The process of settling your debt can make a tremendous amount of sense. However, using a debt settlement company to do this makes absolutely no sense. It’s a very simple explanation:
Definition of Debt Settlement
Debt settlement is the process of having your debt reduced by the entity that holds your debt. In other words, you agree to pay off your balance immediately…but reduced balance. For example
You owe $25,000 on your Chase Bank Visa
They agree to eat $7,000 if you pay off $18,000 in one big chunk.
In this example, you and Chase have settled on this $18,000 payment. Most banks and credit companies are being pretty aggressive with settlements these days. That means that if you have the cash, then you can settle your debts for much less than you owe. Of course the problem is that most people with significant debt don’t have significant cash. That is where things get dicey with the entrance of a debt settlement company.
Here comes the debt settlement company
A debt settlement company will get involved to help you negotiate and accumulate the cash to pay off the debt. However, they charge approximately 14% to do this. Oh, and they take the fee before they start negotiating and paying off your card. Let’s look at the numbers:
You owe $25,000 on your Chase Bank Visa
Debt Settlement Company agrees to help you for 14% of your balance. Therefore you make payments to the company for several months until you pay them $3,500. In the meantime, they have you save money into a pool of money that will be used to pay off your debt. This takes several months. By several months, I mean several several several months. All the while you aren’t paying the credit card company because you only have enough money to pay the debt settlement company and to add to the pool of money that you can use to pay off your balance all at once.
Your credit card companies will continue to harass you. Most people get so scared and frustrated that they start paying their credit card companies, and stop paying the debt settlement company. This means that they completely wasted money that they pay to the debt settlement company. Here is what that looks like:
$3,500 to the debt settlement company
Still owe Chase $25,000.
Booooooo
Working with a debt settlement company is a very bad idea. I would suggest that you never do it.
Peter Dunn a.k.a. Pete the Planner® is an award-winning financial mind and a former comedian. He’s a USA TODAY columnist, author of ten books, and is the host of the popular radio show and podcast, The Pete the Planner Show. Pete is considered one of the foremost experts on financial wellness in the world, but he’s just as likely to talk your ear off about bass fishing.
If a person is able to settle their debts with the credit card companies, will their credit score still take a hit?
Great question. It really depends. Sometimes yes, but most of the time, no. Check with your creditor.