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By Kenneth Long on January 20, 2010
Debt settlement has numerous drawbacks and very few benefits. Even so, for a small percentage of debtors, debt settlement can be a viable option. These are potential benefits for a debtor who successfully settles a debt.
The primary advantage to settling your debt is to reduce the overall payoff for that debt. For example, if you owe $10,000 to a collection agency and you have at least $3,000-4,000 in savings, then you might be able to convince the collection agency to accept a partial payoff.
Most debt collectors want at least 60% of the debt if they are to agree to a negotiated settlement. You must convince them that this is the best that you can do.
Understand that a settlement requires that you have that money upfront and can send them a lump sum payment. Collection agencies will not reduce your payoff if you need a payment plan.
Once a debt has been charged off as a bad debt and turned over to collections, the main damage has already occurred to your credit report. The debt shows as in default and still outstanding, meaning that it is still collectible.
A settled debt is a negative credit mark, but it is slightly better than an account in default in which you still owe a balance. Settling the debt will normally give you a couple of points back to your credit score. You may have lost 30-80 points when the account fell delinquent. However, keep in mind that whereas you may have lost an additional 20-40 points when the account went into default, settling the debt may only get you as few as 5-10 points back.1 Since the benefit to your credit score is so minor, this should not be your reason for settling.
Settling a debt can close your file and prevent legal action. Once a defaulted debt is marked as settled, the debt collector has agreed that the account is closed and no amount is owed on the debt. A promise to settle does not however prevent legal action.
If you are able to rebuild your credit score enough to meet lender requirements, then you might be able to qualify for a mortgage even though you have negative credit items. Most mortgage lenders will require that any major debt that is in default be paid in full or settled before they will approve a loan. They are not willing to risk a judgment that could occur when you owe a large amount on a defaulted debt.
Keep in mind that these benefits are limited in nature and are far outnumbered by the costs and consequences associated with debt settlement. The more debts you have and the higher your balances, the less likely that debt settlement might work for you.
The most important aspect about debt settlement is that you understand how to negotiate your own settlement. There is no action that you cannot do that a debt settlement company can do. These companies commonly have extraordinarily high upfront fees, dismal success rates and a long history of customer complaints.
1 This credit scoring scenario is an example only. FICO credit scoring formulas are secret. Furthermore, the impact of an action on credit scores varies from one consumer to another depending on the nature of their credit history.