By Megan Doyle | American Express Credit Intel Freelance Contributor
7 Min Read | January 17, 2020 in Money
The number of Americans having a hard time keeping up with debt payments is increasing, according to a 2019 report by the Federal Reserve Bank of New York.1 Moreover, the trend appears to be growing faster for those in their 20s: the same report found that about 9% of credit card balances for people aged 18-29 were seriously delinquent (90+ days) as of the second quarter of 2019.
This trend can be particularly troubling for young people, since credit score damage from delinquencies can make it harder to take out mortgages or other loans in the future. But there are many ways young Americans can start managing their debt. One option is debt settlement—though it comes with risks.
Debt settlement is a debt reduction method in which the credit issuer allows a person to pay off their debt for less than the original balance owed, typically in the form of a lump-sum.2 How much a creditor will settle for depends on several factors, including your overall balance and financial situation, but it typically ranges between 30% and 60% of your outstanding balance.
For example, if you owe $10,000 on a single credit card, you may be able to reach a settlement with your credit card company to pay only $6,000, or 60% of your outstanding debt. In exchange for your one-time payment of $6,000, the credit card company will forgive the remaining $4,000.3
But a creditor won’t likely accept a debt settlement if they believe you could pay the full amount—otherwise, why would they settle for less? In other words, a creditor is only likely to approve a debt settlement proposal if they fear you may not be able to pay the balance at all.4
A debt settlement or debt relief company will attempt to negotiate with your creditors to accept a lump-sum payment for less than your original balance. To build that lump sum, you’ll probably have to make monthly deposits into a savings account held by the debt settlement company. Meanwhile, they’ll likely advise you to stop paying your creditors to improve the chance of your settlement being approved—a high-risk move that could have negative consequences.
Debt settlement companies might seem like the easy way out, but experts say they’re not always a good idea. According to the U.S. Consumer Financial Protection Bureau (CFPB), debt settlement programs are notorious for offering unsound financial advice, being expensive, and risky.5 What’s more, the Federal Trade Commission (FTC) says many consumers drop out of debt settlement programs without settling their debts.6 For more information about debt settlement companies, see “Are Debt Relief Programs Too Good to Be True?”
Arranging a do-it-yourself debt settlement with a creditor might take a little bit more time and effort, but it’s also less risky and you won’t have to pay for someone else’s services—and that savings can make a big difference if you’re deep in debt. But still, there’s no guarantee that your debt settlement will be approved. If all else fails, you can try to arrange a modified payment plan to reduce your monthly payments.
Here are the steps experts recommend to negotiate a debt settlement on yourself:
Whether you do it yourself or use a debt settlement company, debt settlement can negatively impact your credit score. Exactly how much depends on factors like the current condition of your credit and the size of the debts being settled.12
When the debt is settled, your creditor will likely send an update to your credit report to show a status of “Settled.” While experts say a “Settled” status is better than seeing “Unpaid” on your credit report, any payment status other than “Paid in Full” can hurt your credit.13 What’s more, debt settlement will stay on your credit report for seven years.14
If debt settlement companies can be risky, and even DIY debt settlement can hurt your credit score, you may be wondering if debt settlement is even worth it. Like all things finance, it depends! On one hand, taking a debt settlement is better than having unpaid debts. But it can also have negative consequences. In the end, you have to weigh the situation on your own and figure out if debt settlement is a better alternative to debt consolidation, enrolling in a debt management program, or filing for bankruptcy.
Debt settlement means your creditor will allow you to settle your debt for less than your outstanding balance. Unfortunately, it’s not as easy—or safe—as it sounds. Negotiating with your creditor can take a lot of time and effort, whereas debt settlement companies can be risky and expensive. What’s more, debt settlement will likely damage your credit score. Regardless, debt settlement might still be the right debt-reduction method depending on your financial situation.
1 Quarterly Report on Household Debt and Credit - 2019:Q2, The Federal Reserve Bank of New York
2 “What’s the difference between a credit counselor and a debt settlement or a debt relief company?,” Consumer Financial Protection Bureau
3 “Debt Settlement: A Guide for Negotiation,” Investopedia
5 “What are debt settlement/debt relief services and should I use them?,” Consumer Financial Protection Bureau
6 “Settling Credit Card Debt,” Federal Trade Commission
7 “Debt Settlement Negotiations: A Do-It-Yourself Guide,” NerdWallet
8 “Settling Credit Card Debt,” Federal Trade Commission
9 “Debt Settlement Negotiations: A Do-It-Yourself Guide,” NerdWallet
12 “How Will Debt Settlement Affect My Credit Score?,” Investopedia
13 “How Will Debt Settlement Affect My Credit Score?,” The Balance
14 “How Long Do Settled Accounts Stay on a Credit Report?,” Experian