Debt Settlement vs. Personal Loans

When you take out a personal loan to pay off your debt, you are paying off the full amount. However, a debt settlement company can talk your creditors into reducing your debt. Your $50,000 in unsecured debt may be cut to $30,000 saving you money. With a traditional loan, you are not only paying off the entire $50,000 but you have hefty interest charges too. With bad credit, no bank is going to offer you a low interest rate.

Currently, a standard interest rate on a personal loan is 10 to 13 percent. If you take out a five-year personal loan at those interest rates, you will be paying over $1,000 per month.  A debt settlement plan can help reduce the amount you are paying by hundreds of dollars per month, as well as enable you to pay off your debt in less time.

Video: How Debt Settlement Works

How Debt Settlement Works

Debt settlement only works on unsecured debt, including credit cards, personal loans, medical bills and college loans. Mortgages, refinances and auto loans do not qualify for debt settlement.

The very first thing you are told is to stop paying off your unsecured debt. This can seem scary as bill collectors will begin hounding you until negotiations are complete.

The company you choose to help you get out of debt negotiates with your credit card company/companies, bank/banks and/or medical center to reduce the amount you owe. They also negotiate terms that state you will not be charged late fees or interest providing your account is paid in full by a set date.

Often, the unsecured debt can be reduced by anywhere from 10 to 30 percent after fees and taxes, depending on your financial situation. Your income and debt levels help determine how much you can afford.

It is important to note that paid off debt is taxable. If your debt is reduced by $20,000, you have to declare that amount on your taxes.

Your negotiated debt does have to be paid in full. If you have that much cash on hand, it works out nicely. However, most people with $50,000 in unsecured debt do not have any savings left. Instead, a debt settlement company sets up a trust fund account where you make monthly payments to satisfy the negotiated debt. These plans generally last three or four years. Debt settlement companies will take a portion of each monthly payment to cover their fees.

Once there is enough in your trust fund account to pay off a creditor, the debt settlement company makes that payment. That account is now paid in full and your next round of savings goes to the next account. The process continues until each account is paid off.

Video: Choosing Between Credit Counseling and Debt Settlement

Selecting a Company

Choose a debt settlement company that guarantees their results. Many companies offer huge reductions but then charge exorbitant fees. Those fees can reduce your savings. Moreover, some companies charge fees before they start negotiations. You may be paying cash up front only to find out the company can’t help reduce your outstanding debt by as much as another company might have. Just be sure to do your research and ask questions before selecting a company.

Qualifying for Debt Settlement

Every debt settlement company has their own terms of service. Generally, you must have at least $10,000 in unsecured debt before they can assist you. A few companies will do the work for smaller amounts of debt, but those programs can be tricky to find.

You must prove financial hardship to qualify. Debt settlement programs work best if you are behind on payments and have lost a job, your spouse or significant other has passed away or you have had your hours cut resulting in a smaller paycheck.

Results of Debt Settlement

It is important to keep a close eye on your debt settlement account and credit report. Failing to pay off an account on time can lead to interest and penalties that increase your debt. Watch your credit report carefully. Late notices may start appearing. Contact your debt settlement company to have these removed.

Once the program is in full swing and you are paying regularly, you will find that a few calls from bill collectors may still occur. If they do happen, send a letter stating you want the calls to stop.

After enrolling in a debt settlement program, as long as you are keeping up with your monthly payments, you should not be harassed. Under the Fair Debt Collections Practices Act, you can tell them to stop calling. If they continue, they are in violation and can be held liable for their actions.

If your income has dwindled and you need instant help in getting bills down to a level where you can afford them, debt settlement plans can help. Debt settlement plans take time to complete, but in the end, you are left debt free.