What Are Debt Settlements?

Debt settlements are a way for borrowers to possibly resolve a default or delinquency on a loan account on modified terms. Such loan modifications may allow you to settle your debt for less than what you owe.

You can negotiate a debt settlement agreement with your lender directly, or you may consider paying a debt relief company to pursue debt settlement on your behalf.

Debt settlement could involve debt forgiveness, which may qualify as taxable income if the lender forgave or canceled $600 of your debt or more. A lender, for example, could forgive 50% of a borrower’s $6,000 personal loan debt if the borrower agrees to pay $100 per month until repaying the modified balance in full. 

Debt settlement companies have sometimes been the focus of criticism, however. Some charge high fees or are not effective. Your credit rating could be worse, not better, after a settlement. 

What Options Are Available for Debt Settlement?

Here are a few different ways one could settle debt:

Private Negotiations

Borrowers can contact their lender or creditor directly or by phone and request a settlement to resolve any matters of default or late-stage delinquency. It’s important to know that failing to pay and defaulting on a personal loan can have a major impact on your credit score.

Debt settlement can potentially allow delinquent borrowers to settle their debts for less than what they owe. A private lender may offer debt settlement to minimize any losses they may incur when borrowers default and go months without paying.

Lenders have no obligation to offer debt settlement, but lenders in some cases may agree to resolve a borrower’s delinquency with a debt settlement agreement. A borrower may request private negotiations at any time to request a debt settlement. 

Lenders may file civil lawsuits against borrowers who fail to make required payments on a loan. If you default on a personal loan and get sued for breach of contract, you may still have the option to reach a debt settlement agreement to resolve the dispute amicably.

Hire a Debt Settlement Company

Borrowers can hire a debt settlement company to resolve any matters of default or late-stage delinquency. Borrowers may contact a debt settlement company by telephone or email requesting enrollment into the company’s debt settlement program. A debt settlement company may advocate on your behalf to persuade a lender or creditor to settle your debt amicably.

A debt settlement company may offer services allowing you to set aside a certain amount of funds in a special savings account. The amount of money you set aside each month in a debt settlement program may ultimately go toward settling your debt with a creditor.

A debt settlement company can negotiate on your behalf with your creditor. The debt settlement company may dedicate its time and resources to help negotiate the best debt settlement agreement for you. Lenders, of course, have no obligation to sign a debt settlement agreement. In the event of default, a lender may pursue legal action against you if the lender is unwilling to settle your debt amicably.

Be careful of large upfront fees. And be aware that you still face tax consequences after debt settlement and your credit rating may not even improve.

Recommended: What Are Settlement Loans?

When Might Debt Settlement Make Sense?

Debt settlement might make sense for you if you’re experiencing financial hardship and find yourself in deep delinquency. If you cannot afford a monthly payment on a loan agreement and find yourself in default, debt settlement may represent a possible path toward rebuilding your credit history.

Borrowers who default on a loan and enter into late-stage delinquency may consider debt settlement vs. bankruptcy. Your credit score could drop if lenders report your loan account to credit bureaus as settled for less than the amount originally owed. Bankruptcy filings, however, can also damage your credit score and may linger on your credit report for up to 10 years as a derogatory event.

Debt settlement can include some amount of debt forgiveness and may give borrowers more time to repay a debt at a lower monthly cost. The IRS, in some cases, may consider debt forgiveness to be taxable income if the lender forgave or canceled $600 or more of your outstanding loan debt. Debt settlement might not make sense if it results in a massive tax liability.

Debt Settlement Percentage

In some cases, debt settlement may result in a creditor reducing a borrower’s outstanding principal balance by up to 60%. Creditors may be willing to forgive a substantial amount of principal to minimize losses from a borrower who may otherwise file for bankruptcy.

Banks, credit unions, and private lenders of personal loans may agree to debt settlement as a possible resolution to delinquency. A personal loan is a lump sum of money that borrowers must generally repay over a set period.

Lenders may offer personal loans ranging from $1,000 to $100,000. Your credit score and debt-to-income ratio may impact how much of a personal loan you can get from a lender. Defaulting on a personal loan can have a major impact on your credit score, while repaying your loan in good standing can bolster your credit history.

Here are some of the personal loan benefits borrowers can experience:

• Borrowers can get an unsecured personal loan with no collateral

• Expecting mothers can use personal loans as a maternity leave loan

• The basic way how personal loans work is borrowers receive a lump sum of cash and have wide discretion on how to use the funds

Among the advantages and disadvantages of personal loans are that they can help you build credit but they may come with high rates of interest.

Debt Settlement Pros and Cons 

Here are some of the pros and cons of debt settlement:

Debt Settlement Pros

Below we highlight some of the pros of debt settlement:

Avoid Bankruptcy

Debt settlement can help delinquent borrowers jumpstart the process of rebuilding their credit histories without filing for bankruptcy. U.S. Bankruptcy Court judges can sign orders discharging most of a borrower’s debts, but bankruptcy may also have a major negative impact on a borrower’s credit score and it can be harder to qualify for loans after bankruptcy.

Avoid Being Sued

Debt settlement negotiations may persuade lenders to work toward an amicable settlement rather than suing delinquent borrowers for breach of contract. Settling debt outside of court can provide you with some relief without involving a judge or jury. Defaulting on a loan and getting sued for breach of contract can result in a judge ordering your wages to be garnished.

Recommended: Can You Go to Jail for Not Repaying a Loan?

No Collections

You may avoid or eliminate debt collection calls by reaching a debt settlement agreement with your creditor. Reaching a debt settlement agreement and honoring its terms and conditions would settle that account. No collections activity would take place once an account is settled via loan modification and paid.

Debt Settlement Cons

Below, we highlight some of the cons of debt settlement:

Deposits

You may need to deposit a certain amount of money into a savings account for several years if you hire a debt settlement company to settle your debt. Such deposits may represent a financial hardship to borrowers facing economic difficulties.

No Obligation

A borrower may request debt settlement relief, but a lender has no obligation to oblige. Lenders may reject calls for debt settlement and may pursue legal action seeking full compensation from delinquent borrowers. Victims of predatory lending may fall into a cycle of debt that predatory lenders may not want to settle.

Credit Score

Your credit score may plunge if lenders report your loan account to credit bureaus as settled for less than the amount originally owed. Having a lower credit score can make it harder for you to qualify for new extensions of credit from a bank or credit union.

Debt Settlement vs Bankruptcy

The below table compares debt settlement vs. bankruptcy:

The Takeaway

Debt settlement may provide delinquent borrowers with some relief, but it can also have a negative impact on your credit score. Consumers may want to consider the costs and terms before borrowing money and taking on new debt.

Lantern by SoFi can help you compare personal loan rates. Just provide basic information about yourself and the loan you need, and Lantern can guide you in the process of applying for a personal loan with the lender of your choice.