There are many TV and radio adverts that play late night and promise that you can get debt relief by simply paying pennies on the dollar for your debts. These adverts are for debt settlement which is a process designed to get the creditors to accept a lump sum payment for less that you owe them, your account is then said to be paid off and you no longer have the
These ads are for debt settlement, a process designed to convince creditors to accept a lump sum payment for less than you owe them. Your account is closed and considered paid off, and you no longer have burdensome debt payments to make, however the settlement can be noted on your credit report and may have an impact on your credit score.
Debt settlement however comes with downsides that can cause you untold amounts of hassle even when you are dealing with a reputable company. ResponsibleLending.org issued a report called “State of Lending: Debt Settlement,” which is a debt settlement program that actually increases the consumer debt by 20% on average.
The following are cons of debt settlement that can end up causing you to have more debt, instead of less.
1. You Have to Stop Paying Your Debts
The majority of debt settlement will not work unless the creditor is under the impression that you will not repay the debt without a settlement figure, in order to convince the creditor though you have to stop making payments to the debt. Nearly all of the debt settlement companies will require you to make regular payments to them, instead of your creditors. They will then keep this money in an account and use this to make lump sum payments to the creditors who have agreed to settle.
For obvious reasons this kind of activity does not fare well on your credit score. As you are now missing payments, fees, penalties and possibly the interest are accumulating and therefore if no settlement is reached you are in even more debt through the costs involved with missing the payments etc and this is one of the cons of debt settlement that you need to be very aware of.
2. Some Creditors Won’t Work With Debt Settlement Companies
There are a number of creditors that are not willing to work with debt settlement companies therefore if you stop making payments this becomes even more problematic and the creditor may choose to send your account to collections. This will result in further black marks against your credit score and this is just another con of debt settlement that can see you adding to the debt through fees, penalties and accrued interest. As your credit score drops further it becomes harder for you to get credit at a good rate and you continue to pay more as a result of your bad credit rating and this is not just for financial matters but also for the likes of insurance.
3. Creditors May Sue
Another con of debt settlement to be aware of is that sometimes sending your account to collections is just the beginning, creditors that will not negotiate with debt settlement companies may decide to sue you for your debt. This in turn can see the debt increasing and now you have the fees and costs relating to the lawsuit to find.
4. Debt Settlement Fees
Debt settlement companies are not allowed to charge upfront fees as instructed by The Federal Trade Commission. They are supposed to charge a fee when the settlement has been reached. However another con of debt settlement is that there is a loop hole and they are more than happy to use it! To get around the requirements that have been put in place many debt settlement companies claim that they employ attorneys and form an association with those willing and then they can charge you an attorney fee. Technically this is not a debt settlement fee and therefore it can be charged.
5. Paying Tax on the Settled Amount
The IRS considers forgiven debts to be income. Therefore if you owe $15,000 but settle the debt for $8,000, you are required by the IRS to report the $7,000 you were forgiven as income. You don’t have the money but the IRS taxes you as if you do. Here is another con of debt settlement because even a good experience can result in costly tax debt and if you have a big settlement you could even end up in the higher tax bracket.
6. Bad Credit Habits
The final con of debt settlement is that whilst the debt might have gone you may not have addressed the underlying problems that you have with money and therefore could easily wind up back on the same road again. Once their credit recovers they take out credit again and even those that have gone through debt settlement can get a credit card fairly easily.
At the end of the day there will always be some that use debt settlement effectively but the truth is that there are a lot of downsides to this process and most people just end up owing more. This is particularly true where the debtor has mixed responses from their creditors with some agreeing and others not, then there are the additional tax liabilities that could come into play.
For those thinking about debt settlement it is important to think through the options and consult a financial professional that can help you to put together a realistic way for you to repay your debts and better your overall finances.