When you're going through a financial hardship, paying only a portion of your balance may seem like an attractive option. However, it's important to understand how settlement affects your credit and what your options are before making any agreements. Work with reputable credit counseling organizations to settle your debt to avoid scams and unreasonable fees.
Definition
Debt settlement is when you pay a portion of your debt in one lump sum to have the rest of your debt excused by the creditor. Generally, the lump sum amount is between 20 to 75 percent of your debt, according to Aleksandra Todorova of Smart Money. Only those who have defaulted on payments are likely to qualify for debt settlement. The reason creditors agree to settlement is because receiving a percentage of the amount owed is better than receiving nothing, which is what will happen if you file for bankruptcy. If you have defaulted on payments, you are at a greater risk of filing for bankruptcy; however, if your payments are up to date, the credit card company would rather continue to take money from you in hopes of receiving full payment.
Credit Counseling
It's risky to work with so-called debt settlement companies, which may charge high fees and may even be fraudulent. The Federal Trade Commission recommends working with a reputable credit counseling organization instead. A credit counselor will present you with your options, including debt settlement, so you may choose the one that will impact your credit the least. In addition, if you have suffered financial hardships, credit counselors will be able to assist in getting you back on track by identifying your goals and helping you to create a budget.
Credit
The effect of credit card settlement on your credit score depends on the state of your credit to begin with. If you already have lots of delinquencies and negative marks on your report, a settlement won't make as big an impact as it would on someone who has a relatively clean report. Keep an eye on your credit report after filing a settlement. The accounts should be reported as settled -- otherwise, the creditor may continue to report your account as delinquent, which could cause your score to plummet. The appearance of a settlement on your report could raise a red flag for lenders in the future, which may make it difficult to qualify for new credit.
Considerations
As a result of the economic recession that began in 2007, credit card companies created a number of settlement options to help make monthly payments feasible for customers. The alternative, for many customers, would be to file bankruptcy. Therefore, to retain as much business as possible, creditors became more flexible about lowering interest rates, eliminating fees and lowering monthly payments. Financial institutions deal with hardship cases individually, so it's important to get in touch with your specific creditor as soon as you begin to experience financial problems to understand your options.
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