Is Debt Settlement Worth It?

Debt settlement could drastically reduce the amount of money you owe, offering real relief when you're in a tough spot. It's a process that takes some time and energy, but every step forward is a step closer to breathing easier. 

If you're weighing the costs and benefits, you're already doing some of the work. After you balance out the costs and benefits, is debt settlement worth it?

The right debt relief answer depends on your circumstances. Debt settlement could be worthwhile if your situation fits and you understand the risks.

How to Know If You're Ready for Debt Relief

Only you can decide whether you're ready to try debt relief. Here are a few questions you could ask yourself to assess your debt situation:

• Have I fallen behind on debt payments?

• Am I in a debt cycle where I take on new debt to pay off old debt?

• Am I turning to credit to pay for necessities?

• Are my credit card balances increasing despite my best efforts to pay them down?

• Is my debt causing me anxiety or sleepless nights?

If you answered "yes" to a few of these, then exploring debt relief solutions might be a smart move. You can go about this in a few different ways, depending on the size and type of debt you have and your own comfort managing financial situations. 

A DIY solution could work if you only need a bit of help and you feel confident that you can stick with your debt relief plan to completion. If the thought of contacting your creditors or putting together a financial plan gets your blood pressure climbing, you might do better with a partner.

A professional debt relief company could work with you to negotiate your debts and possibly get out from under them for a fraction of what you owe. Many debt settlement companies already have relationships with major creditors, which could give them a leg up when negotiating.

If you think debt settlement might be a good fit for you, act promptly. Reach out to a company like Freedom Debt Relief to learn more about how its program works and whether your debts are good candidates for settlement.

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Debt Settlement Is an Option for Unsecured Debt

Debt settlement is for unsecured debt, such as credit card balances and personal loans. Unsecured debt isn't backed by collateral—something of value that the lender could seize if you fail to repay the debt.

Secured debt, like mortgages and car loans, isn’t a candidate for debt settlement. Debt settlement depends on negotiating with creditors to have them accept less than the full amount owed. If you default on a loan with collateral, the lender can just take possession of the collateral and sell it to get their money back. 

It’s common for people to have a mix of secured and unsecured debt. Debt settlement could still work in that case. You simply separate the two types of debt and use debt settlement for the unsecured debts. Once the unsecured debts are settled, it could be easier to afford the payments on your secured debts. 

Debt Settlement Works Best if You Are Insolvent

Being insolvent means the amount of your debt exceeds the value of your assets. Believe it or not, insolvency has a silver lining: It could wipe out a potential tax liability from canceled debt.

Under most circumstances, the IRS treats canceled debt as income and you’d generally have to pay taxes on the amount that was forgiven. Those taxes would reduce the financial benefit of debt settlement.

If you’re insolvent, though, you won't owe taxes on canceled debt. The IRS has a worksheet to help you figure out your situation. You can find the worksheet and more information on insolvency in IRS Publication 4681. Also, it’s a good idea to talk to a tax professional about your specific situation.

Debt Settlement May Be Right if Your Credit Is Already Damaged

You could reasonably ask if debt settlement is worth it because the process could affect your credit. But often, for people considering debt settlement, the damage is already done. 

Late payments are hard on your credit score. If you owe a lot of money and have missed payments, your credit score might not have much farther to fall.

Once you settle one or more debts, you can focus on managing your other bills and paying on time every month. Debt settlement could be the first step to a stronger credit profile and a better financial future.

Debt Settlement Is an Option if You Don’t Qualify for Chapter 7

Chapter 7 bankruptcy is a way to get rid of eligible debts without racking up a tax liability. In Chapter 7, a court decides how to use your assets to pay off your debts. For example, if you have several cars, the bankruptcy court could force you to sell all but one, giving the money to your creditors. If you don’t have much in the way of assets, Chapter 7 could be a cost-effective way of eliminating debts.

You usually need a low income to qualify for Chapter 7. The courts say that if you have the means to pay your bills, you’ll have to file for Chapter 13 bankruptcy instead, which is a three- to five-year payment plan. 

Also, like late payments, bankruptcy has a negative impact on your credit record.

In short, you should consider Chapter 7 bankruptcy as an alternative to debt settlement. If you don’t qualify for Chapter 7 based on your income or if you don’t want a bankruptcy on your record, you may decide debt settlement is a better option than Chapter 13.

