What It Is a Debt Settlement and How To Handle It
Juggling debt, whether it is credit card debt, student loan debt or other debt, can be quite the challenge. In some instances, managing debt can become overwhelming. This often happens when someone experiences a job loss or other financial disaster. Then, before you know it, you are drowning in a sea of debt with no sign of the shore in sight. For most people, it comes down to two options at that point – try to avoid bankruptcy or start taking steps toward filing for bankruptcy.
Debt settlement offers those in debt a way to avoid bankruptcy by settling outstanding debts for a fraction of the amount owed. It is often confused with debt consolidation, which is when you take all of your debts and bundle them together into one outstanding debt with a single debt payment. It is also sometimes mistaken for credit counseling, which is when the counseling agency helps set up low interest payments for easier repayment over a period of time. With debt settlement, the settlement agency contacts your creditors on your behalf and negotiates a smaller pay off amount for you.
A key feature of debt settlement is that the negotiations for the lower pay off amount is for payment in full. This means that you are no longer legally liable for the entire balance. Instead you are only liable for the negotiated amount.
The nice thing about the negotiated settlement is that it does not always have to be paid in a lump sum. In fact, it can be paid over an agreed upon period.
For people who are currently struggling with excessive amounts of debt, this type of settlement may be a good way of dealing with the problem. However, debt settlement is not a good choice for everyone in debt. In fact, it should only be used as a last resort by people who are close to declaring bankruptcy and want to avoid doing so.
If you are current on your debt payments, then debt settlement is not a wise choice due to the hit that your credit score will take. The carnage can be as much as a 125 point hit. The effect seems to be worse for people who have been making payments on time up until the debt settlement. For those who are already behind on payments, the credit score drop can be as low as just a 25 point drop.
It is important to find out the cost of debt settlement before signing up with an agency. Though the Federal Trade Commission has rules against it, some of the debt settlement agencies charge a hefty fee up front. Others may require a monthly fee. But the best option is a settlement company that only charges a fee after the actual settlement has been made with the creditor. Often this fee amount is around 20 percent of the reduced amount.
A final thing to note about debt settlement is that you can be taxed on the amount of debt that is written off by the creditor. In fact, any forgiven amount over $600 can be taxed as income by the Internal Revenue Service. Of course, sometimes this is true of debt written off in a bankruptcy.
Sources: http://money.msn.com/credit-and-debt/when-debt-settlement-makes-sense-liz-weston , http://en.wikipedia.org/wiki/Debt_settlement , http://www.bankrate.com/finance/debt/5-debt-settlement-do-s-and-don-ts-1.aspx
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