(NewsNation) — Many Americans went into debt during the holiday shopping season, something they will have to pay off for months, and in some cases, years.
When debt becomes too much or takes too long to pay off, there are different routes to take. Some may consider debt settlement, but anyone considering it should understand the potential risks.
“While this can help consumers save money and avoid any legal consequences, it is not without drawbacks,” said Chip Lupo, WalletHub writer and analyst.
What is debt settlement?
Debt settlement, also called debt relief, is a way to resolve debt for a lesser amount than you owe.
If a creditor doesn’t think you’ll be able to pay back your debt, they may agree to let you pay off your credit card for less than the outstanding balance, thus “settling” your debt. But more often, third-party companies will help negotiate for you — at a cost.
Debt consolidation or debt settlement: What’s the difference?
What are the cons of debt settlement?
There are some downsides to debt settlement one should consider before starting the process.
“Debt settlement requires that an account must be in default or close to it, which inevitably means severe damage to your credit score,” Lupo said. “In some cases, the forgiven debt may also be taxable as income, which would create an additional financial burden.”
Credit score: Debt settlement can stay on your credit report for seven years, negatively impacting your credit score.
Slow process: The process can be lengthy.
Fees: There are upfront fees associated with settling the debt.
WalletHub recommends against consulting for-profit third-party companies as they charge high fees and “don’t always have the consumer’s best interests at heart.”
“In some cases, these companies stall negotiations until credit scores are severely damaged,” Lupo said. “Employing a do-it-yourself approach or working with a reputable non-profit may be safer and more cost-effective alternatives.”
Debt consolidation or debt settlement: What’s the difference?
What are the pros of debt settlement?
Experts warn against the risks of debt settlement, cautioning there are few positives. The goal is to reduce overall debt and in some cases to avoid bankruptcy, but settlement fees and the impact on your credit may not solve the problem.
WalletHub said debt settlement is not a “quick fix.”
“Before pursuing this option, consumers should exhaust other avenues such as credit counseling, debt management plans, or budgeting strategies that may offer solutions with less credit risk,” Lupo said.
