When unmanageable debt has you in a bear hug, you’ll probably do anything to wriggle free — including striking a deal with your creditors to reduce how much you have to pay. Debt settlement involves negotiating with your creditors to reduce the amount you owe, often with the help of a third-party company.
Having someone lighten the burden of your debt sounds like a great deal, and in some cases it’s the smart move. But debt settlement can be a lengthy, stressful process that sometimes ends in regret. CNBC Select explains what you should know about debt settlement and how to decide if it’s right for your situation.
What you should know about debt settlement
When you settle a debt, your creditor agrees to accept less than your remaining balance. Why would the creditor agree to this? Because they make the calculation that it’s better to get some of the money you owe them rather than hold out for the full amount which you can’t (or won’t?) pay.
You can try to reach an agreement yourself by talking to your creditor, and they can potentially reduce the amount you owe or change the terms of your debt to make it more manageable.
But as you might suspect, creditors typically don’t want to settle for anything less than the full amount, so the negotiation process is almost always tough. Many people choose to hire a debt settlement company and have them do the work instead. In most cases, the company will instruct you to stop making any payments on your debt and to put that money in a savings account instead. The settlement company will use these funds to collect its fee and pay your debt if they’re able to resolve it with your creditors. The process typically takes three to four years.
Note that debt settlement companies can only legally charge you fees once they have resolved your debt — and that’s far from guaranteed. That’s why if a company requests you pay beforehand, you’re most likely dealing with a scammer. Always research a debt settlement provider before hiring them to make sure you’re working with reputable professionals.
CNBC Select analyzed multiple debt relief companies and recommends New Era Debt Solutions as our top pick. The company has more affordable fees than its competitors and has been in the industry for over two decades. It also ranks highly for customer satisfaction.
14% to 23% of enrolled original debt
New Era Debt Solutions has slightly lower fees than some of the other debt relief services we rated. It’s been in business for 22 years, and is rated 4.93 out of 5 for customer satisfaction through the Better Business Bureau.
Pacific Debt Relief is another provider with highly-rated customer service and has been in business since 2002. Note, however, that it only works with clients with $10,000 or more in unsecured debt.
15% to 25% of enrolled debt
Pacific Debt Relief is highly rated for customer service, earning a 4.93 out of 5 according to the Better Business Bureau. Since 2002, the company has settled over $300,000,000 worth of debt.
Pros and cons of debt settlement
At first glance, debt settlement may appear like an excellent solution. In reality, debt relief is a valid tool for some — but for most, it should be a last-resort option.
Here’s what to consider before settling your debt.
- You can reduce your debt. Negotiations can lead to different types of resolution, but essentially, you’ll pay less than what you owe. That’s undeniably the main draw of debt settlement.
- You can have a professional handling negotiations for you. Trying to settle a debt yourself can be time-consuming and overwhelming. The option to work with a third-party company can save you the headache and offer some peace of mind.
- Results aren’t guaranteed. Not even the most reputable debt settlement company can guarantee successful resolution. And if you come across a company that makes such promises, you’re probably dealing with a scammer.
- Debt settlement can be expensive. Often, debt settlement companies charge between 15% and 25% of the resolved debt and require that you have at least $10,000 of unsecured debt.
- It can also damage your credit score. Since debt settlement involves stopping payments to your creditors and can take several years, your credit will potentially suffer a severe blow. In fact, according to the National Foundation for Credit Counseling (NFCC), debt settlement often leads to a credit score drop of 100 points or more.
- You might end up owing taxes on the forgiven debt. This is because the IRS will likely consider this amount taxable income.
As you can see, you’re potentially making a bad situation worse by opting for debt settlement. For that reason, you should first exhaust all of your other options before turning to settlement.
Solutions to consider before settling your debt
The concept of debt consolidation is rather simple. You take multiple unsecured debts and roll them into a single new balance (that hopefully charges an interest rate lower than what you were paying before). This makes staying on top of your bills easier and can potentially save you a hefty sum of money.
The best tools for debt consolidation include a balance transfer card and a personal loan. A balance transfer card lets you move a credit card balance for a fee (usually, between 3% and 5% of the balance) and pay no interest on it for a specified period. For example, the Citi® Diamond Preferred® Card offers a 0% APR for 21 months on balance transfers (18.24% to 28.99% variable APR thereafter). This means the card gives you 21 months to pay off the transferred debt without any interest charges.
0% for 21 months on balance transfers; 0% for 12 months on purchases
Balance transfer fee
5% of each balance transfer; $5 minimum. Balance transfers must be completed within 4 months of account opening.
Foreign transaction fee
A personal loan comes with a fixed interest rate and consistent monthly payments, which gives you a predictable payment schedule. And with a debt consolidation loan, the lender will often directly pay your creditors without you having to get involved.
Many lenders charge origination fees that generally range from 1% to 10%. That said, it’s possible to find lenders that waive them, such as LightStream — our top pick for those with good or excellent credit. Unfortunately, LightStream won’t pay your creditors directly — but you can get the funds to do so yourself as soon as the day you apply.
Annual Percentage Rate (APR)
7.99% – 25.99%* APR with AutoPay
Debt consolidation, home improvement, auto financing, medical expenses, and others
24 to 144 months* dependent on loan purpose
Early payoff penalty
Terms apply. *AutoPay discount is only available prior to loan funding. Rates without AutoPay are 0.50% points higher. Excellent credit required for lowest rate. Rates vary by loan purpose.
Getting your debt under control isn’t just a math problem to solve — it also involves building healthy financial habits. If you don’t know where to start, consider a credit counseling organization. These non-profits have certified credit counselors who can analyze your financial situation, help you figure out a plan and perhaps recommend a debt management program.
When you enroll in a debt management plan, your credit counselor negotiates new terms with your creditors. These may include waived fees and lower interest rates. The debts that are part of the plan get consolidated into a single monthly payment you make to the credit counseling agency. This isn’t a free service, but you’ll probably offset the cost in interest savings.
Declaring bankruptcy is never fun, but it may be preferable to debt settlement in some cases. You might be able to remove most of your outstanding unsecured debt and the process typically takes a few months. When compared to the years debt settlement can require, bankruptcy can sometimes get you back in the black quicker and with less pain.
Consult with an attorney or credit counselor to see if bankruptcy is a wise step for you.
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Debt settlement isn’t a simple way to pay less than you have borrowed. It’s a long process with no guaranteed results — but it will almost certainly tank your credit. Consider other options before turning to debt settlement, and if you do, make sure you work with a trustworthy company.
At CNBC Select, our mission is to provide our readers with high-quality service journalism and comprehensive consumer advice so they can make informed decisions with their money. Every credit guide is based on rigorous reporting by our team of expert writers and editors with extensive knowledge of credit products. While CNBC Select earns a commission from affiliate partners on many offers and links, we create all our content without input from our commercial team or any outside third parties, and we pride ourselves on our journalistic standards and ethics. See our methodology for more information on how we choose the best credit products.
Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.