Debt settlement companies make alluring offers of eliminating your debt for very little money. However, before you make any agreements, it's important to understand how debt relief settlement works and the impact it has on your credit. Since your credit affects major parts of your life, including housing and employment, you need to protect it and find a debt relief option that is the least damaging overall.
Definition
A debt relief settlement is when your creditor agrees to forgive a portion of your debt when you make a lump sum payment. Generally, the one-time payment is for between 20 and 75 percent of the amount owed. Creditors accept debt settlement only in instances where they believe that the consumer is headed for bankruptcy. In bankruptcy, the creditor receives nothing, whereas with settlement they receive at least a portion of the balance.
Timing
Creditors will not agree to debt settlement until you have defaulted for a long period of time, usually six months or longer, according to Zip-Debt co-founder Charles Phelan. During that six-month period, it's vital to save money so that you have money to offer your creditors when it comes time to negotiate a settlement. Communicate openly with your creditors and let them know how much you have to offer in the form of settlement. If they don't agree to accept your settlement, let them know that you will work with creditors you can settle with first before filing for bankruptcy.
Warnings
Defaulting on your credit for such a long period of time has devastating effects on your credit score. To put the damage into perspective, one payment more than 30 days late can push your credit score down by as much as 110 points, according to finance writer Liz Pulliam Weston. This kind of damage may take years to work off of your credit report. Such a low score can make it difficult to obtain new credit, rent property and even get hired for certain jobs. Also, be aware that so-called debt settlement companies often charge high fees, and that many aren't legitimate. The Federal Trade Commission recommends working with a credit counselor instead.
Considerations
Other debt relief options, such as debt consolidation, debt management plans and even bankruptcy may have less of a negative impact on your credit score. Before diving into debt settlement, work with a reputable credit counseling organization recognized by the National Foundation for Credit Counseling, so that you fully understand all of your options. A credit counselor will also help you to create a budget so that you never end up with an intolerable level of debt again (see Resources).
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