Weighing the risks when you feel like you don’t have any other options.
People often get debt management programs confused with debt settlement programs. It’s easy to understand, but in truth the programs are distinctly different in almost every way. While a debt management program allows you to pay back everything you owe in a way that’s more manageable on your budget to help minimize credit damage, a debt settlement program settles your debts for less than you owe, which causes negative remarks on your credit report that damage your credit score.
The information below is designed to help you understand what debt settlement is and how settlement programs work. We also have a helpful page that compares debt management and settlement side-by-side. If you still have questions or you’d like to talk to a certified credit counselor for free to help identify which solution is right for you, call us at . You can also get started by completing an online application to tell us more about your financial situation.
What is debt settlement?
Debt settlement refers to the financial process where you offer the holder of a debt an amount of money that’s only a percentage of what you owe in total. In exchange for this partial payment, they erase the remaining balance owed and close out the account. So basically, you pay a portion of what you owe to make a bad debt finally go away for good.
Debt settlement almost always deals with debts that have already been charged off by the original creditor and sold to a third-party debt collector. So these are things like credit card accounts that have already been closed. You can’t make any new charges and your relationship with the creditor through that account is over. Debt settlement simply allows you to get a debt collector off your back by offering them a part of what you owe to clear away the remaining balance so you don’t have to worry about it.
How debt settlement programs work
Of course, if you’re struggling to make payments and you’ve already fallen far enough behind that your accounts are getting charged off, then you’re not likely to have a large sum of cash on hand to make a lump-sum settlement offer up front – otherwise, you would have used that money to pay off the debts with the original creditor!
In some cases, the money comes from something like a settlement, inheritance or tax refund. So you receive a large lump sum of cash and use all or part of it to settle debt with collectors. However, in most cases people use a debt settlement program. This is where things can become a little risky for your financial outlook and your credit.
So here’s how a debt settlement program works if you go through a third-party provider:
- When you sign up with the company, they will advise you to stop paying your monthly payments to the creditor or creditors.
- You divert the money you were paying each month into a settlement account that the company sets up for you.
- Once that account has enough money, the settlement company starts negotiating with the collectors and creditors to get them to accept partial payment to clear out the account.
- If the creditor or collector agrees, the money is taken out of the settlement account and delivered to the organization trying to collect.
- Once they receive the partial payment, the remaining balance is written off and the account is closed.
- By law, the settlement company should only get paid if they settle one or more of the debts that they were contracted to negotiate.
- Each settled debt generates a negative remark on your credit report that the account was settled for less than the full amount owed. The negative remark remains on your credit report for seven years from the date it was settled.
Understanding the risks of settlement
If it seems like this would be bad for your credit outlook, that’s because it is. This is definitely not a debt solution you want to pursue if you’re concerned about causing damage to your credit that will follow you for the next few years. Remember, you’re talking about a negative credit item that sticks around for seven years for each account settled.
Besides simply hurting your credit score, settled debts don’t look good to anyone who reviews your credit report. You’re unlikely to get a loan or a line or credit because you’ll be considered a high risk borrower since you’ve shown you don’t always pay back all the money you received.
However, that’s not to say that this solution can’t be used successfully in certain financial situations. If you’ve been struggling month after month to get ahead and don’t have any other options left to find relief, and if your credit has already hit rock bottom because of late payments and collections, then this could be the solution you need to finally dig your way out of debt.
Still, it should really only be considered as a last resort before bankruptcy. It should always be done with the understanding that getting approved for financing in at least the near future is unlikely. And while no credit damage is permanent, waiting up to seven years to achieve good credit again is likely to be a long wait.
Know your options before you settle
A certified credit counselor is trained to evaluate personal challenges with debt to help each person counseled find the best path forward in that unique financial situation. Counselors only recommend a debt management program if that’s the best solution in your current financial circumstances. In other words, you can call for a free, confidential evaluation with the knowledge that you won’t get pushed into any one solution. We can help you find the right way out of debt that minimizes credit damage and helps you get back to financial stability as quickly as possible. Call us at to speak to a certified credit counselor today.