Individuals or organizations sometimes borrow money or capital to conduct cash-based activities that they previously didn’t have the financial resources needed to conduct these activities or to pay for provided services by a third party.

Usually, when we borrow cash or capital we put forth a plan to repay the borrowed cash, the same goes for the services we subscribe to monthly or annually.

Although we had a clear plan to repay the borrowed sum of cash to the lender through our source of income to pay the bills, these sources and plans can be challenged by internal or external factors that can hinder our chances of paying back the due amount.

Due to the frequent possibility of this occurring, most financial markets and financial service providers around the world have a certain approach to settling this debt or enabling individuals and organizations to overcome this dilemma without having to sacrifice major assets.

Debt settlement is one of the methods used by financial markets and financial service providers globally to allow borrowers or users to settle these outstanding amounts of cash or capital with lenders.

Yet, this approach has many associated risks and consequences.

This article will explore what debt settlement is, its associated risks, advantages, and disadvantages, in addition to how it works.

In addition, it will also demonstrate a clear example to enable you to fully understand this approach and its effects on you or your business as a whole.

What is debt settlement?

It simply means an agreement is reached between the creditor and the borrower that a lump sum payment will be made to the creditor in exchange for a reduction in the total amount of debt required to be paid by the borrower to the creditor.

In other words, the borrower will pay a lump of cash at one time and the creditor will reduce the amount owed by the borrower to him.

The settlement could be conducted through a lump of cash paid as we have mentioned before in exchange for a lowered amount of cash required to be paid to the creditor, a lowered monthly payment fee to the service provider, or simply a debt discharge.

These options will depend on the creditor’s capacity with regard to their financial ability and lending policies.

When requesting a debt settlement with the creditor, the expected amount to be deducted from the overall owed cash or capital could range between 10%-50%.

This depends on many other financial factors related to a business or an individual. Not all creditors accept this approach and in some cases, this can lead to financial complications for the creditors.

Even though you could conduct it all by yourself, it is not recommended as it requires detailed and accurate demonstrations of your financial situation that can be better demonstrated by an expert.

Third-party companies will charge you a fee after the debt has been settled, this fee varies between 20%-25% of your initial outstanding debt when you requested debt settlement services from the third-party company. This initial sum of debt is called “enrolled debt” which means your due amount owed.

Process of debt settlement

This act has a process in order to be able to be settled. The steps in this process are conducted by the handler of this act and each step is verified by the creditor or service provider.

The process can be costly for the borrower and it can also be lengthy, hence it is usually recommended to be handled by a professional third party.

1. The borrower provides a debt handling firm with an explanation of their financial condition.
2. The debt handling business would urge the borrower to cease paying their creditors and start paying the debt handling company during the procedure (albeit at a lower payment rate).
3. The debt settlement business would deposit the borrower’s payments into a savings account.
4. When the borrower’s savings account reaches a particular amount, the debt settlement company will start talking to the borrower’s creditors about settling the debt.
5. If discussions are successful, the debt settlement business would divide the remaining funds among the borrower’s creditors after keeping a share for its own use (it is paid as fees by the debt settlement company).

Recommended steps

Apart from the process of the act itself, there is an initial process or recommended steps to be taken before you request this service from a third-party company.

These steps are recommended to allow you to have a clear understanding of the outcome of this act and its overall impact on you or your business.

1. Examine debt services firms. There are several reliable debt services businesses in the United States. In most states, having a license is required. Debt settlement firms are expected to abide by industry rules that are intended to safeguard consumers’ money.
2. Take care. Be cautious if a debt service business makes specific results-based promises. They cannot, for instance, ensure that a creditor will even consent to a debt settlement.
3. Inquire about prices. Once you’ve chosen a debt services firm, find out how much it costs to settle the debt. When a corporation avoids answering your queries concerning costs, it may be a clue that the business is dubious.
4. Check your finances. These companies often require money to be placed in a special savings account for at least 24 months before the debt is fully repaid. These payments will help you settle your debt in one go.
5. Keep an eye on the timetable. It often takes two to four years to complete the debt process. During this time,  in addition to the fees charged by the handling company, interest, and fees charged by the creditors may be incurred.
6. Pick a debt-handling company. Once you are fully aware of the potential pitfalls and ready to proceed with the request, it’s time to choose a third-party company based on your research.
7. Nail the details. Before you do business with a third-party company, make sure you understand the schedule and fees. It also asks how much the first payment will be for the company and how much it will pay over time.
8. Find out about the effects of taxes. The IRS considers the debt allowed to be taxable income above $600. Therefore, if you repay a $10,000 debt for $5,000, you may be taxed for the $5,000 allowed.

