Debt settlement has emerged in recent years as an alternative path to freedom from high unsecured debt burdens like credit cards or medical bills. But is it the right debt relief option for you? Here we dive into the pros and cons of debt settlement to help you make an informed decision.

What is Debt Settlement?

Debt settlement, also known as debt arbitration or debt negotiation, involves working with a settlement firm to negotiate reduced payoff amounts with your creditors and lenders. The goal is to settle accounts for less than the full outstanding balances owed. This differs from options like debt consolidation loans or filing bankruptcy, which take different approaches to managing overwhelming debt.

What Are Some Potential Pros of Debt Settlement?

The ability to settle the debt for significantly less than the full amount owed can certainly seem like an appealing and attractive option at first glance.

Here are some of the commonly touted benefits that make debt settlement enticing

Lower Overall Debt Burden

Successful settlements can reduce total debt owed by 50-60% typically. This greatly alleviates the burden for heavily indebted consumers. Settlements also allow you to pay off debt much faster compared to minimum payments.

Pay a fraction of your actual balance

The primary goal of debt settlement is negotiating with creditors to accept a fraction of what you owe in order to call it even. Many people settle their debts for 50% or even much less than the original amount, which can mean huge savings.

Structure affordable payment amounts

Because you are paying considerably less than you originally owed overall, debt settlement companies can divide the total settlement amounts due into much more manageable monthly payments that realistically fit into your budget.

Resolve debt faster

Since debt settlement involves paying lump sum settlements that are less than your full balances, many peoples’ debt can be eliminated much more quickly – often within 2-4 years – compared to paying monthly installments over multiple years.

Best alternative of bankruptcy

Bankruptcy leaaves a negative credit score impact and job prospects for up to 10 years. Debt settlement allows debt relief without resorting to bankruptcy, and is often the best bankruptcy alternative.

Peace of mind

Finally getting out from under the crushing weight of large amounts of debt, regardless of the method, can relieve a huge amount of mental stress and improve both physical and emotional health and well-being.

But Also Know the Potential Cons

While settling debt often seems like an easy or quick way out of a financial mess, it’s very important to have clear eyes going in regarding some of the potential drawbacks and downsides you may face

Hurt your credit score

Missed payments will cause your credit score to plummet substantially, sometimes by over 100 points. Settled accounts will also be specifically noted as such on your credit report rather than paid in full. This can have long-term effects on your ability to borrow money.

Collection calls and lawsuits

Once accounts become delinquent, creditors and third-party collectors will begin aggressively pursuing you for payment. Lawsuits against you are a very real possibility that can lead to wage garnishment.

Owe taxes on settled debt

If the amount of debt forgiven through settlements exceeds $600, the canceled portion may be considered taxable income by the IRS. Failing to report this could lead to penalties or audits, so consult a tax professional.

Risk settlements falling through

Creditors are not obligated to accept any settlement offers. If they refuse, you'd need to find another solution but your credit is already severely damaged.

Alternatives to Debt Settlement

Debt settlement is just one option for managing unaffordable debt levels. Depending on your financial and personal situation, you may want to consider alternative debt relief options including:

Non-Profit Credit Counseling - Reputable credit counseling agencies offer free consultations to review your entire financial picture. They can help you construct a Debt Management Plan (DMP) which works directly with creditors to potentially lower interest rates, waive fees, and consolidate multiple payments. This can provide debt relief without damaging your credit score like debt settlement.

Debt Consolidation Loans - Debt consolidation takes out a new loan to pay off existing unsecured debts at lower interest rates, reducing required monthly payments. This simplifies payments into one monthly bill and can lead to paying off debt faster. Be cautious of lending sources, terms, and eligibility requirements when exploring this option.

Bankruptcy - Declaring Chapter 7 or Chapter 13 bankruptcy immediately stops collections efforts and foreclosures. While bankruptcy damages credit history and has long-term consequences, it can provide a fresh start for those utterly overwhelmed by debt through eliminating eligible debt balances. Understand extensive impacts before considering bankruptcy.

Caution Against Debt Settlement Scams

As debt levels swell more consumers struggling with bills turn to debt settlement companies. Unfortunately, this growth in demand has led many illegitimate firms to take advantage of vulnerable individuals facing financial crisis. Warning signs of potential "debt relief" scams include:

• Guarantees of cancelled debt or settled outcomes before reviewing your accounts. Legitimate firms make no guarantees.

• Requests for substantial upfront fees before settling any debts. Adviseable firms collect only once settlements are secured.

• Failure to explain terms, contracts, services, or fees clearly and transparently. Ethical companies are fully upfront.

• Lack of required state licensing for providing debt adjusting services in your state. Verify licensing.

• Failure to provide documentation throughout the process detailing settlement agreements, payments made, fees charged, and account status updates.

Thoroughly research any firm prior to engagement and walk away from any raising suspicions. Protect yourself and your rights as a consumer facing financial hardship.

What Types of Debt Can Be Settled?

Debt settlement primarily focuses on unsecured consumer debt like credit cards, medical bills, personal loans, and other flexible forms of debt. Student loans, auto loans, mortgages, and other secured debt cannot be settled through this method. The best candidates for settlement have $10,000 or more in debt spread across multiple accounts.

Is Debt Settlement Ultimately Right for You?

At the end of the day, debt settlement can be a viable solution for handling large amounts of unsecured debt like credit cards, medical bills, or personal loans. When weighing the debt settlement pros and cons, the people who see the best outcomes are generally disciplined individuals with steady jobs who simply took on too much debt and can’t keep up with ever-growing monthly payments no matter how hard they try.

If you go the settlement route, go into it with a clear vision, understand the risks and commitments, thoroughly research reputable companies, get everything in writing, and consult tax/legal professionals when needed. While debt settlement can provide substantial savings and debt relief, it also comes at a cost. Look closely at all options and chooses the debt resolution approach that makes the most sense for your unique financial situation.