You may be looking at debt relief and wondering how much you will have to pay in fees if you join a debt relief program. Please note that a debt consolidation program is not a debt consolidation loan.
If you have so much debt that’s making you lose out on all the best options, please read this.
Debt settlement can help you get out of debt only if you’re in a truly desperate situation. For example, let’s say you have $40,000 in debt. And you got laid off or had a severe unforeseen circumstance that makes it impossible to get out of debt.
So you ask a debt settlement company for help. The company steps in calls your loan creditors and negotiates for a smaller amount, say $21,000.
If you would like a personalized estimate of how much debt relief would cost you specifically, you can take this free debt relief calculator that outlines the cost, duration, pros and cons and alternatives of debt settlement.
Then you tell your creditors that if they don’t take the amount, your only choice is to file for bankruptcy, and they’ll never see a cent.
They accept your offer, and you get out of debt for $21,000 less of what you owed. That sounds all great, but there are numerous reasons to put a raincheck on that champagne.
What Is Debt Relief?
We just gave you an overview of how debt settlement works. But what is it? Here’s a simple explanation:
A debt settlement is when a loan creditor agrees to settle your debt for less than you currently owe. And you have promised to pay the settled amount in full.
It also means collectors won’t chase you again for the money you owe, and you don’t have to worry about getting sued.
It sounds great, but some lenders don’t accept debt settlements. And in some instances, debt settlement can cause more financial harm than good. It’s also risky because:
- It can damage your credit score.
- Debt settlement can take a long time, usually between two to four years
- It can be expensive
Even if you get the debt settlement, it can take years, and you may find that you owe tax on the forgiven debt. And if you settle your debt through a debt settlement company, you’ll pay fees.
But this guide will show you the essential things about debt settlement fees to make an informed decision. Let’s start with the debt settlement fees.
What Are The Fees Of Debt Relief?
Debt settlement companies don’t have a fixed fee for their services. So don’t expect to get an estimated quote like what you get from auto mechanic shops. What they do instead is to charge in two ways:
- Charge as a percentage of the overall amount of student debt initially enrolled.
- Charge as a percentage of the amount you saved through the debt settlement process.
Let’s take a deeper look.
Percentage of the total amount of debt enrolled.
When a debt settlement company charges a percentage of the overall amount of debt enrolled, it means the fees are essentially fixed. Therefore, there’s a small incentive for the company’s performance.
For example, let’s say you enrolled in a student loan debt worth $50,000 with a fixed percentage of 20%-25%. The settlement fees would range between $10,000 and $12,500, regardless of the specific amount the company saves through settlement. Here are some companies that potentially charge based on an enrolled debt amount, but to be sure, you may want to confirm with them.
- Accredited Debt Relief
- ClearOne Advantage
- Americor
- JG Wentworth
- DMB Financial
- National Debt Relief
- Century Support Services
- Citizens Debt Relief
- Freedom Debt Relief
- Beyond Finance
Remember that this type of fee structure is often more expensive compared to the second approach.
Percentage of the amount saved through a debt settlement process
The company is incentivized to perform when fees get charged as a percentage of the total amount saved. And that’s because the amount the debt settlement company gets directly depends on their performance.
As a general rule, a successful debt settlement can save you 40%-60% of the total amount of student debt enrolled.
So, for instance, let’s say you enroll in a total loan debt of $50,000 and get a 50% settlement savings (or $25,000). When 20%-25% of this saved amount is applied, you’ll get a debt settlement fee of $5,000-$6,250.
Please note: advanced debt settlement fee is banned. In 2010, the Federal Trade Commission (FTC) issued a rule that prevents debt settlement companies from charging upfront fees for their services.
Debt settlement companies can only collect their fees when they start disbursing payments to creditors.
Fees Broken Out By Type Of Debt Relief
There are two types of settlement: do-it-yourself (DIY) debt settlement and professional debt settlement.
The professional settlement involves a third-party firm; DIY debt settlement doesn’t, but it could include a third party that represents the loan creditor. The fees associated with the DIY are less expensive since you negotiate directly with your creditor yourself.
There’s a limit to the willingness of your creditor to accept DIY debt settlement before the charge-off. Even though the DIY settlement is cheaper, it comes with all the credit score damage of professional debt settlement.
With the professional debt settlement, the fees charged by the company vary according to your state’s laws. But you can expect the debt settlement firm to charge you between 15 and 25 percent of the enrolled student debt.
The Tax Implications Of Settling Your Debt
There can be tax consequences of debt settlement that are important to understand.
Debt settlement can be a huge relief, but you must be prepared to pay taxes on the amount settled. Your loan creditor may send you a 1099-C debt cancellation tax notice, depending on the type of debt.
