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Debt Settlement Pros and Cons

Credit card debts and other unpaid personal loans are causing so many Americans these days to look to companies and services that can offer them some form of debt relief. If you're like them, you may have already seen on TV or read online an offer that sounds something like this, "A professional debt settlement company will slash your debt in half!" Such an offer may sound terribly tempting for many consumers who are desperately looking for a way to cut down their debts. But as the old adage goes, if it sounds too good to be true, it probably is.

Much like the other methods that consumers use to resolve their debts, debt settlement does have its own set of pros and cons. Indeed, debt settlement is a perfectly legal solution and is one of the most widely used forms of debt relief.

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Under a debt settlement program, or what's sometimes referred to as debt negotiation, credit card companies may agree to "settle" your debt for substantially less than you owe. Debt settlement companies will typically advise their clients to stop paying their bills and instead save up funds that this then used to negotiate a one-time, lump payment (the settlement). Be careful that you don't confuse debt negotiation with other debt reduction methods like enrolling in a debt management program, where your high interest debts are typically consolidated into a single lower each month. Bankruptcy is also another option, but remember, it has a more damaging and longer lasting negative impact on personal credit.

Many creditors don't like to advertise debt settlement because they will, in essence, be settling for a lesser amount than what you originally owed. But consider this: If credit card companies decide to "sell off" what they consider to be your "bad debt" or the amount they are likely not going to be able to collect from you to a third-party debt collector, they will often receive as little as 10 cents on the dollar. And if you are severely in debt and decide to file straight bankruptcy, they will not get paid at all. However, if those creditors receive a reasonable offer to settle from you, or made on your behalf by a debt settlement company, they may be likely to agree to settle your debt for much less than you owe.

Pros of Debt Settlement

These days, many consumers find debt settlement appealing because it does offer them a viable way to reduce credit card debt. And, because you are typically paying your creditors far less than what you originally owe, that may represent substantial savings for you. Another "pro" to consider: Some creditors, once they settle, may agree to bring your account to a current status, which can help improve your credit score. Another plus is that you may actually end up with disposable cash that you now may be able to use for housing, utilities, food, and other amenities.

Cons of Debt Settlement

Now that you're aware of some of the benefits of debt settlement, you should review some of the "cons" and the potential scams that you may unknowingly fall prey to. First, consider the fees. Just how much will you pay for having a debt settlement company do the work for you? The answer is as easy as finding a needle in a haystack. Debt settlement is usually costly; some debt settlement companies charge 14 to 18 percent of the total value of the debt you want settled, while others may charge a percentage of the debt savings once you settle.

Consider this: In an MSN Money article, Katie Porter, a professor of bankruptcy law at the University of Iowa, came across an offer from a company to settle $33,551 in debt that projected a $5,032 service fee to be paid in monthly increments. She said that it was only after the service fee was paid off two years later that the client actually started saving up money for the settlement. While this may be an extreme example, it just goes to point out the fact that, while settlement can offer significant savings to consumers, make sure you understand how much you are likely to save, how long it will likely take you to realize those savings, and compare the cost of the service with the savings to make sure debt settlement makes sense for you.

In addition, another protection for consumers has just gone into effect thanks to an FTC ruling which prohibits non-attorney based debt settlement companies from charging any fees until savings are realized by the consumer. This could likely lead to many more consumers signing up for debt settlement programs, knowing that they will not have to pay for services until they realize savings through settlement.

Some debt settlement clients face problems before debt negotiations usually begin. With debt settlement, your credit score will typically suffer. Negative marks may continue to hit your credit score until creditors get their settlement which means your credit will continue to suffer while you save up money to negotiate the settlement. Some creditors, once they know you are working with a debt settlement company, may even send letters threatening to sue you to try to collect the full amount that you owe.

With bankruptcy, your creditors will stop their collection efforts as soon as you file. Not so with debt settlement. Another factor that debt settlement companies should let you know is that the Internal Revenue Service considers forgiven debt to be taxable income. In some cases, that amount can push some people to fall back deeper into debt simply because they did not consider the tax consequences.

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Another area of concern is the high drop-out rate among consumers who participate in debt settlement programs. Reports from industry watchdogs indicate that many people who enroll in debt negotiation or debt settlement programs don't complete the program, citing the lack of savings discipline as the biggest factor in the drop-out rate. This is not surprising when you consider that consumers who get into debt in the first place often have budgeting problems and may not have the discipline needed to stay on course and set money aside for a settlement. In spite of the potential drawbacks of debt settlement, many consumers still consider it a viable option because they are truly burdened by a tremendous amount of credit card debts and are hoping to settle with their creditors for much less than the original amount owed. But no matter which method of debt reduction you choose whether it's signing up for a debt management plan, debt settlement, or even bankruptcy, it pays to be an informed consumer.

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