If deep in debt, shouldn’t ‘settlement loans’ help? Not necessarily, experts say Image Credit: Flickr

Dubai: It’s often considered the last resort of a person deep in debt to settle his or her dues by negotiating and agreeing with the creditor to accept less than the amount owed as full payment.

If you’ve been falling deeper into debt, you’ve also been frequently contacted by debt collectors seeking a timeline on when you will pay your outstanding dues.

If you don’t want them to continue hounding you for the overdue money and not worry about getting sued over the debt, ‘debt settlement loans’, also called ‘debt relief’ or ‘debt adjustment’, can help.

What it means by ‘debt settlement’ or ‘debt negotiation’?
Debt settlement, also known as debt negotiation, involves wiping out debt by paying a portion of it in one lump sum.

What does a ‘debt settlement’ deal entail for the borrower and lender?

How does the borrower benefit from such a deal? A debt settlement deal can provide the debtor financial relief and put him or her on the path toward rebuilding a damaged credit history.

Meanwhile, a debt settlement loan agreement enables creditors to receive at least some of the money they’re owed rather than no money at all.

Furthermore, it may mean the borrower can avoid filing for bankruptcy. Although, according to some credit experts, filing for bankruptcy may be the better alternative in some cases.

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What does a ‘debt settlement’ deal entail for the borrower and lender?

Although it sounds like a good deal, debt settlements can be risky as such loan agreements can irreparably harm your credit.

Moreover, reaching a settlement can take a long time to accomplish, often between two to four years. It can be costly if you use a debt settlement company, because you’ll pay fees. So, it’s a last resort.

How much will a debt settlement agreement cost you?
Once you’ve decided on a debt settlement company, inquire about how much it charges for settling your dues with a loan agreement. However, ensure transparency and see to it that the company doesn’t skirt your queries about costs.

Debt settlement companies typically charge a 15 per cent to 25 per cent fee to tackle your debt; this could be a percentage of the original amount of your debt or a percentage of the amount you’ve agreed to pay.

Let’s say you have Dh100,000 in debt and settle for 50 per cent, or Dh50,000. On top of the Dh50,000, you could be required to pay another Dh7,500 to Dh12,500 in fees to the debt settlement company – which although significant, will seem worth it for those desperate to close their exorbitant loans.

Risks of debt settlement outweigh the benefits

While settling a debt through a debt settlement company could lower your debt amount, get creditors and debt collectors off your back and even help you avoid bankruptcy to a degree, there are risks that may easily outweigh the benefits.

If you are deep in debt looking to settle your loans, a major risk that you fail to factor in is that your creditors may not agree to negotiate or settle with your debt settlement company.

This means that there is no guarantee that the debt settlement company will be able to successfully reach a settlement for all your debts. Moreover, there have been several reports that some creditors refuse to even negotiate with debt settlement companies.

Can I be charged fees by my debt management company, even if my whole debt isn’t settled?
If you stop making payments on a debt, you can end up paying late fees or interest. So while your debt settlement company takes a prolonged time period to negotiate a lower debt with your creditor, fines for late payment will accrue – not to mention countless calls from debt collectors.

Keep in mind that debt settlement companies can’t collect a fee until they’ve reached a settlement agreement, you’ve agreed to the settlement, and you’ve made at least one payment to the creditor or debt collector as a result of the agreement.

But you could still end up paying a portion of the debt settlement company’s full fees on the rest of your unsettled debts, experts reveal. If you have five or six creditors and the company settles one of those debts, they can start charging a fee as soon as they receive a result.

If a debt settlement company settled a proportion of your total debt enrolled with its program, it can charge you that same proportion of its total fee. Let’s say your total debts came to Dh100,000, and Dh50,000 of the total amount was settled, you can be charged 50 per cent of the total agreed-upon fee.
Can I be charged fees by my debt management company, even if my whole debt isn’t settled?

Another key risk: Any delay in negotiating a debt settlement could negatively impact your credit score

A debt settlement company may encourage you to stop making payments on your debts while you save up money for a lump-sum payment.

But at this point, your creditors might not have agreed to anything, which means all those payments you’re missing can wind up as delinquent accounts on your credit reports.

Your credit scores could take a hit as a result of any delinquent payments, and the creditor could also send your account to collections or sue you over the debt.

So coming to a debt settlement loan agreement with a firm that specialises in negotiating them should essentially be one’s last resort. So one should always seek alternatives to debt settlement.

Key takeaways

Before approaching a debt settlement firm, credit experts advise that you should first try negotiating settlements with credit card companies or other creditors on your own. Offer an amount that you can pay immediately, even if it’s less than what you owe.

If you have credit card debt, consider a balance transfer. A balance transfer is when you move debt from one credit card to another, usually to take advantage of an introductory zero per cent interest offer on the new card.

Balance transfer cards have zero per cent introductory rate offers for a specified period of time and may charge a fixed fee or a percentage of the amount you transfer. But check whether you’ll pay more money on the interest payments on your current card than the cost of any balance transfer fees.

Addition debts:
Before approaching a debt settlement firm, credit experts advise that you should first try negotiating settlements with credit card companies or other creditors on your own.

And you should also try to pay the balance off before the card’s promotional period expires to avoid paying interest on your balance. There are other debt relief and management options if you cannot get a large lump sum to pay the debt settlement or the credit card company will not negotiate a settlement.

You can take also take debt counselling sessions to tackle this situation. By talking with a credit counsellor, you can explore your options. But if you opt for such settlement services, the debt management programs are structured in a way so as to reduce the Debt Burden Ratio of the borrower.

(Debt burden ratio is the ratio of total monthly instalment or commitments of credit card, loans or any other committed monthly repayments to the total income of an individual.)

Moreover, the negotiating skills of a debt settlement company's experienced mediators definitely offer an added advantage.