Pros and Cons of Consolidating with a Debt Settlement Program
For a long, long time, debt settlement was a thorny topic. For too many years, the debt settlement industry was overrun with scammy businesses leaving distressed consumers in a worse position then when they started.
Today things are a bit different. Tighter regulations have squeezed out many of the worst actors, but like any debt repayment tool, it's not without risk. Of course, for many people overwhelmed with debt, but unable to afford other debt repayment options, it may be their best and only way out.
So let's set aside any preconceived notions about settlement and break down the pros and the cons.
Pros of consolidating debt with a debt settlement
You’ll pay less than what you owe
This is the big one. Debt settlement (also known as debt resolution) is the only form of debt consolidation where you pay back less than what is owed. That can make a world of difference if other debt consolidation options simply aren't affordable given your financial restrictions.
If you owe significantly more than you can reasonably afford to pay back, settlement and bankruptcy may be your only options. And if you don't want to go through a bankruptcy, either because you don't think you'll qualify or you don't want to risk losing your assets, settlement may be your best chance to clear away your debts and let you start fresh.
It may be the most affordable payment
Because you aren't paying back your entire debt, the actual monthly payment for your settlement plan will likely be lower than any other consolidation option.
Ultimately, most people who choose a settlement do so because they simply can't afford the payments of any other option.
No credit requirements
It's typically a given that most people pursuing a settlement are already behind on their debt payments and have damaged credit as a result. Fortunately, there's no credit requirement for a settlement, so a poor credit score isn't a barrier to getting help.
Cons of consolidating debt with a debt settlement
Your credit will suffer
Debt settlement works by withholding payments from your creditors until your accounts become delinquent and eventually charge off. Those months and months of missed payments are very likely to harm your credit score.
If you’ve already missed multiple payments and seen your credit score drop, this may not be as big of a deal, but if you want to preserve your credit (and you have other options), you're better off not doing a settlement.
It can be costly
If you use a professional settlement agency, they will charge you for their services and it can add up. Settlement agencies technically can’t charge clients upfront fees, but they will collect a fee once it’s time to settle the debt – usually a percent of either the original debt balance or the amount of debt eliminated in the settlement.
While they may not claim their fee until the debt is settled, they will often bank their fee first, meaning that the money you send them goes to their fee first and then goes to negotiating your settlement once the fee is accounted for.
There may also be other fees associated with the ongoing maintenance of your account, so be sure to factor that in when weighing your options.
Forgiven debt may be considered income at tax time
Depending on how much debt was forgiven, you’ll likely have to claim that amount as income on your tax returns, which could cost you more money.
This may be negligible, though, especially since the amount saved through the settlement will almost certainly be more than the potential cost of being bumped up to a higher tax bracket.
You can be sued by your creditors
Settlements are often staggered. Funds are collected and then used to negotiate one of multiple debts. The other debts, meanwhile, receive no payment until enough funds have built up for another negotiation.
Creditors and debt collectors are not known for their patience. So there's a real chance that one or more of your creditors may sue you for the unpaid debt. It doesn't matter that you're working with a settlement company and plan to offer them a settlement.
Being sued by a creditor could result in having your wages garnished. If you receive a summons stating that you're being sued for a debt, follow the instructions and respond in a timely manner. The worst thing you can do is ignore it.
Final verdict
While debt settlement can feel scary, it's a perfectly legitimate option, especially if paying your debts in full just isn't possible. The key is make sure you're working with a company that you can trust.
When dealing with debt, it's a good idea to explore all of your options. Debt settlement is just one of those options, but for those who can't afford or don't qualify for most debt repayment plans, settlement may be the right choice.
Struggling with debt and not sure if you can afford a repayment plan? MMI offers free online financial analysis. Enter your debts, income, and expenses, and we'll show you the best options for your situation and goals.
