Debt Settlement

How Does Debt Settlement Work?

How does debt settlement work when you’re down and out? Debt settlement programs have helped many Canadians like you get out of debt and save money on interest fees and even on their principal balance. While every institution is different, this is the basic process involved for those who sign up for a debt settlement program.

If a debt collection company has been calling you or your credit card company is seeking you out, debt settlement might be right for you. You may already have a bad credit score, but it can get worse if you settle your debt. However, it’s better than having to file for bankruptcy or a consumer proposal, which increased by 9% in 2019.

An agency can contact your creditors on your behalf and reduce your debt to a percentage of the full amount you owe. If you have enough cash on hand, you may be able to settle considerably lower if you can offer a lump sum payment. You can also get a lower monthly payment. However, a settlement will result in a lower credit score for you.

If you’re still asking, “But how does debt settlement work?” see below for more details on the process.

The Debt Settlement Process

With so many Canadians dealing with credit card debt, it’s no wonder why people are seeking debt relief options. The process can be similar to other choices, but it all depends on which program you qualify for.

See what you can expect when you consider a debt settlement program.

Debt Consultation

Your first step is to speak to a representative of the debt settlement company.

You might think that debt settlement is the best option for you, but sometimes, after looking at your specific situation, you’ll find you’re better suited for another debt relief option such as:

All of the above have their benefits and drawbacks. Ask about their differences, so you get the most out of your conversation and repayment plan.

You should know before you contact a debt relief provider that debt settlement is usually best for medium-sized debts. Generally, only those with debts higher than $10,000 enter into debt settlement. Those who owe less and can make some payments often do better with a low-interest debt consolidation loan.

Make sure you ask as many questions as you need to understand your financial situation.

The Negotiation

If debt settlement is the best choice for you, you will enroll in a program that entails professionals working on your behalf with your creditors. The goal is to reduce the amount of principal that you owe to your creditors (not just your interest rates). Working with creditors day in and day out, your representative knows the best ways to get them to look at your situation more favourably.

Because of this expertise, you will usually get better debt reduction offers from your creditors than you would when trying to negotiate a settlement yourself. If you have ever used the balance transfer method to consolidate debt on your own, it is nothing like negotiating on your own behalf.

Professional companies have relationships with the creditors and are likely to achieve more than you would on your own.

Depending on your credit reports, history, and financial status, you may be able to reduce the amount of principal that you owe from anywhere between 20 and 80 percent. While that can be a significant advantage, it can also hurt your credit score, so you have to weigh the pros and cons.

Note that the types of debt you can settle are unsecured debts, such as:

Credit cards
Consumer loans
Some car loans

Secured debt, like a mortgage, does not qualify as part of a debt settlement program.

The Payment Process

The payment process occurs at the same time as your rep is negotiating with your creditors. Once you enroll in a program, you begin making payments into an exclusive purpose account. Continue to pay your balance as per the agreement monthly. Except for this time, you only have one payment to make and keep track of. Unless you had unsecured debts that could not roll into the settlement.

As you go, your creditors get paid from this account one at a time as you accumulate enough money to pay the agreed-upon settlement amount for each creditor. You will see your debts eliminated one by one as you pay them off, and at the end of the process, you will be debt-free!

After You Pay Off the Last Creditor

After you pay your final creditor off and you are debt-free, you may receive a graduation package. It has copies of your settlement agreements, as well as some information on how you can start rebuilding your finances.

You must now save or invest the money that you no longer have to use to pay your debts.

While you may no longer have debt, you now begin to rebuild your credit. Start by:

Paying all bills on time
Avoid using credit
Building a budget
Saving for essential items
Investing in your future and your retirement fund

This may seem intimidating to you, but you’re on your way to financial stability. Congratulate yourself for the progress you’ve made!

Keep this in Mind

While this sounds amazing, we cannot stress how much you should equip yourself with knowledge. Not only can your credit score drop, but you can also experience the following:

It can take a few years for your creditors to agree to a settlement. All the while, you must pay your debts on time. Otherwise, your account can go to collections.
You may accrue penalty fees and late charges
Success is not a guarantee – You may spend a lot of time, money, and energy all without anything to show for it if it all falls through
You may have to pay taxes on forgiven debt

If you only have credit debt to consider, a balance transfer may be a better alternative, but that comes with its own drawbacks, too. If you do not pay off the entire balance by the end of the 0% introductory period, you may face higher interest rates than before.