Debt Settlement: Why a Settlement May Not Be in Your Best Interest

Debt Shown with a calculator and cash in hand

Settling debt is fueling the debt settlement market, with the CAGR expected to rise between 2021 and 2026. As a result, consumers in debt need to choose between bankruptcy, debt consolidation or a settlement.

How Does Debt Settlement Work?

A debt settlement plan is only offered when creditors know that you can’t pay the full amount of debt back. You’ve likely missed payments on multiple accounts, and a settlement will allow you to reduce your overall payment by putting money into a savings account.

When the account has reached a certain amount, the settlement company negotiates on your behalf to try and get the creditor to agree to take the lump sum in your savings account to satisfy your debt.

Is Debt Settlement Worth It?

Maybe. Most financial advisors see a settlement as a last resort because your credit score will plummet. The relief company will ask you to stop making payments, and since delinquent payments are a major factor in determining your credit score, your score will drop drastically.

Don’t expect to be able to be approved for any of the following any time soon:

  • Mortgage
  • Car loan
  • Credit card

You’ll settle the debt at the risk of having to rebuild your credit. But settlement companies may be able to reduce your debt by as much as 50% and help you become debt-free in three years.

The company that helped you settle your debt will also require a fee for their services when the negotiation period ends, and your debt is cleared.

Debt Settlement Vs Bankruptcy

Bankruptcy offers a clear path to settling your debts, but you will need to file for bankruptcy in court. In addition, you will suffer from a 7 to 10-year impact on your credit score, making it almost impossible to obtain a loan or a line of credit.

Lenders would rather you settle so that they receive some of their money back rather than file for bankruptcy and receive nothing.

If the settlement is done properly, the impact on your credit will still be significant, but the impact will not last as long.

Debt Settlement Vs Debt Consolidation

Consolidating your debt may be an option and cause a much lower impact on your credit score in the process. The idea of consolidating your debt is simple: roll your debts into a single loan, hopefully with lower interest rates, and pay off the debt over time.

The goal is to consolidate to keep payments manageable for you.

When payments are manageable, you’ll still be repaying your debt while also building your credit. Your monthly debt obligations are typically lower and may even boost your credit if your credit utilization is lower due to the loan.

But consolidating doesn’t lower your overall debt obligations like a settlement does.

If your main goal is to lower overall debt, a settlement is ideal. However, it’s important to weigh the debt settlement pros and cons before deciding whether a settlement is in your best interest. All of the options available will negatively impact your credit score and help you alleviate your debt in the process.

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