Even though we're an internet company, our phone rings a lot. And one of the most common questions people ask is if we can settle or consolidate their debt for them.
The quick answer is that our mission isn't to do debt consolidation, settlement, or management. Our mission is to help you find a strategy that you can use to pay your debt off faster, on your own. Then we track your progress to keep you motivated along the way.
The second half of that phone call can go one of two ways. One is disappointment that we don't provide an even faster solution (like debt settlement) and one is interest in trying the plan out. Since it's become clear that many people seek out debt settlement as an option, I wondered if debt settlement is really the fast solution it seems to be.
Recent data seems to prove that it isn't. In fact, the data points to debt settlement being a cause for even more financial troubles down the road. So if you've been hoping to try debt settlement as a means to eliminate your debt quickly, then read on first to make sure this is the right solution for you.
Defining Debt Settlement and More
First of all, let's go over some basic definitions. Here are a few terms you might see when researching debt payoff options:
Debt Settlement Debt settlement is the act of negotiating to pay less than the full amount you owe on your debt. This is commonly done through a company that withholds your payments to the creditor and puts them into an escrow account. Once you reach a certain amount of money "saved up", the company attempts to persuade your lender to take that amount in full and forgive the rest of the debt. This will have a large effect on your credit score.
An unknown fact is that you could do this on your own by negotiating with your lender directly – although it's preferable to continue making your payments and wait until you have enough money put aside to persuade them to settle.
Debt Management Debt management is a special program that you enter into with a third party company. Debt management companies negotiate with your lenders in an attempt to get lower interest rates and payments for you and put you on a plan for repayment. Then you make your payments on your debt through them. This will have a large effect on your credit score.
Debt Consolidation Debt consolidation is the act of consolidating all of your debt accounts into one. That usually happens in the form of new credit to pay off all of your accounts. And it only works well if the new loan or line of credit comes at a lower interest rate than one or all of your current accounts.
Many people seek out companies to help them with this, but it's often a trap leading you down a path to debt management or settlement. Rather, you can consolidate your debt on your own by: 1) applying for a balance transfer credit card 2) applying for a peer-to-peer loan 3) using a home equity loan. These are all ways you can use new credit to pay off old debt at a lower interest rate – thus making your payments easier to manage and helping you pay your debt off faster.
It's important to understand the difference between these three things because a Google search for one of them will often bring up the other two – making it hard to understand what exactly a company is advertising and what steps you should take.
Data on Debt Settlement Shows It May Be More Harmful than Helpful
Now that you know what debt settlement is, it's important to know that this is what sounds like the quickest and easiest way to eliminate debt (aside from bankruptcy). In fact, many people seek out debt settlement companies in the hopes that it will allow them to take action and get a fresh start when it's all finished. Sadly, new data shows that the very opposite might be true. As seen in The New York Times:
"A report from the Center for Responsible Lending, a nonprofit research group, finds that consumers who sign on with for-profit debt settlement companies find their debts grow about 20 percent on average before a settlement, with no guarantee that such a settlement will be reached."
In other words, as your payments continue to go unpaid (the tactic debt settlement companies use to negotiate for the settlement), you debt can continue to grow (thanks to interest and fees) and there's no guarantee that the settlement will be successful in the end. In fact, this article goes on to say that "the percentage of clients successfully completing a debt settlement program was in the ‘single digits'".
As if that weren't bad enough, debt settlement, which is often used as a last resort before bankruptcy, can actually lead to bankruptcy in the end:
"Typically, consumers consider debt settlement as an alternative to filing for personal bankruptcy. But Edward C. Boltz, a bankruptcy lawyer in Durham, N.C., says he sees clients who have ended up seeking bankruptcy protection despite having gone through debt settlement. Settlement companies usually will negotiate credit card debt, but often may not include medical or tax debt in their services. So clients who have a broad mix of debt may not get the relief they need, Mr. Boltz said."
In short, if you're battling multiple types of debt, even a successful settlement may not cover all of your debt, leading you to a position in which you have to find more relief in the end.
How You Can Decide on the Best Way to Handle Your Debt
If you're reading this and feeling your hopes of debt relief dashed, worry not. There are multiple ways to handle debt and the most successful strategy is one that will work best for your unique situation. Here are multiple avenues you can seek, based on your level of need:
Can Make Your Payments but Fear Your Debt Will Never Be Paid Off If you can make all of your monthly payments but see no end in sight to your debt, then a debt payoff strategy is what you'll need. There are multiple methods you can try:
Debt Payoff Strategy First of all, line up all of your debt and calculate how much you're paying at a minimum each month. Then you'll want to prioritize your debt using one of the methods below. Once one debt is paid off, you'll continue to pay the same amount each month by rolling that debt's payment amount over to the new target account. Continue doing this until you're debt-free.
Debt Snowball The debt snowball method is the act of lining up your debt accounts in order of balance, low to high. Then you'll target the lowest balances first and, once paid off, roll over those payments to your new target account. Some find this to be the most motivational method as they can see accounts getting paid off quickly.
Debt Avalanche The debt avalanche method is the act of lining up your debt accounts in order of interest rate, high to low. Then you'll target the highest interest rate accounts first and, once paid off, roll over those payments to the new target account. This is the fastest way to pay off debt (and you can automate it on ReadyForZero).
On the Verge of Not Being Able to Handle All of Your Payments If you're on the verge of not being able to make all of your monthly payments, then you'll want to first see if you can lower the interest rates you're paying and, in turn, the amount you're paying each month. Debt consolidation through a balance transfer or peer to peer loan can help you do this. However you should only consider that route if the interest rates you're approved for are lower than what you're currently paying.
If your consolidation pays off some, but not all, of your debt, then choose one of the strategies above to pay off the consolidation loan/line of credit along with your other debt.
Truly Cannot Meet Your Monthly Payment Obligations If you're in dire straights and truly cannot make your monthly payment obligations, then bankruptcy might be the best option for you. While you could try debt settlement, that option still requires you to make some monthly payments to the settlement company each month and might not end in your debt being settled. Whereas bankruptcy should eliminate most or all of your debt (except for federal student loans).
Both of these options will have an impact on your credit score that will last for up to 7 years, but if you truly cannot make your payments or find a way to earn more money, then getting your head above water again might be more important than your credit score. You can start the rebuilding process as soon as your head is above water again.
Keep Moving Forward
No matter what route you take to pay your debt off, keep your eye on the prize: financial freedom. Paying off debt is often a long road, but it's one that will get you closer to being financially stable so you can then focus on building wealth!
But don't forget to do the most important thing – avoid debt as much as you can during and after this process. Address what it was that put you in this situation and build buffers so you don't end up back there again. (For example: If it was an emergency, focus on building an emergency fund. If it was habits, zone in on changing those habits for the better.) Then you can know that your debt payoff will be debt payoff for good – and not a process you'll have to go through again several years from now.
Shannon, Community and Customer Support Manager at ReadyForZero. Shannon McNay is a transplanted Midwesterner living and writing in San Francisco. She enjoys writing about personal finance and many other topics while helping ReadyForZero users pay of their debt.