Debt settlement may seem like a good option to many people who are in over their head when it comes to debt. There are many different sources of debt in today’s modern age, ranging from student loans and auto loans to credit cards, medical bills, mortgages, and more. When these debts become overwhelming and you’ve missed many payments and your credit score is suffering debt settlement becomes an attractive option, but how much can you really save when it comes to debt settlement?
The Costs of Settling
There are a number of different costs associated with debt settlement that you should keep in mind when you are planning your finances around a settlement. Understanding these costs will give you a better idea of what the total costs and savings of any debt settlement will be
The first cost you should consider I the blow to your credit score. A debt settlement will reflect negatively on your credit score and might cause your interest rates to go up. This will cost you more on financial products in the future, and should be considered in the total cost of debt settlement. The good news is that at the point where companies are willing to settle debts your credit score has probably already taken some serious damage, so it will be much easier to move your score up.
The next thing to consider is taxes. The IRS considers forgiven debt to be income, so you need to be prepared for a higher tax bill than you would normally receive at your level of income. This can be a large hit to many people and needs to be taken into account when you are considering debt settlement.
Finally, you should consider the fact that any debt settlement company or lawyer that you use to assist you with the debt settlement process will need to be paid. That will also add to the costs of debt settlement. Most companies charge a commission on the amount of savings the settlement generates. For example, if you settle a $10,000 debt for $9,000, the company will charge you a percentage of $1,000, the difference between what you owed and what you paid. Assuming a 20% commission, you would owe the debt settlement company $200. You can see how, at higher amounts of debt, this can rapidly increase the costs of your settlements.
The Savings of Settling
That’s not to say that settling debts is all cost. Obviously consumers wouldn’t be interested in debt settlement if they didn’t save some money, so how much money can you save? Different lenders have different policies on settling debts, and you or your representative should talk to your creditor to see what kind of position they take. Moreover, this can be influenced by the situation that you find yourself in, the interest rates you pay, and how much money you have on hand to settle the debt. Lenders are in the business of making money, which means that they’ll try to get as much of what you owe as possible. Most companies won’t be willing to settle for less than 90% of the total debt owed. This means that the amount of savings that you’ll get can be summed up as:
Amount You Owe – Amount of Settlement – taxes – fees and commission.
You can see that this can lead to less savings than many advertisements make it seem like you’ll get. That’s why most consumer advocates recommend trying other methods to resolve your debt before attempting to work out a settlement. In the end you won’t save as much with settlement as you think you might and the other costs and damage to your credit score can result in even higher costs down the road.
Make sure you understand what you’re getting into before you enter into any settlement agreement. The implications of a settlement go far beyond that one transaction, and you should do your best to try and use other mechanisms to resolve your debt before you try to negotiate a settlement. Companies are under no legal obligation to settle debts, and some may not be willing to enter negotiations. Think carefully before making any financial decisions as drastic as debt settlement.