Debt Settlement Vs. Debt Reduction

You should only enter debt settlement when you've examined all your options and there's no way you can pay off your debts without putting yourself at risk of financial peril. Debt settlement is preferable to throwing all your savings, investments and retirements at a giant pool of debt. However, bankruptcy may be better than debt settlement, because it eradicates the debt, not just reduces it. When possible, debt reduction is the best strategy.

How Debt Settlement Works

According to MSN Money, debt settlement companies usually advise consumers to stop paying their bills and amass cash to make lump sum payments for a fraction of what the original debt was. Meanwhile the debt settlement company negotiates the lump sum payment, for a fee. Typically the fee is 14 to 18 percent of the face value of the original debt. So if you owe $30,000 you may pay a debt settlement company around $4,800 to settle the debt. But you may only pay $15,000 or less on the original debt. The process often takes a couple of years.

Debt Settlment Risks

Many debt settlement companies are not reputable and some are even frauds. Inexperienced companies might not get the best deal with creditors. In addition, settling debt is a black mark on your credit record that warns creditors you are probably not a great credit risk. You may also have to pay taxes on the difference between what you owed and what you paid. And some creditors are unwilling to deal with debt settling companies and prefer to file lawsuits.

Debt Reduction

Consumer credit counseling agencies can offer free advice for reducing debt. They can also create a debt management plan where consumers pay them a small fee to receive a monthly installment from the consumer and pay the customer's unsecured debts. They frequently negotiate reduced fees and interest rates. Those negotiations can negatively impact the way some creditors treat you but not as badly as a debt settlement can.

Snowball and Avalanche

Another approach is simply to tackle debts yourself. Write down all your debts and their interest rates. Then allot a certain amount each month to each debt. Some people use the snowball approach and pay the most to the smallest bill, rolling that amount over when the bill is paid off to tackle the next bill. Others choose the avalanche, pay the most to the bill with the highest interest rate, thus saving yourself interest cost in the long run. Except for the time it takes to recover from already damaged credit, this approach, when consistent, has no negative credit impact.