The Pros and Cons of Debt Settlement

Sarah Edwards | November 11, 2022

Edited by Hannah Locklear

If you’re having difficulty repaying your debts, you’re probably looking for a solution.

You may have heard of debt settlement. Debt settlement typically involves paying an overdue debt with one lump-sum payment, usually equal to a percentage of the total value of the debt.

Use SoloSettle to reach a debt settlement agreement

You can settle your debt for less when you use SoloSettle.

Our software drafts and sends emails to debt collectors for you, starting the debt settlement negotiation process. This helps you save yourself from being harassed by the collector on the phone.

The collector can only respond with relevant answers that move the negotiation forward Essentially, they can accept or counteroffer. Having this conversation over email ensures you get everything in writing and helps you maintain a calm composure.

Once you’ve reached a settlement, SoloSettle manages the settlement agreement and payment for you. This protects your financial information from predatory debt collectors and helps you avoid debt collectors who go back on their word.

Settle your debt on your own with SoloSettle.

To learn more about how to reach a settlement with debt collectors on your own, check out this video:

Learn about the debt settlement process

Individuals can settle their debts on their own or with the assistance of a debt settlement company. Settling debts on your own is a good option since you won’t need to pay a debt settlement company for their services. However, saving money to settle your debts can be challenging, and some people are uncomfortable negotiating with creditors and debt collectors.

People sometimes choose to work with debt settlement organizations to eliminate their debts.

When you sign up with a debt settlement agency, the company asks you to pay them a set amount of money each month. They deposit your payment into a special account, and when you have enough saved, they’ll attempt to negotiate an agreement with your creditors.

Typically, the debt settlement agency will settle accounts one by one. By the time you finish the program, you will have paid off all of your debts. Most debt settlement programs last between two and five years. The amount of debt you have to settle and the total you can pay each month will determine how long you’ll be on the program.

Understand the advantages of debt settlement

Debt settlement probably sounds like a great idea. You’ll avoid bankruptcy, pay partial amounts on your overdue debts, and get a new financial start. Here are some of the key benefits of debt settlement.

1. You will end up saving money in the end

This is probably the biggest perk of reaching a debt settlement: you may end up paying less overall, especially if you’re dealing with a debt collector that purchased your old debt account.

On average, debt collectors purchase old debt accounts from banks or credit card companies for just 4% of the original debt amount.

That means, if you owe a debt of $1,000 and it gets sold to a collection agency after months of missed payments, the collection agency will probably only pay around $40 to transfer ownership of the account. When they come after you to collect the debt, they make a huge profit if you end up paying the debt in full.

Instead, offer to settle for a lump-sum payment at a percentage of the original debt. Most collectors will be willing to settle for less. In fact, the American Fair Credit Council reports that the average consumer who uses a debt settlement program will reach a settlement of 50% of the original debt amount.

2. You can pay off your debts more quickly

Making minimum payments can turn a small hill of debt into the Himalayas. Unfortunately, you might not have the resources to make extra payments.

With debt settlement, you’ll repay your creditors faster than you would if you simply made minimum payments.

When you settle your debts, you don’t pay your entire outstanding balances. Instead, you pay 30% to 80% of their total value. Interest and fees stop accruing, and you stop making minimum payments.

A debt settlement is usually a one-time payment. You or your debt settlement service will negotiate with your creditors for an agreement. You pay the creditor according to the contract, and they release all future claims to collection.

Let’s consider an example.

3. You can get relief from overwhelming debts

People with several credit cards and loans can quickly get into a financial mess if they don’t keep track of their spending. With each new line of credit comes a new monthly payment, most of which is interest—interest that goes right into the creditor’s pockets.

Individuals stuck in a debt spiral struggle to meet their regular expenses, such as rent, groceries, and utilities. The CDC notes that financial problems can exacerbate or cause mental health problems like depression and anxiety.

Those who decide to settle their debts will likely feel great comfort once they have a clean financial slate. Their feelings of relief can positively impact other vital areas of their lives, like their families and careers.

4. There is no need to file for bankruptcy

Bankruptcy involves declaring yourself insolvent in a federal court. But that doesn’t mean shouting “I declare bankruptcy!” in front of a judge.

Instead, you will hire a lawyer who reviews your financial situation to determine whether you qualify for a Chapter 7 or Chapter 13 bankruptcy.

Under a Chapter 7 bankruptcy, the court excuses you from most debts, except student loans and certain tax obligations. You’ll go through the filing process and spend a few hours in court. Then, the court will discharge your debts. Once a court formally discharges your debts, no creditor can take any further legal action against you to try to collect them.

However, not everyone will qualify for Chapter 7 bankruptcy. You must meet specific guidelines, including a means test that evaluates all of your sources of income and determines whether you are genuinely unable to pay your debts.

