How Does Debt Settlement Really Work?

Debt settlement is one of those areas of personal finance where what sounds too good to be true almost always is. If you’ve gotten in trouble with credit card debt, there is no “reset” button. Your best option is usually:

  • Cutting unnecessary expenses to free up more money for debt repayment
  • Taking on extra work to increase your income
  • Using a balance transfer offer for temporary relief from high interest rates
  • Discussing lower monthly payment options with your creditors to keep from being delinquent
  • Getting serious about paying off what you owe without falling behind on payments

That approach will improve your credit score and put you back on track with the least amount of hassle. However, there are times when negotiating a lower settlement may make sense. This might be true if an emergency rather than your spending habits is what put you in an overwhelming debt situation. There may be no light at the end of the tunnel regardless of whether you cut back on lattes and other extravagances. Debt settlement offers a middle road between paying debts off in full (and on time) and filing bankruptcy.

Why would a credit card company agree to debt settlement?

The fact is they won’t if they think they can get back all the money they loaned you. That’s why it’s not possible to even start negotiating a reduction in the total amount of your debt until you are behind on payments. You have to look like a bad credit risk (because that’s what you are). That’s tough on your pride, but it may be the only way out.

It’s best not to wait until you completely run out of money trying to pay off debt to start this process. Instead, you should start stockpiling money in a checking or savings account as soon as you begin exploring the idea of debt settlement. That’s because you’ll need to make lump sum payments to your creditors as part of a negotiated settlement (and the settlement agency will want a fee as well). They get money up front and can cut their losses and walk away. That’s often cheaper than pursuing you with collections efforts for years. It also ensures they get something instead of being left empty handed if you file for bankruptcy.

Tags: Finance