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Debt Settlement: How Does It Work?

By: Michael Millington

When debt seems overwhelming and a little debt help proves necessary, it’s not out of line to consider debt settlement as a step before going to bankruptcy. Once the decision has been made to carry on with such a program, it’s easy to wonder what to do to carry out this decision. So today, we’ll take a look at just how the process starts so that those planning to get debt assistance in this way will have a better understanding of what to do.


Getting Started With Debt Settlement

Debt settlement, like many other forms of debt relief, starts by doing your homework. Those seeking debt settlement can generally start by finding a reliable agent to engage in the settlement proceedings, though it’s also possible to engage in a do-it-yourself debt settlement. Whether finding a settlement company or doing the job yourself, it’s important to note one key point: being proactive. Don’t wait until the threatening letters start piling up in the mail; if you’re dealing with extenuating circumstances, start talking to creditors as soon as you can. The less time that elapses between a problem in repayment and requests for alternate repayment methods—debt settlement, payment plans and the like—the better the chances of a positive outcome.


Potential Consequences of Debt Settlement

With the settlement process started, it’s important to note that there are several potential consequences of a debt settlement that must be considered. Debt settlement won’t eliminate your debt, but it will provide some important assistance with debt, at a price. The first such price is a taxable matter; if someone with a debt of $20,000 gets a settlement for $10,000, the $10,000 saved by the debt settlement is considered taxable income by the IRS. That might mean an unexpected new bill, a reduction of potential refund, and potentially even a new tax bill at the end of the year (depending on how your withholding is structured). Other potential problems include a hit to the credit rating and possibly a mark on a credit record, as missed payments—even settled—can appear on a credit report up to seven years after the fact.


Once a Settlement Has Been Reached

Once the settlement has been reached, either by you personally or by the settlement company designated to serve as your agent in the matter, you’ll then have to begin the process of meeting the terms of the settlement. This can involve either a large lump-sum payment, or a series of smaller payments paid into an escrow-style account to eventually generate a lump-sum payment later on. It’s important to consider what you’re capable of doing so as not to overextend your finances.


Once Your Debt Has Been Settled

Even though it might seem like the matter is settled, always try to receive some form of confirmation that your debt has been settled. Some creditors might not report settlement payments to credit bureaus, despite it being illegal to not do so. That might leave the debtor’s account looking delinquent despite the fact that it has been effectively paid off. This is a point that hits more users more often than expected, especially given reports that 34.4 percent of enrollees had at least 75 percent of their debt settled within three years. Moreover, a Colorado Attorney General report found that the percentage of users who had all their debt settled after being in a program over three years was just 11.35 percent.


No matter how the process is carried out—whether do-it-yourself, with the aid of a lawyer or a full debt settlement company—the process is fairly simple. Start early. Be diligent. Consider all the consequences. Consider all the potential financial ramifications. Conclude the process actively to ensure the debt is considered paid. Keeping all these points in mind before starting out will help make your debt settlement plan a success, and provide valuable relief in the process.


Written by Steve Anderson