It's frustrating. Home prices are super low, mortgage rates are too, and your rent is increasing. You'd really like to get into a new home but your debts are too high for a mortgage lender to approve you for a loan. Then you start getting calls from debt settlement companies, promising to settle your bills for pennies on the dollar. Without those debts, you could afford a new home! But will you qualify to buy one?

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Debt settlement: what you give, what you get

Debt settlement involves convincing your creditors to take less than you owe as payment in full for the balances owed. There are several ways to accomplish this.

You can save up a lump sum, then make an offer. This is the preferred method of debt settlement companies. They recommend that you stop paying your creditors and instead deposit the funds into an account (if you work with one of these outfits, never deposit the money into an account that someone else controls or has access to -- you could lose it). The downside is that the settlement company takes a large upfront payment (would could be better used to settle your debt), many creditors don't want to work with these companies, your credit score takes a big hit every month it takes to save up the money, you will be robo-phoned until you scream, and you could be sued). This probably accounts for the very high failure rate of such plans.

Another way to accomplish a settlement is to save a lump sum while making payments as agreed. This is slower but less stressful. A better way if you can swing it is to borrow against retirement and /or sell some things until you have the needed funds. Again, the fewer payments that you miss, the less damage to your credit.

The negotiation

Your next move is to contact your creditors in writing. There are many good sources of suggested letters online. It's important though that you personalize your letter just a bit. Explain why the amount that you offer is the best that you can do. Then indicate that your only reason for settling your debt instead of filing for bankruptcy protection is that you don't want major credit damage. That gets the creditors thinking that something is better than the nothing they would likely get in a bankruptcy. One condition of your settlement should be the way that you want it reported. The worst case is a charge-off, the best case is paid-as-agreed, and the middle ground is paid--settlement. You want to shoot for paid-as-agreed. The creditors may say they it can't be done but in fact it can. Expect to have to pay more for a paid-as-agreed report.

Credit standing

Once your debts have been settled, check your credit report to make sure that the settlements have been reported as the creditors agreed to report it. Then wait a few months (paying your remaining bills in time of course) and check your credit. If your score is over 620 you have a fair shot at an FHA or bad credit mortgage and a new home loan.