your own.

Stopping Collection Calls

One of the most common reasons that borrowers seek debt relief is because they’re tired of being harassed by creditors and debt collectors. Settling your debt will help stop the collection calls and allow you to regain your peace.

Avoiding Bankruptcy

Another major pro of debt settlement is avoiding having to file for bankruptcy. Bankruptcy can have incredibly severe, long-lasting effects on your finances. Settling your debt is often considered a favorable alternative.

Improving Your Credit

A common misconception about debt settlement is that it will destroy your credit score. In most cases, if you’re seeking debt settlement, you’re behind on payments and have a high credit utilization ratio. Both of these factors likely mean your credit is not in good shape. The process of debt settlement does involve letting all of the accounts you wish to settle go delinquent, which will temporarily hurt your credit. However, because your debts will be paid off at the end of the settlement process, your credit score will then improve – in some cases, drastically. Some clients even notice their score increasing before they’ve even completed the process.

Cons of Debt Settlement

Tax Consequences

Any time you borrow from a creditor, you are legally obligated to repay the debt. Settling your debt does not allow you to duck this responsibility. Therefore, your creditor will send you a 1099-C form if you settled debt for more than $600 less than what you owed. This form details your settlement, and informs the IRS that the difference between the amount owed and the settled amount is taxable income. However, you may not have to pay taxes on this amount if you can prove insolvency. Additionally, what you would pay in taxes is generally still favorable to having to pay off your entire balance.

Lingering Effect on Credit Report

Debts that are settled rather than paid in full will be noted as such on your credit report. Your debt settlement will stay on your credit report for seven years. You may have a more difficult time applying for new credit. However, if you work on building good credit habits, the effect of this will diminish over time.

Creditor Unwillingness

In some cases, the creditor will simply be unwilling to negotiate your account. Debt settlement is never a guarantee. However, working with a professional is beneficial in these cases. Debt professionals generally have standing relationships with creditors and therefore know the best strategies for working to reach an agreement.

Possible Scams

Many debt settlement companies are only looking to take your money. Before working with a company, do your research. Read online reviews and talk to other financial professionals, such as your financial advisor or account, for referrals. A reputable debt relief company will have a real address – not a PO box – and you’ll be able to reach a human on the phone. Additionally, reputable companies will not advertise being able to settle all debts for a certain percentage or in a specified period of time. Because every individual’s situation is different, it’s impossible to make these claims in reality. If it sounds too good to be true, it probably is.

When you’re struggling with debt, it can feel like there’s no way out. Debt settlement can be an intimidating option because it often gets a bad rap. As with any debt relief option, debt settlement certainly has its pros and cons. In doing weighing them, you can determine whether it’s the right path for you.

Talking to a financial professional can also help you with the decision. The experienced team at Tayne Law Group, P.C. is here for you. We can guide you to the best solution for you and your financial situation. Call us for a free consultation at 866-890-7337 or fill out our short contact form and we’ll get in touch!

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