With the amount of exposure that debt settlement is receiving these days, one could easily be lead to believe that it is the "cure-all" solution for anyone who is struggling with debt. But unfortunately, that is just not the case.
Now, that is not to say that it isn't an excellent solution for some people. In fact, none other that the Chairman of the FTC (Federal Trade Commission) recently made the following statement...
But is it right for you? Well, before we answer that question, let's take an in depth, behind the curtains, no B.S. look at what debt settlement is, how it works, what it costs, the pros and cons etc. In other words, let's cut through all of the "fluff" you'll read at most debt relief company websites and dig down to the "real" debt settlement information.
In order to do that, I have come up with a list of questions (followed by answers of course) that people ask when trying to decide whether or not they should try and settle their debt.
Debt settlement is the process of making a lump sum payment to an unsecured creditor in exchange for them dismissing your debt. The objective is to get you creditors to accept as little money as possible, in as short of a time frame as possible. It is not uncommon for creditors to accept as little as 30 to 50 cents on the dollar (ie. a 50% to 70% discount on the total debt) as a result of a successful debt negotiation.
Yes and no. It is the same as debt negotiation, but depending on
what type of debt arbitration is being referred to, it might be
You see, one of the most confusing things about getting out of debt is figuring out what all the "terminology" means. Many times different debt relief options have confusingly similar names. For example, many people think that the term "debt consolidation" refers to the consolidating or "lumping-together" of ones debts through the use of a debt loan. While this is true, the term also refers to the consolidating of one's debt payments by a credit counselor. (You can learn more about it here if you would like.) Other times the same service will have multiple names. For example, many people use the terms debt settlement, debt negotiation and debt arbitration interchangeably. Which is fine, except for the fact that the term debt arbitration is often used to describe two different services.
Some folks use the term debt arbitration to describe what is actually debt settlement. Others use the term to describe the settling of a debt conflict by an independent third party, which is completely different than debt negotiation/settlement.
Believe me, I am not trying to confuse you. But one of the most important steps that you can take in your journey to become debt free is to educate yourself with respect to all of your debt relief options. And part of that process is understanding the industry "terminology".
Let's keep going...
As I mentioned above, the process basically involves negotiating with your creditors to try and convince them to accept a one time lump payment in return for dismissing your debt. And ideally that payment is 50% to 70% less than the total of your outstanding debt with that creditor. Of course, that is the "simplified version". Here's a more detailed look at what happens.
Once you sign on with a company or debt lawyer to handle your debt negotiation, the first thing that happens is that you stop paying all of your unsecured creditors. (It is important that you continue paying your secured debts like your mortgage however.) If you have already stopped making payments then obviously you don't have to do this.
Why do you have to stop paying your creditors? For two main reasons. One is that your creditors will not begin negotiating the settling of your debts while you are still paying them every month. The other is so that you can begin to take the money that you were using to make payments on your debts each month, and begin to put those funds into a debt settlement savings account. The idea being that eventually you will build up enough funds in that account to use for the lump sum payments that you will be paying your creditor(s) down the road.
Once you stop making payments on your debts, the settlement company or attorney handling your negotiations will contact your creditors and explain that you are looking to make a settlement offer. But don't expect anything to happen right away. It usually takes about 6 months of non-payment before your creditors will sit up and take notice.
Once the actual debt negotiations begin, the strategy will be to convince your creditors that you do not have the ability to make your payments anymore and are on the verge of filing bankruptcy. The objective being to get them to decide that it's better to take a fraction of what is owed to them now, rather than risk getting nothing in the future if you were to file Chapter 7 bankruptcy.
Eventually, say in 6 to 18 months, some of your creditors will likely be ready to deal, agreeing to dismiss your debts in return for a one time lump sum payment.
Of course, the answer to this question depends on a lot of variables.
The expertise of the person negotiating your debts, the particular
creditor you are dealing with, etc. Having said that, it is not
uncommon for people to pay off their debts for as little as 30 to 40
cents on the dollar, but somewhere in the neighborhood of 50% is the norm.
If you have an income, then as I mentioned above, instead of paying your creditors each month, you would divert those funds into a bank account and, over time, build up funds that can be used to pay your creditors once a settlement has been reached.
Other alternative sources of funds include loans from friends and relatives, equity from your home, sale of other assets etc.
If you save more than $600 when you settle your debts, there is a possibility that you will have to pay tax on what is called "Discharge of Indebtedness" income. If, however, you are insolvent (your liabilities outweigh your assets) you may not have to report the forgiven debt as income. Check with your tax professional on this.
Only unsecured debts qualify for a debt settlement program. Creditors that hold these debts have no other recourse but to go after you personally for the money (ie. they can't pursue your assets).
