When you begin to get behind on your bills, the anxiety can be overwhelming. Many turn to debt settlement as a way to escape the fear, but debt settlement is often a matter best handled by you directly. It will not be easy, but you are likely to come away in a much better situation.
Do not confuse debt settlement with debt consolidation or debt counseling. Each of these is a different strategy for managing debt. Debt settlement requires you to close your credit card accounts and work out a settlement with the credit holder. Some of your debt is often forgiven, hence the creditor "settles" for a smaller amount than you actually owe.
Debt Settlement Services
Many companies advertise debt settlement services for people who have become overwhelmed by debt. These companies argue that they have some sort of "in" with credit card companies that will allow them to get a better debt settlement that you can secure on your won. But debt settlement services cost money, often much more than the service itself will save you.
Just finding out how much the service will cost you is a challenge. These companies structure fees so that consumers can never know the final cost. Some charge a percentage of your debt. If these companies can’t save your more than that, plus the taxes you might pay on the forgive debt, you are not any better off.
Some companies ask for a percentage of the settled debt, about 25%. There is also an up-front fee and monthly service charges. Some simply charge a flat monthly fee that you will have to pay while they negotiate then debt and continuing while you are paying the debt off.
There are also many unethical debt settlement companies. They may take your fee, set up an escrow account with it and then withdraw your money for monthly fees until it is gone, without ever settling your debt. Leslie Linfield, Executive Director at the Institute for Financial Literacy says, "As you talk to bankruptcy attorneys you'll hear horror stories of clients who paid thousands of dollars to a company and they're still in the exact same place."
According to University of Iowa Professor of Bankruptcy Law Professor, Katie Porter, the cost of debt settlement can cost more than hiring an attorney to help you navigate your debt situation. Many programs charge as much as $5,000 for a $35,000 debt. "You can get a consumer attorney to represent you and help with your debt problems for a lot less than that."
In addition, creditors will often take legal action against you as soon as they learn you are working with a debt settlement company. Because these companies cannot offer legal advice, they cannot help you with your legal woes. This is another reason you may be better off with a consumer or bankruptcy attorney.
Debt Settlement versus Bankruptcy
Like bankruptcy, debt settlement is a last resort. The unpaid debt will show up on your credit report even though it was technically "forgiven." That black mark stays on your report for seven years. While the seven years is shorter than the black mark of a bankruptcy (10 years), debt settlement usually drags out for about two years.
Bankruptcy is over in a matter of months and allows you to begin rebuilding credit right away. Bankruptcy is often cheaper as well, costing up to $2,000. By choosing debt settlement, you win back a year on your credit report, but pay emotionally for that saved year. Many economists recommend bankruptcy over debt settlement.
There are situations where debt settlement makes sense, however. Those who do not meet the "means test" for bankruptcy must choose debt settlement. This generally applies to high wage earners who have gotten in over their heads. In cases like this, debt settlement may be a smart choice. Just be certain the company is above board and that debt settlement is legal in your state. If debt settlement is not an option, then Chapter 13 is your only recourse, requiring you to pay back as much of the debt as you can afford over a five-year term.