We understand how challenging some high-interest debt can be to eliminate. If you’re currently struggling to keep up with your payments and are worried that your income is not enough, a debt settlement may be the appropriate solution. However, this type of procedure is not right for everyone, so let’s take a closer look at it before you decide it’s the avenue you want to take.
This is for you if you’re trying to get out of debt fast with a low income.
Is it Time to Consider a Debt Settlement?
A debt settlement can be done in two different ways (which we’ll explain further below). Essentially, it involves reaching out to the creditors that you owe outstanding balances to and negotiating an agreement that allows you to pay back a portion of what you owe through one single payment. In order for this deal to be acceptable, you’ll first need to prove your inability to pay your full balance. If the creditors accept your offer, you should soon be free to start over with a clean slate.
That said, choosing a debt settlement is all about the right timing. In other words, it’s best to only consider such a procedure when:
- You have too much high-interest debt to handle with simpler methods
- You’re behind on all your payments
- Interest and late penalty charges are building up as a result
- Your accounts are about to be or already have been sent to collections
- You want to avoid more harmful alternatives, such as filing a consumer proposal or declaring personal bankruptcy.
As effective as a debt settlement can be, it is a drastic program that can have a lasting negative impact on your finances. It’s also not legally binding, so your creditors don’t have to accept it if your offer is unfair. Only consider this route if you’re fully aware of what it entails and you’ve got an income that will support you throughout the process.
Have you ever considered the true cost of borrowing? Take a look at this infographic.
How Does Debt Settlement Work?
As we said, there are two ways that a debt settlement can be negotiated. Always consult a financial advisor or credit counsellor before you make your choice.
Solo Debt Settlement
A solo debt settlement is when you would, of course, contact your creditors and attempt to strike a deal with no outside help. This may be effective if you’re a good negotiator and you can provide sufficient proof that you cannot pay your full balance, such as recent bank statements and pay-stubs. It’s also a good way to save a bit of money, as the second alternative comes at a cost.
However, doing this alone can be challenging, especially if you’re unprepared and your creditors aren’t convinced. In that case, professional aid might be a better way to go.
For a more detailed look at how to negotiate with your creditors, click here.
Debt Settlement Company
There are also companies that deal specifically with such procedures, which can be helpful if you’d prefer someone with experience to broker the deal and guide you through it. They may even be able to negotiate a better settlement than you would’ve received alone.
Then again, a professional debt settlement is not going to be free. Once the ordeal ends, you’ll likely be charged a flat service fee that can be quite pricey depending on the company you’re working with. It’s also important to research a debt settlement company properly, as scam artists like to prey upon those who are desperate for a solution. If they don’t have a reputable background and are clearly trying to manipulate you into forking over your personal or financial information, walk away.
Be sure to ask a debt settlement company these questions before you trust them.
What Happens to Your Credit?
Unfortunately, one significant drawback of a debt settlement is that it can have a negative impact on your credit report. That’s because, once the settlement has been confirmed, your creditors will notify Canada’s credit bureaus (Equifax and TransUnion), who will update your credit rating accordingly.
For a better understanding of your credit rating and credit score, check this out.
Any account associated with the settlement will receive a credit rating of R7, which is the third lowest position it can fall to. Your debt settlement will remain visable on your credit report for several years. During that time, it may be difficult to obtain any new credit, as potential creditors may consider you a high-risk borrower with the possibility of defaulting in your future.
That said, don’t let this drawback alone influence your financial decision. Typically, it’s better to hit the ground running and recover as quickly as possible, rather than letting the situation drag out until you’re forced to declare bankruptcy.
Check out this infographic to learn more about what affects your credit score.
Do All Debt Types Qualify?
Another unfortunate setback to a debt settlement is that certain debts won’t qualify. Generally, such a procedure is restricted to unsecured debt, meaning any kind that is not collateralized by an asset, such as your car or house.
Secured debt, on the other hand, means that the creditor involved still holds temporary ownership over the collateral that you would’ve offered up during the approval process, which you may have done to secure say, a loan with a low interest rate. It can therefore not be included in the settlement procedure.
Examples of Unsecured Debt
- Credit cards
- Personal lines of credit
- Non-government student loans
- Unsecured personal loans
- Unpaid income taxes
Examples of Secured Debt
- Home equity products
- Secured personal loans
- Government-backed student loans
- Vehicle loans
Look here for a more detailed explanation of secured and unsecured debt.
What Are the Pros and Cons?
Remember, there are a few pros and cons to this procedure that can affect your financial situation, some of which we’ve already described. However, we’ll go over them out again so you can truly confirm whether a debt settlement is appropriate for you.
- Your debt-to-income ratio may be lowered by a significant percentage, which is great for your credit score.
- Once the settlement is over, your creditors should stop adding any late penalties and interest to your accounts. Collection efforts should also cease.
- Since you’re only paying part of your outstanding balance, you may be able to save what you didn’t pay for other things.
- The faster you settle your debts, the easier it will be to recover from the incident and get back on track.
- Scam artists may pose as debt settlement companies.
- Your credit rating will drop to R7, damaging your credit report for some time.
- Secured debts won’t qualify.
- Creditors may not cease their collection efforts during the settlement, as it will not be a legally binding affair.
- Even a legitimate professional debt settlement is not free of charge, which could lead to more debt problems if you can’t afford their fee plus your lump sum.
Wondering which debt you should pay off first? Find out here.
Are There Other Debt Solutions?
In the end, the debt solution you choose will depend on how healthy you are financially. For instance, if you think you won’t be able to afford your settlement, it probably isn’t worth taking the risk. Again, be sure to consult a certified advisor beforehand.
Otherwise, you can look into some of the following alternative solutions:
- Borrowing from friends or family
- Selling your car or another asset
- Going to credit counselling
- Applying for a debt consolidation loan
- Entering a debt consolidation program
- Filing for a consumer proposal or bankruptcy (only as last resorts)
How Can Loans Canada Help?
We’re no strangers to the difficulties of unmanageable debt. If you’re living in Victoria a struggling to find a solution, a debt settlement may be necessary and Loans Canada can help you every step of the way. Contact us today for more information!