Bankruptcy is the Slender Man of the finance world. When people hear the term, they automatically start running the other way towards any refuge that seems safe. Debt settlement is such a refuge that seems superficially safer than declaring bankruptcy. However, in truth, the former option can be the real haunting you need to stay away from. We agree that the rule of debt settlement companies is not as authoritative as it used to be even a couple of years back and a lot of them have cut down their upfront fees to appear more approachable. They are not as safe as they seem to be!
Most people usually fall into debt due to uncontrollable spending habits. Others are a victim of multiple small and medium debts that demand varied interests and APRs. People who do not find easy debt management solutions often fall into the clutches of debt settlement companies. Sadly, many of these companies rarely provide debt relief, but most of them compound their clients’ monetary woes by charging a consultation fee, service fee and a plethora of other fees.
Negotiation is a lengthy process
Debt settlement companies can never provide prompt debt relief. Most of these companies start by asking their clients to stop paying their monthly debt installments, credit card payments and creditor payments. The clients need to redirect their payment into a savings account instead. Even for the leading debt settlement firms, it can take 3 to 4 years to settle just 25% of the client’s debts. Most clients come to these companies after paying 75% of their debts anyway. Therefore, this delay further exacerbates the debt situation by attracting payment penalties, depreciating the credit scores and calling for higher interest rates on all future debts. Sometimes, the clients also face a high risk of lawsuits as the companies fail to convince the creditors to settle for lower monthly payments and lower interest rates.
It is a costly process
The math simply does not add up! Debt settlement is supposed to make the process more bearable for the debtors. Most people end up paying 45% to 50% APR by the end of their debt payment anyway. This is much higher than their initial agreed-upon rate since it includes late fees and monthly interests as well. Did you know? Most debt settlement companies can charge up to 20% of the debt as their fee. This is usually in the form of an upfront payment during the enrolment process. Now, the company has to report the amount of debt the creditors forgive to the IRS and the IRS usually treats this as taxable income. In case, the borrower falls within the 25% tax bracket; he can end up paying 90% or more as the cost of debt settlement to the company. That does not seem like a relieving option from any angle for any borrower at all.
Debt settlement is bad for reputation
When businesses fail to deliver and multi-million dollar tycoons cannot pay the loans to the government, they usually declare bankruptcy. None of the individuals and corporations with proper legal aid ever goes for debt settlement. Although bankruptcy has a bad name and most debt settlement companies will try to tell you that the former does irreparable damage to your reputation, it is hardly any different from the effects of hiring a debt settlement company. These companies can interrupt your monthly payments, and your FICO scores can even plummet to the mid-500s from mid-600s upon hiring a similar company to negotiate with your lenders.
Bankruptcy may be a better option in case you are in deep trouble
Chapter 7 bankruptcy takes a shorter time to settle scores with your lenders and credit card companies. It has the power to halt all payments and collection activity. Even alimony and child support are a part of these payments that bankruptcy can overrule with ease. Even lawsuits cannot do much damage when a bankruptcy declaration is in action. In fact, contrary to what you have heard for so long, bankruptcy can help your credit scores. In 2010, people who filed for Chapter 7 bankruptcy had credit scores in the range of 530 to 540. However, by the end of discharge (within six months), their average score rose to 620. This is as per the Equifax scores, but FICO scores see smaller gains during the same period.
When should you go for debt settlement?
Debt settlement should never be your first option of debt management or debt relief. Only when your other option is a Chapter 13 bankruptcy, debt settlement makes somewhat sense. Chapter 13 demands five years of continual payments before all remaining balances reset themselves. Compared to this, debt settlement does take shorter time, but it can cost you more. Always consult a reliable bankruptcy attorney before starting your consultation with a debt relief company.
