Why should you avoid debt settlement companies?
Working with a debt settlement company may lead to a creditor filing a debt collection lawsuit against you. Unless the debt settlement company settles all or most of your debts, the built-up penalties and fees on the unsettled debts may wipe out any savings the debt settlement company achieves on the debts it settles.
Key takeaways. Undergoing the debt settlement process can help you avoid future financial headaches but is not the best choice for every person. There are many drawbacks to debt settlement including high fees, potential for legal issues and a negative impact on your credit report.
Debt Settlement Program Disadvantages
A debt settlement program requires you to stop paying your creditors, which will add a significant amount to your debt because of late charges and the interest applied. Debt settlement companies can charge a fee for each credit card debt they settle.
Debt Relief Service and Credit Repair Scams
These operations often charge cash-strapped consumers a large up-front fee, but then fail to help them settle or lower their debts – if they provide any service at all.
Despite the potential downside, settling a debt by making partial repayment is better for your credit (and peace of mind) than neglecting it and leaving it unpaid. If you ignore a debt, the creditor will typically turn it over to a collection department or third-party collection agency.
Key Takeaways. Debt settlement can eliminate outstanding obligations, but it can negatively impact your credit score. Stronger credit scores may be more significantly impacted by a debt settlement.
Settling debt can have both a negative and a positive effect on your credit scores. You're most likely to see a drop in points up-front, but over time you can gain back everything you lost and more. Regardless of the setback, you can always work to experience the benefits of better credit.
- Best overall: Money Management International.
- Best for private student loans: National Debt Relief.
- Best for customized options: Accredited Debt Relief.
- Best for all unsecured debt types: Americor Debt Relief.
- Best for customer support: Pacific Debt Relief.
- Best in availability: Century Support Services.
Completion rates vary between companies depending upon a number of factors, including client qualification requirements, quality of client services and the ability to meet client expectations regarding final settlement of their debts. Completion rates range from 35% to 60%, with the average around 45% to 50%.
While you can still use your open credit card accounts after debt consolidation, consumers should do so with caution. If you do use your credit card after debt consolidation, be sure to pay off your balance regularly.
Can I buy a house after debt settlement?
Yes, you can buy a home after debt settlement. You'll just have to meet the lender's requirements to qualify for a mortgage. Unfortunately, that could be harder after you settle debt.
There is a high probability that you will be affected for a couple of months or even years after settling your debts. However, a debt settlement does not mean that your life needs to stop. You can begin rebuilding your credit score little by little. Your credit score will usually take between 6-24 months to improve.
Based on Investopedia research, minimum debt settlement fees often start at around 15% of the debt. Maximum debt settlement fees are commonly around 25%, though they could go as high as 30% in some cases. See our picks for the best debt relief companies to find some options with fees on the low end.
Cons of debt settlement
Creditors are not legally required to settle for less than you owe. Stopping payments on your bills (as most debt relief companies suggest) will damage your credit score. Debt settlement companies can charge fees. If over $600 is settled, the IRS will view this debt as a taxable income.
Bankruptcy is your best option for getting rid of debt without paying.
For instance, hiring a debt settlement company can leave you with severe credit damage and no spare cash, both of which make it harder to qualify for a mortgage. Once your debts are settled, you might need a few years to recover and become eligible for a conventional (meaning not government backed) mortgage.
| Pros | Cons |
|---|---|
| Might be able to settle for less than what you owe | Creditors might not be willing to negotiate |
| Pay off debt sooner | Could come with fees |
| Stop calls from collection agencies | Could hurt your credit |
| Could help you avoid bankruptcy | Debt written off might be taxable |
The worst thing they can do
If you fail to pay it off, the collection agency could file a suit. If you were to fail to show up for your court date, the debt collector could get a summary judgment. If you make an appearance, the collector might still get a judgment.
Typical debt settlement offers range from 10% to 50% of the amount you owe. Creditors are under no obligation to accept an offer and reduce your debt, even if you are working with a reputable debt settlement company.
Reputable debt settlement companies almost never cold-call potential clients. Upfront fees: Be extra cautious if the company is trying to charge you before doing any work. Note that scammers may claim these fees are actually payments to your creditors that will remove negative information from your credit report.
Do you pay taxes on debt settlements?
Settled debt is taxed as ordinary income. The amount you'll pay is based on your tax bracket and marginal tax rate. Say you earn $75,000 a year as a single taxpayer. Your top marginal tax rate is 22%, so any additional income from a settled debt will be taxed at 22%.
Debt settlement programs can be risky. If a company can't get your creditors to agree to settle your debts, you could owe even more money in the end in late fees and interest.
Stopping payment on a debt means you could face late fees and accruing interest. Additionally, just because a creditor agrees to lower the amount you owe doesn't mean you're free and clear on that particular debt. Forgiven debt could be considered taxable income on your federal taxes.
Once your credit card balance is zero, you can still use it as long as you don't close the account. But if having it open will tempt you to rack up more charges, then closing it may be beneficial.
If a credit card account remains open after you've paid it off through debt consolidation, you can still use it. However, running up another balance could make it difficult to pay off your debt consolidation account.
