Mary Grace McCormick, Credit Writer
Debt settlement is the process of negotiating a lower repayment amount for an unsecured debt (typically credit card debt). Debt settlement ends with the party who owes the money making a lump-sum payment to the creditor for the reduced amount, satisfying the person’s repayment obligation.
A debt settlement agreement can be reached by the individual debt holder or through the services of a debt settlement company. A debt settlement company will provide a recommendation for a new monthly payment, which you will deposit into an account that enables third-party access. While you make payments into this new account, you do not make any payments on your outstanding accounts with creditors. This is because as a rule, creditors do not settle accounts in good standing. Once the account has reached an agreed-upon threshold (which may be after charge-off), the debt settlement company will reach out to your creditors to negotiate a settlement. When an agreement has been reached, funds will be transferred out to settle the debt.
Debt settlement companies generally make money through fees. You could pay a combination of fees upfront, throughout the process, and upon settlement. Typical fees can range between 15% and 25%, calculated on either the amount saved, or the initial amount owed.
A typical debt settlement process takes about two to four years, but how long it takes is very dependent on your creditors and their willingness to negotiate with either you or your debt settlement company. Your creditors do not have any obligation to settle, so there is not guarantee that a settlement will even occur.
At the end of the process, your credit history will reflect the settlement of an account, or accounts, if applicable. This settlement will remain on your credit history for seven years and may cause your credit score to dip by over 100 points. It is also worth noting that while debt settlement may save you money in terms of the principal, interest, and fees owed, you may need to pay taxes on the forgiven portion of the debt, as the IRS considers this taxable income.
To learn more, you can visit our guide on how debt settlement works.
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