What Happens When Debt Settlement Programs Fail?

Debt settlement programs offer a viable alternative to bankruptcy for those people who are facing financial hardship. However, there is no guarantee that negotiating your debts will end successfully.

Let's take a look at why some debt settlement efforts fail, and what happens to you when the do.

Why Debt Negotiations Sometimes Fail

A debt settlement program can fail for several reasons. But what the cause of the failure really boils down to is that in the end, the creditor(s) would not accept an offer to settle that was low enough for you, the consumer. This scenario can come about for two separate reasons.

The first reason is that the consumer simply could not come up with enough money during the course of the debt negotiations. (This is the most common reason why debt settlement programs fail by the way.) In other words, if you were trying to settle your debts with your credit card company and all you could come up with was 20% of the value of the total debts you owed, it is likely that you would not reach a settlement.

The second reason that a creditor might not agree to settle a debt is that they believe that ultimately they will end up with more money if you were to file Chapter 13 bankruptcy or if they were to sue you and obtain a judgment against you. And the reason that this happens is usually poor negotiating skills by the person acting on your behalf.

What Happens After Debt Settlement Programs Fail?

Unfortunately, by the time you realize that you will not be able to settle all of your debts successfully, you may have already paid the debt settlement company or debt settlement lawyer you hired their full fee, or at least a portion of it. How much is that? Well, usually debt negotiators charge a fee equal to 15% to 20% of the total debt that you had at the start of the process. So if you have $40,000 in debt, and were being charged 15%, the debt settlement fees you would have to pay would be $6,000.

Now here's the kicker. You usually have to pay this fee upfront, before the person or company trying to settle your debts has delivered anything to you. "On the bright side" however, most companies and lawyers will allow you to pay this fee in monthly installments over the first 12 to 15 months of the program.

Update: As of October 2010, the FTC (Federal Trade Commission) has enacted new laws that deal with how and when debt settlement companies can collect fees from consumers. "In general" it now bans companies from collecting fees before any settlements take place. Now, I say in general because there are some exceptions to this. Specifically, companies that deal face to face with their customers and companies that sign up consumers via the internet are exempt from these new fee restrictions.

Ironically it is these same fees that consumers pay for debt settlement programs (whether they are successful or not) that are often one of the main reasons why they fail. To illustrate this, let's continue with the example above. With a total debt of $40,000, you would be aiming to put $800 per month into your debt settlement program bank account in order to build up funds to settle your debts. However, if you also have to pay $400 per month for the next 15 months ($400 X 15 = $6,000) in fees, then only $400 per month is going into the settlement fund.

Having to pay these fees prolongs the time it will take you to build up enough funds to make a reasonable settlement offer to your creditors. And because time is of the essence when it comes to debt settlement programs, this can be the difference between success and failure. If your debt settlement efforts end in failure you are left with the following:

  • you still owe our original debts plus any interest and penalties
  • if your creditors have sued you, you may have judgments against you which could mean garnishment of your wages
  • you are out the debt settlement fees that you paid the debt settlement company or debt attorney

Not pretty.

Before You Commit To Entering A Debt Settlement Program

Just because you are in debt does not necessarily make you a candidate for debt settlement. How do you know if you are a good candidate? Ask yourself this question. "If I didn't choose a debt settlement program, would I be forced to file bankruptcy?" If the answer is "yes", then there is a good chance that you are candidate for settling debt.

Of course, the decision is a little more complicated than this, and is not one that should be taken lightly. Before entering a debt negotiation program it is highly recommended that you at least speak to a bankruptcy attorney so that you can weigh the pros and cons of bankruptcy(both Chapter 7 and Chapter 13) vs. debt settlement. If you do decide to negotiate your debts, make sure that you come up with a realistic plan that will allow you to accumulate the funds that will be necessary to actually settle your debts when the time comes. Remember, settling debts for 30 cents on the dollar sounds attractive, but you still have to come up with the "30 cents" so to speak. And that is in addition to the fees that debt settlement programs charge.

Alternatives To Debt Settlement Programs

One realistic alternative to hiring a company/attorney to settle your debts (and paying their hefty fees), is to negotiate your own debts. This option is not for everyone, but if you are willing to take matters into your own hands so to speak, this is a viable alternative.

As I mentioned above, bankruptcy, both Chapter 7 (liquidation bankruptcy) and Chapter 13 (wage-earners bankruptcy) is an alternative to debt settlement. You would be doing yourself a favor if you educated yourself on the differences between Chapter 7 bankruptcy, Chapter 13 bankruptcy and debt settlement programs before making a final decision on a debt relief plan.

But even before you do all that...

You need to get a complete handle on all of your finances, and then make a game plan for going forward. The corner stone of this "game plan" will be a detailed personal budget. Now, don't panic if you feel overwhelmed by this. If you do, I recommend that you seek the help of a reputable credit counselor who can assist you. Most offer an initial free consultation during which they will assess your financial situation and work on a budget with you.

And once they have a clearer picture of your situation, they can also recommend a debt relief program that they think is suitable for you.


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