Professional Negotiators Could Relieve Some of Your Burden

If you work with a debt settlement firm, they will do the heavy lifting. A trustworthy debt settlement company has trained experts who can:

• Help you organize your debts 

• Make the calls to your creditors 

• Negotiate the settlement 

• Handle the transfer of your money to the creditor

• Ensure the creditor stands by what they agreed to

If you’re not comfortable with the idea of negotiating, which could be a difficult process that requires multiple calls, you can hand that task off. Debt settlement companies may already have relationships with some or all of your creditors and might be able to negotiate a better deal than you could get for yourself.

You’ll probably pay a fee for their services. So deciding if debt settlement is worth it becomes a cost-benefit decision: Would you eliminate more debt than the amount of fees you’d owe? 

Keep in mind that you should never pay a fee until you get results. By law, debt settlement firms can’t charge a fee until they negotiate a settlement, you approve it, and at least one payment has been made. Only then can they charge their fee.  

The Right Debt Settlement Firm Is a Key to Success

A big factor in whether debt settlement is worth it is having the right professional to guide you through the process.

Some questions to consider when choosing a debt settlement firm:

• Have they been in business for several years?

• Do they have a successful track record with a large number of clients?

• Is their explanation of the process and costs clear and sensible?

• Are they transparent about the debt settlement industry laws that they must follow?

Understand the Costs of Debt Settlement

Debt settlement could wipe out a portion of your debt. You can decide if that reward is worthwhile once you’ve considered the costs.

Fees and interest charges

During debt settlement, you might choose to stop paying your creditors while you save up funds for settlement offers. It’s hard to afford both. Stopping payments could lead to late fees that raise the amount you owe. 

Instead of paying your bills, you'll make payments to a dedicated bank account where you save up money for settlement offers. These payments may be less than the minimum payments on all your debts that you were paying previously.

Also, if you stop paying your bills, your credit will take a hit and your creditors will likely begin collection efforts. They could even file a debt lawsuit against you.

Potential damage if your credit is currently fair to good

If you have decent credit at the start, it's likely to take a major hit as you go through a debt settlement process. This may not be a concern for you if your credit is already fair or poor because of a history of late payments. In that case, your credit score may not be affected as severely.

Fees may reduce the debt settlement benefit

If you work with a professional debt settlement firm, you’ll pay a fee for its help—typically, 15% to 25% of the settled debt. Here’s how that could look for a settled amount:

It's not possible to know ahead of time the exact savings you'll get because creditors don't have to accept any settlement offers. Consider more than just the financial aspect of working with a professional. If working with a debt settlement company reduces your stress and saves you some legwork, the fee delivers even more value.

Settled debts could be taxed

Be sure you understand your tax situation before accepting a debt settlement solution. It's best to talk to a qualified tax professional.

A debt settlement program could take three to four years to complete depending on how much you owe and how quickly you're able to save for a settlement offer. So you may need to work with a tax professional on an ongoing basis to assess how each offer will affect your tax liability.

Recognizing these potential costs puts you in a stronger position to make an informed decision about debt settlement. Once you know how it works, you can be more confident that debt settlement will be the right choice for your situation.

If anything is unclear, make sure you get a solid explanation from the debt settlement company before you move forward. Most offer a free consultation that will give you a chance to ask any questions and understand how the process works.

Warning Signs of Debt Relief Scams

There are many legitimate debt settlement companies out there, but you’ll need to watch out for the scammers who just want your hard-earned cash. Scammers often:

• Demand upfront payment

• Make guarantees about settlement offers

• Promise to stop all collection calls and lawsuits

• Refuse to provide or are evasive about their business details

• Pressure you to hand over personal or financial information

If you encounter any of these red flags, don’t give the company any personal information. Report the company to the Federal Trade Commission (FTC) as soon as you can.

Then, look for a legitimate debt relief company. You want to work with a company that:

• Doesn't take payment until it's negotiated a settlement offer you've agreed to, and it's paid at least one creditor

• Has been in the business for many years

• Is transparent about how it operates and how it gets paid

• Is a member of an organization like the American Association for Debt Resolution (AADR) or the International Association of Professional Debt Arbitrators (IAPDA)

It's a good idea to do some online research about the company you choose. Look into customer reviews, both to assess the quality of the service and find out how long it's been in business. Make sure you're comfortable with what you find before you hand over your information.

Alternatives to Debt Settlement

If you don't think professional debt settlement is worth it for you, you have other options to get yourself clear from debt.

