How Does Debt Settlement Work?

Debt settlement is actually also referred to as credit card debt negotiation or even debt reduction as a relatively recent way for dealing with your debt problems. In a debt settlement program, by settling with a creditor, it is possible a client may be able to negotiate their debts for less than the amounts they owe and thus get rid of debt much faster than simply paying the minimums


How Does Debt Settlement Work?

If you settle a debt, you get a creditor to agree to accept less than the amount you owe as full payment. But a lot of painful things have to happen first.

If you are worried about falling behind — but haven’t yet — you won’t be able to settle. A creditor or collector is not going to accept less than you owe if there’s reason to believe you could pay the full amount that you originally agreed to.

Debt settlement comes into play only when you have many late or skipped payments and possibly collections accounts. Your credit scores will have been shredded; you feel hopelessly behind; your income isn’t enough to keep up with your debt obligations.

As you explore debt settlement, beware: Consumer finance groups warn in very strong language that it’s risky, doesn’t work for many people, and may just prolong your financial pain. It won’t stop late fees, collection notices or even threats of being sued while the process plays out.

“If you can erase your debts in a Chapter 7 bankruptcy, that’s a much better option than trying to negotiate settlements,” says NerdWallet columnist Liz Weston, author of “Your Credit Score” and “Deal With Your Debt.” “Only if Chapter 7 isn’t an option — you refuse to file for bankruptcy, or you can only qualify for a Chapter 13 repayment plan — should you consider debt settlement.”


How debt settlement works

Debt settlement aims to reduce what you owe, mostly on unsecured debt such as credit cards. It’s not an option for certain types of debt, such as a house that can be foreclosed on or a car that can be repossessed. It’s also not for student loans (but an income-based repayment plan might help you).

Settlement offers work only if the alternative appears to be that you won’t pay at all.

There are three ways to approach it:

Debt settlement companies: You generally stop making payments on your outstanding debts and instead pay a debt settlement company, which deposits the money into a dedicated account. Once the company believes there is enough for a lump-sum offer to be considered, they negotiate it on your behalf.

By law, they can’t charge you upfront fees. You pay the debt settlement agency either a percentage of your total debt or a percentage of the debt eliminated by the settlement.

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