Advantages and Disadvantages of a Debt Settlement Program

Jul 19, 2010
Asa Ghaffar

Pros and Cons of a Debt Settlement Program - dearmansoor

Debt settlement negotiation is a way to reduce the overall debt burden and improve affordability. Find out the pros and cons of a debt settlement program.

When income exceeds expenditure, it is necessary to take action to address this imbalance. Debt settlement companies can include almost all unsecured debts in a debt free plan. The objective of a debt settlement program is to reduce the total amount owed through a negotiation process. The client repays the remainder over a 12 to 36 month period at an affordable rate.

Advantages of a Debt Settlement Program

Eliminate debt. The main selling point of this debt reduction program is the opportunity to write-off up to 50% of the principal. Although the client will make monthly repayments on the reduced amount, the agreed debt reduction won't take place until the final payment has been made.
Affordability. Reducing the total debt burden means that the percentage of income needed to service the debt will also be lower. This helps to balance income and expenditure.
Stop debt collection. Although not a legal obligation, most creditors will stop contacting the debtor for repayment. The client also has a source of professional support and advice.
Convenience. Rather than making multiple repayments, it will only be necessary to make one payment to an intermediary. They distribute the proceeds to creditors.

Disadvantages of a Debt Settlement Program

Monthly repayment. Unlike filing chapter 7 bankruptcy, debt settlement negotiation involves offering creditors a payment from disposable income. If no disposable income is available, possibly due to unemployment or poor health, it isn't an effective way to get out of credit card debt.
Management charges. In order to cover the administrative costs, it is necessary to pay a 15% management fee from each monthly payment. Always avoid debt management companies that front-load their charges as this will add to the amount owed.
Purely voluntary agreement. A debt reduction program isn't a legally binding obligation which means that it can be canceled at any time by either party.
Secured debt. Any debt that is secured cannot be included in the arrangement.
Low credit score. In order to consider a debt settlement program, it is necessary for the debtor to have defaulted on each of his credit agreements. This will be reported to credit reference agencies, which will make it more difficult to borrow money or refinance in the future.
Debt forgiveness. Any debt that is eliminated with a debt settlement program is treated as a taxable income by the Internal Revenue Service (IRS). Ken Clark, a Certified Financial Planner, stated: "If you're going to owe the IRS big money, you'll want to think about it much more carefully." It is advisable to get professional tax advise before proceeding.

Is Debt Settlement Negotiation Worthwhile?

Anyone with substantial debt understands what an overwhelming burden this can be. Although writing off debt is taxable under the current IRS rules, it remains possible to dramatically reduce the amount of money that needs to be repaid. It is a voluntary agreement so creditors can still contact the debtor in an attempt to recover their money - filing for bankruptcy is the only legally binding debt solution. A debt settlement program provides light at the end of the tunnel for people struggling to pay back revolving debt.

How to Choose a Debt Reduction Program

Debt settlement negotiation may appear to be the best debt free solution, but it won't work if there isn't sufficient disposable income to offer creditors a monthly payment. If this is the case, filing for chapter 7 bankruptcy may be a more appropriate course of action. If a small amount of money is owed to several creditors, it may be more effective to plunge for a debt management plan. That's why it is so important to seek advice from a free credit counseling service before proceeding.