The commercials promise you debts settled for much less than what you owe and a chance at a fresh start free from credit card debt. Before you consider working with a debt settlement company, ask some basic questions about what the company can actually do for you and how it will really affect your financial future.
Is Debt Settlement Right for Me?
Debt settlement is best for people who have large sums of money but not enough to totally pay off the debt, are financially struggling enough to consider filing for bankruptcy, and those who want something faster than Chapter 13 bankruptcy. Debt settlement works by offering your creditors a one-time lump sum payment to settle the debt instead of potentially never getting paid if you file for bankruptcy. If Chapter 13 bankruptcy is being considered, debt settlement may be another viable option, as it is quicker but often more costly.
How Will Debt Settlement Affect My Credit Score?
Debt settlement will severely affect your credit rating, causing it to drop steeply. According to Fair Issac, as quoted at MSN Money, debt settlement will knock your credit rating down by 45 to 125 points. This is a major hit as credit scores only range from 350 to 850, depending on which credit bureau is doing the rating. Ranges of "excellent," "good," "fair" and "poor" credit scores only range between 60 to 100 points. This means that, depending on the credit bureau, your credit score can go from "good" to "fair" or "poor" just from working with a debt settlement company.
Can They Really Settle My Debt for Pennies on the Dollar?
Settling your debt for pennies on the dollar is not going to happen. Between the negotiated settlements with your creditors and the fee the debt settlement company charges you, you will most likely pay 40 to 70 percent of what you owed your creditors to begin with. MSN Money used a man named Dennis F. as an example: he originally owed $221,000 in credit card debt that he could not pay. He ended up paying his creditors $75,000 to settle the debts and the debt settlement company $38,000 for their services, making his paid grand total 51 percent of what he originally owed.
What Are the Negatives to Debt Settlement?
Other than a major hit to your credit score, debt settlement can create a tax problem. Because the debt you owe but are not paying is charged off, it is considered by the IRS to be taxable income. In Dennis F.'s case, for example, the IRS expects him to claim the $108,000 of charged off debt he did not pay as taxable income for the year he settled the debt. This can quickly make for a hefty tax bill many financially strapped people do not expect and may not be able to pay. Another huge problem people run into are debt collectors with wage garnishments and lawsuits that may legally continue until the debt is settled and paid.
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