Debt Settlement or Debt Management?

October 20th, 2011, by

Q: Which is a better option: debt management or debt settlement?


A: First, let’s define those terms.

“Debt settlement” means getting your creditor to accept less than you owe. So, for example, you might have a debt of $10,000. You save up $5,000 and offer the cash to your creditor to settle your debt. Depending on how old the debt is, the creditor may accept your offer, because cash today is better than hoping you will make monthly payments in the future. Of course, it’s not always that easy; and you may not be able to get the creditor to reduce your debt by as much as 50%. But, you can try. The best way to get a deal is to have cash. One other thing to remember is that any forgiven debt is taxable.

I’m not a fan of debt settlement companies, which promise to negotiate with your creditors on your behalf to reduce your debts. But, such services often come at a high price. Debt settlement companies can typically cost several thousands of dollars. In many cases, working with such companies can also ruin your credit history. Essentially, the companies will tell you to stop paying your debts for several months so that you can stockpile some cash. In the meantime, your credit history is getting trashed because you aren’t paying anything.

Here’s some good news about debt relief services. Effective Oct. 27, 2010, for-profit companies that sell debt relief services over the telephone are banned from charging upfront fees before they settle or reduce your credit card or other unsecured debt. The rule covers telemarketers of for-profit debt relief services, including credit counseling, debt settlement and debt negotiation services. It does not cover non-profit firms, but does cover companies that falsely claim non-profit status.

“Debt management” is a better option, because you work with your creditors to come up with a payment plan. If you can’t do this on your own, or you’re too stressed to do it, find a good non-profit credit-counseling agency. You can go to the National Foundation for Credit Counseling Web site and search for an agency near you.

Typically, you pay a fee of about $50 to set up a payment plan. Depending on your income, you might also be charged a monthly fee of between $25 and $35 for the agency to handle your payments to creditors. Still, that’s a far cry from what a debt settlement company will charge with far less results.

A good agency can work with your creditors to reduce the interest rate and eliminate some fees and penalties. It may take you three to five years to pay off the debt, but you won’t have spent several thousand dollars paying a debt settlement company with money that could have gone toward your debts.

Last modified: October 20, 2011 at 3:54 am