On the other hand, creditors that hold
secured debts, or debts that are secured by an asset, can seize that
asset if you fail to make the agreed upon payments. Therefore, their
motivation to negotiate a settlement for anything less than they are
owed is limited. Of course there is the possibility these secured
creditors might take a slight discount (to avoid the hassles and
expenses of pursuing you legally), but chances are it would be a small
discount. For this reason secured debts do not qualify for a debt
It's a natural reaction to be concerned about your credit report and credit score. However, most people for whom a debt settlement program makes sense are well past worrying about their credit. Typically they are facing a bankruptcy filing, are looking for a way to avoid bankruptcy, and are focused on getting rid of their debts rather than worrying about their credit. In fact, if you still have a decent credit score and are up to date with your debt payments, then this type of debt elimination program is likely not right for you. There are probably much better debt help options for your situation.
Having said that, your
credit will probably take a beating, so to speak, during this
But on a positive note you will avoid having a bankruptcy filing on
your credit history.
Beware of debt negotiators who promise things that they cannot
deliver. Some may promise that they can stop the collection
stop your creditors from contacting you, prevent your accounts from
being charged-off and/or prevent your creditors from suing you. They
The truth is, anyone can negotiate your debts on your behalf. However, this task is usually performed by one of three people:
1. A professional debt negotiator, working for a debt settlement company.
3. You. Yes you can negotiation the settlement of your own debts.
No you don't, but it is strongly advised. Why? Well, as I mentioned earlier, people who decide to settle debts through negotiation are also prime candidates for filing bankruptcy. A bankruptcy lawyer can look at your entire financial situation, explain the pros and cons of bankruptcy (Chapter 7 or Chapter 13) vs. debt settlement and help you decide on a course of action. The quicker you can zero in on the "right" debt relief option, the more money and time you will save in the long run.
By starting out in a debt settlement program when in fact a
bankruptcy filing would have been more appropriate, could cost you
dearly. It's best to get on the right path, right away.
Absolutely. There is nothing
illegal about negotiating with creditors
to reduce the amount of debt that you owe them. But when some people
read that it is possible to negotiate reductions of as much as 70% of
their debts they are skeptical, thinking it must be illegal. On the
other hand, your creditors have no legal obligation to either negotiate
with you and/or agree to a reduction of the debt amount owed.
One word. MONEY. You will save yourself a lot of money by avoiding the fees that settlement companies and lawyers charge to settle your debt. Keep in mind however that this can be a stressful process and for the majority of people, a completely new experience. At the very least you should educate yourself with a good self-help, do-it-yourself debt settlement course or book.
You can expect to pay roughly 15% to 20% of the amount of your outstanding debts at the time you enter the program. Therefore, if you have credit card debts totaling $30,000 for example, you will likely pay a minimum of $4,500 in debt settlement fees. ($30,000 X 15% = $4,500)
Another fee structure used by some companies is to charge a
percentage of the amount of debt that they save their customers.
Therefore, if they negotiated a $12,000 settlement on $30,000 worth of
credit card debts, and they charged a fee equal to 30% of the savings,
the cost to you would be $5,400. ($18,000 X 30% = $5,400)
candidate is someone who is experiencing a financial
hardship (divorce, loss of employment, serious illness, etc.) and is
considering a bankruptcy filing, but who wants to try and avoid that
route. It is for this reason that it is often called the "New
It is not suitable for someone who has a significant debt load, has an
income (or other means of paying off their debts) can make the payments on those debts, but simply wants to
avoid paying them back in full. For this type of person a debt consolidation program may be more appropriate.
No. And if a debt settlement tells you otherwise (or fails to point out to you the possibility of lawsuits) then seek the help of another company.
For people whose situation is truly suited for debt negotiation, the obvious alternatives are Chapter 7 and Chapter 13 bankruptcy. And as "unappetizing" as these alternatives may sound, in some situations they are the best alternative. Again, a bankruptcy attorney can help you decide between the settlement route and the bankruptcy route, or at the very least enlighten you as to the pros and cons of bankruptcy.
If you still have an income but are feeling completely overwhelmed by
your debts, there are other debt help options as well. And talking with
a qualified credit counselor is a great way to learn about some of
these options that can help you start tackling your debts.
You gone ahead and hired a debt negotiator to work on your behalf. But in the end
they fail to reach a settlement with your creditors (some or all of them), or you simply cannot afford
the settlement that is reached. What happens now? Find out more here...
The first thing I should point out is the fact that many people do not even qualify for Chapter 7 bankruptcy (or what is often referred to as "liquidation bankruptcy"). Instead, they must file Chapter 13 bankruptcy which, unlike Chapter 7, does not dismiss all of their debts, but rather requires them to pay back some debts under the guidance of the court. For these folks the choice is then narrowed down to either debt settlement or Chapter 13 bankruptcy (often called "wage-earners" bankruptcy.)
Some people say "avoid bankruptcy at all costs". Others disagree, if it truly is the best solution, and is in your best interest (not the best interests of the bankruptcy attorney). Which is best for you and your situation? Unfortunately that is not something that I can answer here without knowing the intimate details of your finances.
However, what I can tell you is this. The best thing you can do is educate yourself on your debt relief options, and then seek the appropriate help and/or advice. I like to tell people that it is never a bad choice to start by speaking to a credit and debt counselor. Most offer a free initial consultation, will provide a thorough review of your finances, work out a budget for you, and, if necessary, recommend an appropriate debt help program. And who knows, this just might be a debt settlement program.