When your credit card bills are piling up and you’ve got little hope of ever paying them down, the option that comes with the most risk can feel like the only choice.
That’s often the case for those thinking about debt settlement, where a company provides debt relief by negotiating with your creditors to accept lower payments. Choosing this option can come with pitfalls and should be a last resort if you need help dealing with overwhelming credit card bills, financial experts say. Doing due diligence can help you determine whether it’s the right choice for you.
Here are five questions to ask before you sign up for a debt-settlement plan.
How much will I pay?
People who complete a debt settlement plan typically end up paying 65% to 80% of the amount they owed when they enrolled, says Steven Boms, an advisor to the American Fair Credit Council, a debt-settlement industry coalition. That amount includes service fees the debt settlement company charges, typically about 20% to 25% of the enrolled balance.
This is how the industry makes money, although some companies, upon settling an account, charge a percentage of the amount they negotiate off of your original debt, which limits service fees that consumers pay, says Michael Bovee, a debt-settlement coach.
You can eliminate a debt-settlement fee if you negotiate with creditors, and some creditors encourage consumers to contact them directly before enlisting a third party.
Will this take care of all of my debt?
Consumers who complete a debt-settlement program typically finish in two to five years, Boms says. The time depends on the number of accounts, the balances owed and the client’s ability to set aside settlement money. Debt settlement companies require that you open an account where you deposit money to be allocated toward settlement.
Completing a debt settlement program can be difficult for many. A February 2018 report by the American Fair Credit Council showed that just over 50% of accounts enrolled in debt settlement at the beginning of 2013 had been settled by March 31, 2017. A handful, about 3%, were still active, and over 40% had been terminated, which means the customer withdrew from the program before the debt was paid off. Data on how many customers settle all of their enrolled debt wasn’t available, Boms said.
Why do consumers pull out before settling? The nonprofit Center for Responsible Lending points out that consumers who can’t pay their bills might not be able to keep up with payments into the settlement account. Or they may have to drop out to deal with creditor lawsuits if the creditor sues rather than settles.
Will my creditors negotiate?
Policies on dealing with debt settlement companies vary among credit card issuers. Some, like Bank of America and Capital One, will negotiate with the customer’s consent; some, such as American Express, say they won’t negotiate with debt settlement companies.
A debt settlement company can still settle your debt if the original creditor won’t negotiate. They just have to wait until after the issuer writes off your debt as a loss — typically after 180 days of nonpayment — and sells it to a third party, likely a law firm or debt collector. But waiting for a “charge-off” can make the process go on longer, which will hurt your credit score.
What’s the impact to my credit score?
When you sign up for debt settlement, you stop paying credit card bills, which can trigger late fees that only add to your balance. That doesn’t matter much if the debt gets settled, but what if it doesn’t for some reason? You’ll owe that bigger credit card balance, according to the Center for Responsible Lending.
Meanwhile, even one missed payment will hurt your credit, and a charge-off will damage it even more; the negative mark can show up on your credit report for seven years.
After a charge-off, whoever holds your debt may sue you to collect it, which will incur additional costs and can lead to garnishment of wages if you lose. Judgments also damage your credit.
Is debt settlement better than other debt relief options?
Consider all options, Bovee says, including Chapter 7 bankruptcy, which he calls “the heavyweight champ in debt relief.” Other alternatives include debt management plans, credit counseling or directly negotiating with your creditors.
Bovee recommends consulting with experts, such as bankruptcy attorneys or credit-counseling agencies, to understand how each option works and determine what makes sense for you. Debt settlement with a company should be a last resort, he says.
“Consumers should do their homework to evaluate their options,” he says. “Don’t just talk to a guy trying to sell you a widget.”