Debt Settlement

By Kaitlyn Szabo • July 12, 2022

Debt settlement is the act of resolving delinquency with a creditor for less than the amount owed through a large lump-sum payment. The main benefit of a debt settlement plan is that, if accepted, it can help you get out of debt sooner for less than what you owe. However, there are several risks associated with the debt settlement strategy. 

For example,

• The creditor is not required to settle, so there is no guarantee you’ll get an agreement.
• Settlement often negatively impacts your credit score since you likely need to be delinquent to qualify.
• Forgiven debt (the difference between what you owe and what you pay) is considered taxable income.

Debt Settlement Companies

Consumers can negotiate independently or work with a debt settlement company for a fee. Here’s roughly how working with a debt settlement company will play out:

• The company will contact your creditors for you to negotiate a repayment plan or lump-sum settlement.
• At the same time, they may advise you to start depositing funds into an account to save for this payment. You will also need to stop paying your creditors until they settle. However, they must explain the negative consequences of missing payments and becoming delinquent on your debt if they advise you to do so. 
• If you, the company, and your creditors reach an agreement, you must pay the new agreed amount. Debt settlement companies can only charge fees after they get an agreed settlement.

Avoid Debt Settlement Scams

If you feel working with a debt settlement is your best option, do your research before signing a contract. The Office of Minnesota Attorney General Keith Ellison provides helpful tips for consumers to avoid debt assistance scams. 

• Confirm the company has a license from the Department of Commerce using the “License Lookup” search.
• Beware of too-good-to-be-true “guarantees” of lowered payments, interest rates, or money-back offers.
• Read the fine print of all contracts before signing. Obtain all verbal promises made in writing.  

Another Option: Credit Counseling

Nonprofit credit counseling with certified personal finance professionals might be an option if debt settlement doesn’t seem like the best fit for you. Our partners at LSS Financial Counseling and other financial service providers are good examples of reputable services.

You’ll receive personalized feedback during a credit counseling session like free budgeting help or a credit report review, action steps to improve your situation, and referrals to other resources. Counselors may also advise you to consider a debt management plan (different from debt settlement) to help you get out of debt with lower interest rates and a streamlined payment schedule.

Reminder: There’s No “Quick Fix”

No matter what route you take, remember that there is no quick or magic fix to resolve or eliminate consumer debt. Sustainable debt relief requires skills we all can learn or improve on (like discipline and budgeting) and resources not all of us have equal access to (such as money, time, or a support system). We strongly encourage you to be practical, patient, and kind to yourself as you take steps to become debt-free.

Money Management E-Newsletter: May 2022