Debt Settlement Pros & Cons

Jun 17, 2014 by

erase credit card debtIf debt is really weighing down your finances, you’ve likely found intriguing those enticing television commercials promoting a service to slash your debts by half or more. These commercials are selling “debt settlement,” a legitimate technique for paying off seriously past due debt.

What’s Debt Settlement?

Here’s how debt settlement works:

  1. Say you have an old $5,000 debt that was written off by the original creditor and sold to a collection agency a couple of years ago.
  2. You’ve paid nothing on the debt, despite the collection agency’s aggressive tactics.
  3. Either you or the collection agency proposes a $3,000 payment to fully pay off the debt. (This works for the collection agency because it may have paid the original creditor only $1,000 for the debt.)
  4. After negotiations, you and the collector agree on a payment of $2,500 to take care of the debt.
  5. You make the payment, the debt’s balance on your credit report goes to $0, and the collection agency leaves you alone, forever.

Pros & Cons of Debt Settlement

The benefit to the collection agency of a debt settlement is that it’s booked a profit on the debt it purchased from your original creditor.

For you the benefits of debt settlement are:

  • The collection agency stops hounding you
  • A past due debt stops hammering your credit score
  • You’ve lived up to, at least in part, your obligation to repay money you borrowed

The downsides of settling a debt include:

  • A notation that the debt was settled for less than the full amount can linger on your credit report for seven years, taking a gradually fading toll on your credit rating
  • The IRS may consider the portion of the debt “forgiven” as taxable income to you


Alternatives to Debt Settlement

In my opinion, for most people most of the time, a Debt Management Plan is the best way to pay off debts. Because you’d be paying off your debts in full, a DMP would have much less negative impact on your credit score than would settlement. For the detail oriented person with good discipline, a do-it-yourself DMP may be a great option. For those who need help setting up and managing a DMP and who want to minimize their debt payments, a Plan offered through a non-profit credit counseling agency affiliated with the National Foundation for Credit Counseling is a good choice.

Do-It-Yourself Debt Settlement

If you conclude debt settlement is the best option for you, please don’t pay the high and generally non-refundable fees charged by the sponsors of those enticing television commercials. Settling a debt is not rocket science! Check out “Settle Your Debt in 10 Easy Steps“, part of the Money Counselor Simple Guides to Debt, Credit, and Wealth Series.

Have You Settled a Debt?

Have you or someone you know settled debts? What did you learn?

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