Hardship programs

Some creditors offer hardship programs for people experiencing temporary financial setbacks. They may not advertise this, but if you call or write to the company and explain your situation, you may be able to get lower payments, a lower interest rate, or deferred payments for a while.

It's best if you explain your situation in detail, including what caused you to fall behind on payments, what steps you're taking to remedy the situation (like cutting costs), and how long you expect the situation to last, if you know. 

This could be all you need to do if you're experiencing a temporary setback and you're only a bit behind on a couple of debts. It may not be right for you if you believe your debt problems are going to be a long-term issue.

DIY debt settlement

You could negotiate your debts directly with your creditors if you'd rather not pay a company to do this for you. A DIY approach could help you minimize your fees, but you have to be prepared for the time involved in negotiating yourself. You'll also have to budget money for debt repayment on your own each month.

Credit counseling

Credit counseling agencies are nonprofit organizations that can work with your creditors to lower your interest rates where possible and set you up with a debt management plan (DMP). In a DMP, you make regular monthly payments to the credit counseling agency, which pays your creditors on your behalf. You may need to close your credit cards as part of the DMP. 

There are modest setup and monthly fees for a debt management plan. 

Credit counseling monthly payments tend to be high because they’re meant to fully repay your debt in three to five years. But it doesn't hurt to explore the option to find out how much you might have to pay. 

Debt consolidation loan

A debt consolidation loan is a new loan you take out to pay off your existing debts. Often, this is a personal loan because they don't require collateral and you can use the money for any purpose, including debt relief. 

Debt consolidation loans give you a regular monthly payment that could be lower than the total of the minimum payments you were making before. Also, you'll only have a single payment due date to worry about. You may pay slightly less in interest than you were paying with credit cards.

Personal loan interest rates are higher than other loans because they’re not secured by any collateral. The creditor just has your word as a guarantee of repayment. If you have fair or poor credit, a personal loan for debt consolidation may not offer you much savings. You'll also have closing costs.

Assuming a debt consolidation loan saves you money, it could be a good choice provided you're ready to turn over a new leaf. If you charge a lot of new debt to your credit cards, you could wind up in a worse financial position than you were in before.

Cash-out refinance

Homeowners with substantial equity in their home could try a cash-out refinance to get money for debt repayment. This strategy replaces your existing mortgage with a new, larger mortgage. You use the cash difference to pay off your existing debts. Then, you make regular monthly payments on your mortgage until it's gone.

You’ll have to go through all the usual steps associated with taking out a mortgage, including having an appraisal done and paying closing costs. Make sure you understand these costs before going ahead with a cash-out refinance.

Bankruptcy

A bankruptcy filing is a formal request to a bankruptcy judge for protection from creditors. In this request, you demonstrate that you can't repay your accounts and provide a list of creditors, as well as proof of income and a list of assets. Bankruptcy is an alternative to debt settlement for those who want to erase their debts for good. It’s wise to weigh the pros and cons of bankruptcy to figure out if it’s the best course for your situation. 

Bankruptcy has two main types: Chapter 7 and Chapter 13. Chapter 7 could get you out from under your debts within a few months if you meet the income requirements. You may have to give up some of your assets. Chapter 13 bankruptcy doesn't require you to give up any assets, but you'll make payments to your creditors for three to five years as part of a court-ordered repayment plan. You may not save any money over the long haul. 

The judge’s decisions are binding in a bankruptcy. Creditors can’t opt out.

Building Your Financial Future After Debt Relief

Graduating from debt settlement is an exciting milestone, and it's really just the beginning of a new and more solid financial future. Once your debts are paid off, it's time to build a new budget so you don't fall into debt again.

You'll want to gradually build an emergency fund to help you cover unexpected costs. Ideally, this would contain three to six months of living expenses, but it's fine to start with less. Keep this money in a savings account where you can access it quickly when needed, and be sure to replenish your emergency fund after you use it.

Now is also a good time to start rebuilding your credit. Focus on making on-time payments and not charging more to your credit cards than you can afford to pay off by the end of the month. Whenever possible, limit yourself to 30% or less of your credit limit. Apply for new credit sparingly and focus on building financial habits.

It may take some time, but you should gradually notice your credit score begin to rise. This will make it easier to borrow money more affordably in the future if you need to.

Are you seeking debt relief in Florida or across the country? The first step is the most important one—explore your options.