The IRS will get this information, and you’ll have to report it as “other income” on your tax return. So even if you don’t get a 1099-C, you may still be legally required to report the canceled debt as income.
But there are some exceptions. Check out IRS Publication 4681 to find the exceptions and other relevant information.
Also, remember that the IRS will levy taxes on every settlement savings for amounts that go beyond $600, except you qualify for insolvency.
Types Of Debt That Qualifies For Debt Settlement
Most types of unsecured debts can be negotiated for a debt settlement. Credit cards and medical bills are the most common types of debt that qualify for settlement. And that’s because medical facilities and credit card companies have few options when an individual can’t clear their debt.
Other types of unsecured debt also qualified for a settlement, such as student loans. Now, even though federal student loans can be eligible for a debt settlement, they can be challenging to navigate.
As you probably know, if you get into default, you’ll not be eligible for student loan forgiveness like PSLF. When that happens, the government uses a collection agency to retrieve a lump sum from you. However, their terms are restrictive, which makes it an unlikely option for many people.
To settle your student debt, you’ll have to either:
- Pay the principal, including half the unpaid interest,
- Pay the loan balance and interest rate but not the collection agency charge, or
- You pay 90% of the remaining interest or principal.
It’s much simpler to deal with private loans since they’re issued by banks and thus, follow the normal debt settlement process. That can help you get the private student loan relief you want.
Is Debt Settlement Worth It Based On The Fees?
Settling debts yourself can save you money on fees instead of using a debt settlement company. As explained earlier, the charges vary depending on the state you’re currently located in.
You can hire a lawyer if you can’t do it yourself and don’t want to use a debt settlement firm. However, there are other things to consider.
Let’s go through them
If your account is already delinquent and your credit is damaged, it makes sense to pursue debt settlement. You may save money, and it’s even more advantageous from a tax perspective if you’re insolvent (or almost insolvent).
However, if you haven’t fallen behind on your account and your profile and credit score have not been damaged, it’s not advisable to pursue debt settlement. That’s because you’ll cease payments on your account as part of the settlement process, and that can negatively affect your credit score.
Furthermore, if you’re solvent, it’ll result in a massive tax liability. Combine that with the debt settlement fee, and you’ll be surely eroding more than half of any settlement savings.
So if you’re solvent and about to be seriously delinquent on your student loans with a high interest rate, debt settlement is ideal. But it’s better to pursue the settlement when your debt is at least $50,000 or higher.
Even then, you still have to consider the fees you’ll pay in the end, the taxes, and the long-term damage to your credit score and profile. When you settle your debt, it’ll remain on your profile for seven years.
What Are Alternatives To Debt Settlement?
If, for some reason, debt settlement is not an option for you, there are several alternatives to try out. Let’s quickly go through them.
Chapter 7 Bankruptcy
Chapter 7 bankruptcy is also called liquidation bankruptcy because it erases most of your unsecured debts like medical bills, credit cards, personal loans, etc. It’s the most common form of bankruptcy, and you can get it done in three to four months if you’re eligible.
Here’s what you should know about Chapter 7 bankruptcy:
- The taxes you owe won’t be erased, and there’s a high chance that you won’t get your student loans forgiven.
- It’ll damage your credit score and will stay on your profile for a maximum of ten years, even if you restore your credit history. And that’s no small thing because poor credit history can affect your qualification for specific jobs., getting an apartment lease, and the amount you pay for car insurance.
Chapter 13 Bankruptcy
Chapter 13 bankruptcy is a court-approved repayment plan for three or five years, based on your debts and income. If you stick with the repayment plan until its full term, the remaining unsecured debt is forgiven.
It takes longer than chapter 7 bankruptcy. But if you keep up with the payments, you get to keep your properties. (By the way, most people aren’t able to keep up.) When you file for chapter 13 bankruptcy, it stays on your file for seven years.
Debt Management Plan
A debt management plan helps you pay your unsecured debts, usually credit cards, in full. But it’s often at a decreased interest rate, or the fees are waived. Then, all you have to do is make a single payment each month to a credit counseling agency, and they distribute it among your creditors.
Credit card companies and credit counselors have agreements in place to assist debt management clients.
Conclusion
Sometimes, overwhelming debt catches us unawares with devastating swiftness, which can dent essential areas in our lives. But before you opt for a debt settlement, consider the pros and cons and consult an expert.
If it’s not convenient for you, try other alternatives. And if you’re feeling overwhelmed, don’t make decisions based on which collectors are giving you the most pressure. That may lead you to take actions that are not in your best interest.
