How to avoid common pitfalls in debt settlement

How to avoid common pitfalls in debt settlement
Key Takeaways:
  • Debt settlement can be a viable option for unsecured debt, but it's not a quick fix.
  • Understand the costs and potential tax implications before choosing debt settlement.
  • Consider working with a reputable debt settlement professional for guidance.

We’ve all fallen behind occasionally. If you find yourself owing more than you can pay back, debt settlement is a debt relief strategy that could help you get your finances back on the right track. Debt settlement does involve costs. Being aware of the costs and potential problems can help you decide whether debt settlement makes sense for you. 

Here are some common pitfalls to be aware of, and how to avoid them.

Pitfall #1: Thinking debt settlement is a big magic wand

Solution: Focus on the right form of debt

The first thing you’ll want to do is figure out whether debt settlement is a good fit for your financial problems. One critical factor is the type of debt you have. 

Debt settlement works best with unsecured debt like credit cards, personal loans, or medical bills. On the other hand, secured debts like mortgages and car loans are not a good fit for debt settlement. 

Pitfall #2: Believing there’s no other path that you can handle

Solution: Consider other alternatives. You can do it.

Even if debt settlement is a potential solution for your problems, you need to decide whether it’s the best solution. 

Here are some alternatives to consider:

  • Credit counseling might help you learn how careful budgeting or other strategies could help you get (and stay) caught up on your debts.

  • Negotiating directly with your creditors could help you get more affordable payments.

  • Debt consolidation could help you streamline your debts and possibly lower your costs. 

If none of these alternatives fit your situation, debt settlement may be the best solution for you.

Pitfall #3: Underestimating how long debt settlement takes

Solution: Get ready for the long haul

Debt settlement is not a quick fix. Then again, most big financial problems don’t have easy answers.

According to the Consumer Financial Protection Bureau, an account is typically 10 months delinquent before the debt can be settled. Sometimes it takes even longer.

The debt settlement process typically takes two to four years. During that time, expect to continue to deal with debt collectors. Also expect your use of new credit to be extremely limited. Even after the process is complete, it may take time to rebuild your credit record.

Pitfall #4: Worrying about your credit score more than your wallet

Solution: Build financial stability first. Credit naturally follows.

You might be considering debt settlement because your credit account payments have gotten way overdue. When that’s the case, creditors are likely to realize that negotiating a settlement is their best choice. 

Having delinquent accounts is bad for your credit record. If your credit score isn't already low, expect it to suffer some damage during this process. 

But remember—the goal is to find a solution that will put these problems behind you once and for all. The sooner you can do that, the sooner you can start rebuilding your credit history. 

Pitfall #5: Going it alone

Solution: Get professional guidance

You can negotiate with creditors yourself. However, if you’ve never done it before, you might not know the best ways to convince creditors to negotiate. You also may not have a feel for what creditors might be willing to accept.

This is a difficult process, and you have to multiply those difficulties by the number of creditors you have. A debt settlement professional might make the process easier and more successful for you. 

Pitfall #6: Falling for a debt relief scam

Solution: Choose professional debt settlement help carefully

A debt settlement professional might be able to help, but only if you choose the right one. 

Here are some of the things to look for in a debt settlement company:

  • A long history in the business

  • A successful track record

  • Trained professionals

  • Membership in an industry association, such as the American Association for Debt Resolution

  • Doesn’t charge fees unless a settlement is reached, you approve it, and at least one payment is made

  • Does not make big promises about how much debt they can wipe out

  • Doesn’t claim to prevent debt collection calls and lawsuits

  • Doesn’t claims access to “government programs” to wipe out consumer debt

Pitfall #7: Underestimating the tax consequences of debt settlement

Solution: Consider your tax situation before you settle a debt

Having debt written off can affect your taxes. This is complicated, and depends on the details of your situation. If you’re insolvent (meaning what you owe is more than what you own, before you settle any debts), you won’t have to pay federal income tax on the forgiven debt. But if you’re solvent, you might get a tax bill. Before you settle a debt, consult with a tax professional. 

Pitfall #8: Feeling hopeless and lost

Solution: Have a debt expert describe the plan, your options, and what to expect

After you’ve explained your situation to a debt expert, have them detail their expectations for you. This should include how they will negotiate with your creditors and what fees you will have to pay.

Lean on your debt expert and professional negotiators. Their job is to help people going through a rough time. They’ve helped others just like you. Having open communication helps you see if the debt expert has an organized and realistic plan of attack. It also helps you understand what the process is likely to cost, and any potential issues you are likely to face along the way.

Using debt settlement to get your finances back on track

Are there potential pitfalls to debt settlement? Yes. But knowing what they are can help you avoid them.

Using debt settlement successfully can be the turning point that eventually puts your financial problems behind you.

Debt relief by the numbers

We looked at a sample of data from Freedom Debt Relief of people seeking debt relief during June 2024. This data reveals the diversity of individuals seeking help and provides insights into some of their key characteristics.

Credit card balances by age group for those seeking debt relief

How do credit card balances vary across different age groups? In June 2024, people seeking debt relief showed the following trends in their open credit card tradelines and average credit card balances:

  • Ages 18-25: Average balance of $7,378 with a monthly payment of $209

  • Ages 26-35: Average balance of $10,797 with a monthly payment of $300

  • Ages 36-50: Average balance of $14,340 with a monthly payment of $405

  • Ages 51-65: Average balance of $14,364 with a monthly payment of $420

  • Ages 65+: Average balance of $14,837 with a monthly payment of $397

These figures show that credit card debt can affect anyone, regardless of age. Whether you're just starting out or nearing retirement, managing credit card debt can be challenging.

Manage Your Finances Better

Understanding your debt situation is crucial. It could be high credit use, many tradelines, or a low FICO score. The right debt relief can help you manage your money. Begin your journey to financial stability by taking the first step.

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