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Explore the hidden reasons to ward off debt settlement

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By: Phil Bradford
on 29th Jun,2016

If legal debt settlement is good, then why we are avoiding it? Don’t know? Find out your answer here.
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DEBT - this four letter word can capsize your life and finances if you can’t handle it properly. There are various debt relief methods to help you put back your finances on track such as debt settlement, debt consolidation, debt management, and bankruptcy. But, you can’t choose an option blindly to recover your finances. You need to analyze your financial background first before picking up a debt relief option for yourself. The correct debt relief option would ease all your debt problems.

Debt settlement tops the chart as one of the most common debt relief options. But, it’s not the best debt repayment option always. Different debt problems need different way outs. Debt settlement can’t be the only solution to all your debt problems. There are better alternatives to it.

In today’s post, I would like to draw your attention toward why we avoid debt settlement even if it’s suitable for our financial case. You would find sufficient answers to clear all your doubts. Just take a look at these below-given points.

1. Debt settlement affects credit ratings

“According to Lauralynn Schueckler of National Foundation for Credit Counseling, your credit score could drop by 65 to 125 points.”

How much debt settlement would affect your credit rating depends on your financial details. You’re already delinquent on your payments; that means settling debts would hurt your credit score, since it shows that you’re not creditworthy. However, your past records would say how much a debt settlement plan would damage your credit score. Unlike debt management that has less effect on your credit score, debt settlement, and bankruptcy damages your credit rating severely.

Though debt settlement helps to settle your debts, few actions of yours can hit your credit score hard. For instance, your old debt that was already sent to the collections 3 years ago will be reactivated and shown as your current debt if you try to pay it off through debt settlement. It would damage your credit rating to a great extent. However, creditors don’t negotiate if you aren’t badly behind on your payments. Your credit score would suffer more if you manage to avoid delinquencies and charge-offs.

2. You may have to pay high fees to the debt settlement company

Negotiating with the creditors and settling the debt amount is not everyone’s cup of tea. You need to know every detail of the game before you start playing. The debt settlement companies are best at this job. Almost everyone takes help of the debt settlement companies for settling their debts. Well, these companies won’t help you for free! You need to pay them for their service. Some companies charge you high fees for negotiating your debts. At times, these debt settlement companies may charge a part of the settled amount as their fees. But, as per FTC rule, a settlement company can’t charge upfront fees. So, take this thing into consideration before signing up for a debt settlement program.

3. You have to pay taxes on forgiven debt

The amount of debt that is forgiven by the creditor is considered as income of the debtor. The Internal revenue System calculates the canceled debt as taxable income. If the forgiven balance goes beyond $600, then it’s taxable income. For example, if you consider the tax rate as 15%, then $5,000 of a forgiven debt would carry a tax liability of $750. It is the debt amount that is not forgiven by the IRS. You would also find an exception here. Consider this: If you’re broke, that is, your assets are less than your liabilities, you can request the IRS to forgo the tax liability by filing form no. 982.

4. Creditors can sue you

The bankruptcy court gives you legal protection from being sued or harassed by the creditors. On the other side, even if you try to settle your debts through debt settlement and inform the creditors of the same, they can sue you for the amount you owe. It totally depends on the motives of the individual creditor. Usually, a good debt settlement company would never fasten you to a program that lasts over 48 months.

Don’t miss out: Avoid debt settlement company: Select the right company

5. Debt settlement isn’t the correct option for your finances

As per the report from the Center for Responsible Lending, a nonprofit research group, “consumers who sign on with for-profit debt settlement companies find their debts grow about 20 percent on average before a settlement, with no guarantee that such a settlement will be reached.” Also, “the percentage of clients successfully completing a debt settlement program was in the ‘single digits.”

A recent data states that getting rid off debts through debt settlement can ultimately lead to financial troubles. So, before heading toward a debt settlement firm, have a talk to a financial expert regarding which debt relief option is suitable for your finances. It’s considered as the last option before filing bankruptcy. However, debt settlement is a reasonable alternative to Chapter 13 bankruptcy.

Read more: Settle debt or bankruptcy - A brief idea

6. Debt settlement won’t give you instant relief

A debt settlement program requires you to deposit a certain amount of money in your escrow account. Until you have sufficient money in the bank account to make a reasonable settlement offer, the debt settlement company can’t start their negotiations with your creditors. Remember, the fees of your debt settlement company are being deducted from your bank account while you’re trying to save money for making a settlement. Arranging adequate money for a settlement can take more time than you’ve thought. Moreover, saving money for multiple debts can take several years. So, debt settlement is not an instant painkiller to all your debt aliments.

7. The success rate of debt settlement is very misleading

“Industry figures show that the majority of debt settlement customers drop out of the programs within the first six months, after they have paid a large portion of the fees but before their debts are settled.”

The success of debt settlement is not guaranteed. After you have saved enough money, your creditors might not be ready for the settlement. What will you do if this happens? All your hard work will go in vain. So, before coming to any conclusion regarding settling your debts through debt settlement, you must analyze your financial footing first and then decide the best debt relief option to revive your finances.

Debt settlement is a good debt relief option. But, it does have some deficiencies. It’s probably due to these above drawbacks that most of us avoid debt settlement, even if it suits our financial situation. So before opting debt settlement, you must keep in mind that, it isn’t always a sure-fire way to end all your debt problems.

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