How does debt settlement work?

For those who have come into a significant sum of money while repaying debts, the concept of debt settlement is tempting. But what does this mean?

Debt settlement is when you approach the creditor (or creditors) you owe money to and offer a full and final sum – with the intention of them wiping the rest of the debt and closing the account. In most cases, the amount you can offer is usually less than what you actually owe.

For example, if the lump sum of money you have is 60% of your total debt, you should then try to offer all of your creditors at least 60% of what you owe them.

This means you will need to negotiate with your creditors to come to a new agreement, whereby your debt is partially paid in a large lump sum but the rest is waived. If the amount is high enough, a creditor(s) should consider your offer.

Paying more than one creditor via a debt settlement

It’s important you carefully work out how much to offer each creditor from the lump sum you have available. This means proposing a higher amount to the creditor you owe the most money to and so on, working down the list.

We have a full, in-depth guide on how to negotiate a full and final settlement here on the site, which can help if you are considering this.

What can you use in a debt settlement?

Any type of lump sum can be used to clear your debts. This means whether you have won a significant amount via the lottery, have earned a bonus at work or have received inheritance or a windfall, these can all be used to settle debts if they are of a significant amount and creditors agree to a reduced lump sum payment.

Debt settlements and your credit report

A debt settlement will leave a credit account being classed as ‘partially settled’. While this does mean you don’t owe anything on it and it is closed, it is a warning to future creditors as it suggests you might not repay the full amount on future borrowing. Bear this in mind when considering proposing such an offer.

The creditor should notify the three credit reference agencies – Experian, Equifax and Callcredit – of your debt settlement and then this will be updated accordingly. Keep an eye on your records to ensure it is updated and the balance on your account is changed to £0 to indicate that there is nothing left for you to repay.

The benefits of debt settlement

For those who want to get out of debt quickly, this solution can be advantageous. Here we break down the benefits:

• Freed up income – Debt settlement can allow you the opportunity to get your finances back on track without worrying about monthly debt payments. You’ll have more disposable income to ensure bills are paid on time and in full, or to put away each month to create a savings buffer.
• Your debts will be gone quicker – In most cases, if the debt is a significant amount, it could take you years to repay what you owe, with interest being added all the time. However, a debt settlement means that the amount you owe is gone much sooner than you think.
• You will no longer need to deal with creditors chasing you – As the debt is settled, you won’t receive any more letters or phone calls from creditors demanding payment. They also won’t be able to take legal action against you, although it’s a good idea to keep hold of all written confirmation of your new agreement just in case.

What to think about when considering debt settlement

Debt settlement has its pros, but here are a few things to consider before talking to your creditors:

• You may be left with no disposable income – If you use all of your money on a lump sum for your creditors, you could be left without a savings buffer. This, in turn, could then lead to future debt issues if an emergency expense should arrive and you could end up back at square one.
• Your credit report will be affected – As noted above, a debt settlement can have a slightly negative impact on your credit report and how future creditors view you as a candidate for borrowing.
• Any judgments or defaults linked to the accounts will still be on your credit report – These will not be removed, even if the debt is paid off, and so will continue to affect your credit rating.
• You should be confident you won’t need credit in the near future – As debt settlement affects your credit rating it will be harder to borrow for a short time after. Plus, you may well have less disposable income because this will have been used to settle the debt. Think carefully before you negotiate with your creditors.

Debt settlement is a great option for those who want to remove debt quickly and have a large amount of money to offer, as it relieves the stress of monthly payments. If you want to discuss debt settlement for free with one of our expert advisors at PayPlan, give them a call on 0800 316 1833 or complete our contact form to receive a callback.