When a creditor agrees to take less than the whole amount of debt you owe as complete payment, this is known as a debt settlement. Also, you won’t be harassed by debt collectors or threatened with legal action because the obligation has been discharged.
When it comes to debt relief organisations, or “debt settlement businesses,” their services can come at a high price—even beyond the considerable fees they charge.
What Do Debt Relief Companies Actually Do?
You pay a fee to a debt relief company to negotiate on your behalf with your creditors. In exchange for settling your debt, creditors will accept less than the whole amount you owe.
Many of these companies such as Canada Debt Relief claim to be able to dramatically reduce your debt. Although it sounds nice, the practices used by debt reduction businesses with vendors can have a devastating effect on your credit score. The following are some hard facts about how they operate:
Prior to talking with your creditors, debt relief businesses often urge you to stop making debt payments and instead make an agreed-upon monthly deposit into a savings account they have set up for you, frequently for a fee. Before approaching your creditors, you’ll have made a few payments into your account. Then, the debt reduction firm will represent you and argue that it’s in your best interest to settle with them for a portion of your debt rather than risking no payment. The implied threat is that you’re at the end of your financial rope and that lenders may be unable to collect everything you owe them if you file for bankruptcy.
You may also be charged fees if the debt settlement business is successful in negotiating a reduction in your debt and paying the lowered amount to you on your behalf.
Is Debt Settlement a Dangerous Option?
Several factors make debt settlement a risky proposition:
You will have to pay for debt settlement. There are costs that debt relief businesses charge for debt settlement, and these fees can quickly add up over time. For federal income tax reasons, if a debt settlement organisation is able to get your debt forgiven, the amount they lower your debt may be considered income. According to your income and tax rate and available deductions, you may have to pay back at least a portion of the debt that was forgiven to the IRS.
Debt settlement might have a negative impact on your credit history. It is possible that your missed payments will be noted on your credit report if you have halted payments as advised by your debt settlement firm. Missing a number of payments will have a significant impact on your credit score because payment history is the most important component. Failure to make timely payments might lead to creditors suing you for an unpaid debt or selling your debt to collection agencies. Collection accounts show up as a blemish on your credit report.
A debt-relief business can also help you lower your debts by negotiating with your creditors, which will show up as “resolved accounts” on your credit record for up to seven years after you pay them off. A resolved account will show up on your credit report as a negative event, even if it’s less serious than a bankruptcy or foreclosure. As a result, some lenders may reject candidates with resolved debts on their credit reports when they apply for a loan.
Settlement of debt is not always successful. A creditor’s agreement to lessen your payment obligation is not guaranteed. Even if they don’t agree, you’ll still owe the settlement business money because of the time and money you’ll have wasted, and you may have had late or missing payments on your credit record as a result.
What Are the Differences Between Debt Relief and Debt Consolidation?
You may be able to work with a debt reduction company to set up a single monthly payment that they would use to make payments to your creditors. It’s common for settlement companies to refer to this procedure as “debt consolidation,” but that’s misleading.
As a free strategy, you can consolidate your debt by taking out a low-interest loan and paying off high-interest bills with that money, all without the involvement of third parties. This makes it easier to budget and pay your bills because you only have to worry about one monthly payment. It can also save you money in the long run because you pay less interest.