Advantages and risks of debt settlement

This act can be beneficial to all the parties involved. For the creditors, it will end losses by receiving a sum of cash rather than no cash at all from the borrower, and for the borrower, it will allow them to settle their debts and limit complications related to the debt, and finally for the third party, handling the settlement will receive a fee for their efforts and services.

This act has associated advantages some are obvious like repaying the debt or putting an end to this due amount for both parties creditors and borrowers, it also allows both parties to commence their financial activities without outstanding amounts still lingering.

Advantages

This approach has a direct advantage that will enable individuals to make a great attempt to save their assets, businesses, and wealth. Yet, we need to weigh these advantages against the possible risks and their long-term complications.

• Reduction of unpaid debt

Debt repayment will reduce the amount of outstanding debt. In the example above, the borrower was in debt of $30,000 but eventually paid only $24,000.

• Avoid bankruptcy

It allows the borrower to avoid bankruptcy. In some countries, consumer bankruptcy can last up to 10 years, which can have a significant impact on a borrower’s creditworthiness. In addition,  bankruptcy filings can affect employment aptitude.

Although this act has obvious benefits to all the parties involved, there are some major risks that have to be considered before the borrower engages in this financial solution. These risks can have a long-term impact and can hinder many financial aspects of individuals and organizations.

Risks

Risks vary in their nature and severity. Some are bearable in terms of expectancy of defaulting; meaning although the risk exists it doesn’t necessarily mean the individual with this risk is likely to default. Yet, a collection of these risks may change the outcome.

• High fee

Fees associated with debt handling services vary by local and state law. However, it is not uncommon for external debt settlement professionals to charge 20% to 25% of the debt settled.

• Credit rating can be compromised

Repaying debt using this approach through the settlement process can adversely affect your credit score.

For example, many debt-handling companies demand that lenders and creditors refrain from paying by credit card during negotiations as they are unlikely to negotiate with consumers who can still make monthly payments for invoices.

• The process may take a long time

First, you need to deposit a significant amount of money into your payment account. At the same time, a lawyer or debt settlement company must work with each of your creditors to reach a settlement. The entire process often takes 3-4 years.

• Taxes on the relieved debt

Debt settlement can be a relief, especially when you engage with the IRS regarding an amount lesser than what you originally borrowed. This is due to the fact that any debt which exceeds $600 is prone to taxation.

• Owe more cash

When you start the debt handling process, debt attorneys or third-party companies often advise you to stop paying your debt.

However, even if you stop paying, you will still be charged interest on the debt. In addition, you will be charged with late billing. After all, these charges can increase your debt.

• Inability to pay back

Not all companies pay off their outstanding debt. And even if they agree to a settlement, some refuse to work with debt repayment companies. Please note that not all companies with outstanding debt may not be able to settle their accounts.

Debt settlement scams

There are many companies looking for your best interests, but some debt-handling companies are scammers. Here are some ways to avoid scammers:

• Avoid companies that make false promises

Be careful if a company says you can get rid of your debt and stop proceedings and collections. Keep in mind that your creditors are not obliged to accept the settlement and some do not work with debt adjustment companies.

There is no guarantee that your debt and the problems associated with it will be gone.

• Don’t Pay Before You Pay Debt

If your debt repayment company wants money before you finish your job, it’s a red flag. When they request payment, read the fine print and make sure you know what you are getting.

• Keep up with communication

If your debt-handling company doesn’t tell you about the risks associated with this approach and the consequences of not paying your collection agency, that’s a problem.

You need to understand the risks before giving money (or suspending payments). It’s the debt settlement company’s job to see what’s wrong.

Final take

This act is an approach to repaying loans or due bills for services provided by third parties. This approach is usually taken by individuals and organizations when they fail to fulfill their scheduled payments to third-party creditors or service providers.

This act has obvious benefits like closure and end of the dispute, but it also has risks associated with credit scores, scams, increased due fees to third-party companies, and also it usually takes a long period of time before it is settled and this also has complications like compounded fees to the handlers.

Overall, this act should be put under a thorough study before being conducted by individuals or organizations in order to grasp its benefits without allowing its side effects to take a major toll on the entities requesting this act.

There are steps to be taken like conducting research about the third party company which will handle this activity and many other steps before conducting debt settlement.

Any financial decision requires knowledge and experience, knowledge can be found from many sources but a reliable and experienced source serves the best.

Wall Street Oasis is one of those credible and reliable sources, there are an array of free and paid courses available for you to gain the needed knowledge before deeply engaging in the business world.

Researched and Authored by CEO of NeuralWize Ahmed Fagiry