If you don’t qualify for Chapter 7 bankruptcy, you may file Chapter 13. Under a Chapter 13 bankruptcy, you must repay a portion of your debts according to a schedule designed by the courts. Once you make all repayments, the court discharges the rest of your debts.

A Chapter 7 bankruptcy will appear on your credit report for up to ten years, while a Chapter 13 will appear for seven years. While the bankruptcy remains on your credit report, you’ll find it much more difficult to qualify for loans, including mortgages. With time, the impact of your bankruptcy will lessen, and your credit score will begin to improve.

Many people see bankruptcy as an opportunity for a fresh start. However, its negative impacts will make your financial life more difficult for years to come. Settling your debt will help you avoid bankruptcy and its financial consequences.

Understand the disadvantages of debt settlement

Despite the benefits of debt settlement, it does have some drawbacks.

1. It could have a negative impact on your credit score

When you enter into a debt settlement, you’ll most likely stop making payments to your creditors. Most debt settlement companies require you to do so since creditors will be more likely to accept a settlement if they see you’re not paying them.

As each month of nonpayment goes by, your creditors report it to the credit bureaus. The adverse reporting will hurt your credit, sometimes significantly. Poor credit makes it very hard to get a new credit card, obtain a car loan, or buy a house. And if you’re job hunting, employers who check your credit report will be less willing to hire you.

Once you make your settlement payment, the negative reporting will stop. Your credit report will show the account as settled or paid in full. Over time, the adverse effects of the negative reporting will decline, and your credit score will increase.

Adverse reporting can stay on a credit report for up to seven years. The sooner you improve your score, the better off you’ll be.

2. It can be expensive if you work with a debt settlement agency

Many debt settlement companies are out there, all seeking to help you settle your debts. However, their services aren’t free. Most charge anywhere from 15% to 25% of the unsettled value of your debt, and they can’t guarantee what settlement your creditors will agree to.

Let’s take a look at another example.

3. There is no guarantee you’ll get a settlement

Your creditor is under no obligation to accept your debt settlement offer. They can easily refuse and attempt to sue you for the debt in court, especially if you aren’t abiding by the repayment agreement.

While uncommon, some creditors won’t accept debt settlement. If you’ve only recently stopped making payments on a debt, they are more likely not to accept your offer.

If your debt relates to a property or automobile, creditors are unlikely to accept your settlement. Instead, they’ll seize the collateral and attempt to sue you for the balance in court.

Some creditors are unwilling to provide much of a reduction to the value of your debt. For instance, they may agree to 80% of the account’s worth, but nothing less than that.

4. You may owe additional taxes for settled debt

If you manage to settle your debts for a fraction of their original value, you will likely owe additional taxes for the amount forgiven. The IRS considers forgiven debt to be income unless you file bankruptcy. You may also owe taxes to the state you live in.

When deciding whether settling your debts is the appropriate action, make sure to consider the additional taxes you may owe. A tax accountant can advise you of the tax impact of forgiven debts.

Debt settlement isn’t for everyone

Debt settlement offers a lot of promise. You’ll be able to pay off your debts quicker without resorting to bankruptcy. In the meantime, you’ll save money on interest and fees.

However, if you choose to work with a debt settlement agency, you must pay them for their services. The cost of a debt settlement company can eat into the amount you save from settling your debts, and you may owe additional monies in taxes.

Make sure to carefully weigh the pros and cons of debt settlement before deciding if it’s the right solution for you.

Alternatively, consider settling the debt on your own with SoloSettle. Protect your financial information, get everything in writing, and save yourself the time and stress of dealing with unruly debt collectors.

Respond to a debt collection lawsuit

You can still reach a debt settlement if you’ve been sued, but first, you must respond to the lawsuit with a written Answer. This will help you avoid a default judgment, which gives collectors the right to garnish your wages and seize your property.

You can draft and file your own Answer in all 50 states with SoloSuit.

What is SoloSuit?

SoloSuit makes it easy to fight debt collectors.

You can use SoloSuit to respond to a debt lawsuit, to send letters to collectors, and even to settle a debt.

SoloSuit's Answer service is a step-by-step web-app that asks you all the necessary questions to complete your Answer. Upon completion, we'll have an attorney review your document and we'll file it for you.

>>Read the FastCompany article: Debt Lawsuits Are Complicated: This Website Makes Them Simpler To Navigate

>>Read the NPR story on SoloSuit. (We can help you in all 50 states.)

How to answer a summons for debt collection in your state

Here's a list of guides for other states.

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Guides on how to beat every debt collector

Being sued by a different debt collector? Were making guides on how to beat each one.

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