The Pros and Cons of Debt Settlement

Debt negotiation is the process by which a debtor (or his representative) negotiates with a creditor to reduce the amount of an outstanding debt in exchange for a prompt, lump-sum payment. The agreement that the debtor and creditor arrive at is called "debt settlement."

Debt settlement clearly has benefits for both the debtor and the creditor. For the debtor, debt settlement allows them to reduce the total amount owed, satisfy the debt immediately, and get on with his or her life. For the creditor, the immediate payment saves them the time, energy, and expense of trying to collect the debt, and it also protects them from the possibility of getting nothing at all if the debtor files bankruptcy. But while on the surface, debt settlement may seem like a win-win proposition, there are sacrifices that both the debtor and the creditor have to make - and there are some hidden benefits, as well.

Debt Settlement Requires a Lump-Sum Payment

Generally speaking, creditors will not reduce the amount owed to them unless their debtor agrees to pay the reduced amount in one lump sum - usually within 30 days or less. Occasionally, agreements can be made in which the creditor agrees to reduce the amount owed in exchange for two or three reduced payments, but a creditor is never going to slash a debt in half and allow you to keep on making monthly payments. Why would he?

The question quickly becomes: Where do you come up with the money for the lump-sum payment? After all, you must be in some form of financial distress if you need to resort to debt negotiation, right? Well, many times debtors stop paying their creditors - all of them - and instead, begin setting aside money for the eventual settlement of their debts. In addition to potential moral qualms with this strategy, it also does a serious number on your credit report, since each missed payment hurts your credit score.

On the positive side, the one lump-sum payment not only provides the benefit of reduced principal, it also allows you to wipe the debt off your credit report and walk away clean. The tremendous amount of stress than debts can cause cannot be overlooked, and the personal benefit of being liberated from that stress should not be underestimated. If you have a kindly old grandmother or friendly neighbor who can gift you with the money needed to settle the debt, all the better.

Debt Settlement - Pros and Cons for Your Credit

As hinted at above, debt settlement can be a double-edged sword for your credit report. On one hand, halting payments to all creditors will result in a lot of late and missed payments on your credit report, which can slash your credit score by several hundred points in short order. On the other hand, once the debts are marked "settled as agreed," your credit score will be improved by the fact that your total outstanding debt will be reduced.

But wait a minute: Why would you necessarily have to stop paying all of your creditors in order to pursue a debt settlement? Well, creditors are unlikely to take your hardship case very seriously if you're still able to pay all of your creditors except them. You have to make it clear that debt settlement and bankruptcy are your only options and force them to choose which would be more preferable to them.

Debt Settlement Won't Save Your Home or Your Car

Generally speaking, debt settlement can only work for unsecured debts. Mortgages and auto loans are secured by the underlying properties - your house and your car. If you fail to pay as agreed, your mortgagor or car lender can legally repossess your property to recoup what they're owed. Of course, if you still owe $5,000 on a $1,000 car, then debt settlement might work in such a case, but generally, your house and your car are exceptions to all debt settlement rules. By this same logic, however, you can keep current on your mortgage and car loan and still threaten bankruptcy, since secured debts are not discharged by Chapter 7 or 13.

As with debt management and bankruptcy, debt settlement has both advantages and disadvantages. Most preferable is to stay current on your bills and not take on more debt than you can afford. Second to that, debt management is preferable - if you can afford to maintain your debt management plan. But if your only options are bankruptcy or debt settlement, generally debt settlement will be the right move. As always, bankruptcy should be the last resort.

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