A Guide to Debt Settlement

••• Peter Dazeley/Photographer's Choice/Getty Images

Debt settlement is an option for people who are currently behind on their debt payments. It is an alternative to bankruptcy and will let you get rid of a lot of debt with less money than you owe. You can negotiate debt settlement yourself or you can use a company to do it for you.

How Debt Settlement Works

When you settle debt with a company you offer to pay less than you owe in exchange for the rest of the debt to be forgiven. Sometimes you can negotiate down to twenty or thirty percent of the original amount that you owed. Debt settlement only works on unsecured loans or debts without collateral such as credit cards or personal loans. For loans with collateral such as your car or home loan the bank will repossess the item and will not negotiate a different payment. Since the company had a hard time collecting debt from you in the past, you must pay the amount you negotiated in one lump sum within a few days of making the agreement with the company.

For this reason, you should negotiate with just one company at time. Debt settlement does affect your credit score negatively since the debt does say settled, but it is better than having a lot of outstanding over due debt on your credit report. It may be a better option than bankruptcy.

Pros of Debt Settlement

Debt settlement can help clear up your debt much more quickly than paying it off. The negotiation may make it possible to take care of your debt rather than ignoring it and hoping that it will go away. Debt settlement also allows you to pay something towards your debt, which may help you resolve concerns if you feel badly about not being able to pay your current debts because your financial circumstances have changed.

Cons of Debt Settlement

Debt settlement does have a negative affect on your credit score, since the debts will not say paid in full. You can only address one debt a time, which means you may still be fielding collection calls while you try to save up money to pay off your debts. It may take time to pay off all of your debts, where as bankruptcy would take care of paying them off more quickly. You will need to pay taxes on the amount of debt that is forgiven. You need to plan for how debt settlement will affect your taxes now

Negotiating Debt Settlement Yourself

You can negotiate debt settlement on your own. You will need to list the debts you are currently behind on in payments and look at the amount you currently owe. Try to save up about fifty percent of that amount and then call the lender to offer an amount as settlement in full. Start with a smaller amount than you currently have saved, since you will need to negotiate the payment amount with the lender. If they will accept the amount as payment in full, you need to request that they send you a letter stating that and wait to receive it before sending the payment.

Keep a copy of the check with the letter on file indefinitely. This will protect you in the event that the company argues that you still owe them money. Once you have settled one debt you start the process over with another debt.

Using a Debt Settlement Company or Lawyer

You can use a debt settlement company or a lawyer to settle your debts as well. The debt settlement company will contact your creditors for you and negotiate the settlements. During this time you will be making monthly payments to the debt settlement company, which they will save to negotiate settlements for you. The debt settlement companies will take a portion of that money for fees for their services. Additionally some debt settlement companies suddenly close and take all of the money you have paid with them.

It is important to carefully research the company and make sure it is legitimate and has been open for several years before going with them. A debt settlement lawyer will work in a similar way as a debt settlement company. It is important to carefully consider all of your options when you want to work with debt relief firm.

Alternatives to Debt Settlement

There are alternatives to debt settlement. One is to set up a debt payment plan yourself. This plan has you list your debts in order of smallest to largest or highest to lowest interest rate. Then you find extra money to pay on your debt each month and apply it to the first debt on your list. After you have paid off the debt you move on to the second debt. For debts you are behind on you can make payments to get caught up or save up money and pay off the amount in full all at once, where the debt fits in your list.

Credit counseling provides another option. A credit counseling service will help you create a budget and will work with your creditors to reduce your monthly payments or interest rate. You will make monthly payments to them and they will pay your creditors. This is better than debt settlement, but it does affect your credit score. Bankruptcy is another option. It will severely affect your credit score and make it difficult for you to borrow money in the future.