Ask Community

Do it Yourself

Get FREE counseling

If you're knee deep in debt, cannot pay your bills, and wish to avoid collection calls you may want to consider debt settlement (also known as debt negotiation). This is where you negotiate with your creditors to reduce your outstanding debt by 40-60%. The creditor forgives the rest of the debt, helping you to get out of debt faster.

In this article, we've highlighted the following sections:

• How settlement works
• How to choose best debt settlement companies
• Pros and cons of debt settlement

How settlement works

Debt settlement companies offer a wide range of settlement programs where they negotiate with your creditors/collection agencies to settle your debt for less than what you owe. Some companies charge an upfront fee for their services. Below is an example of how a settlement program (or credit card settlement) works:

Let's say Jesse owes a total debt of $100,000 on 5 credit cards. She is finding it difficult to keep up with the minimum payments. She consulted a credit counseling agency, but the monthly payments they negotiated with her creditors were too high for her to pay. Jesse doesn't want to file bankruptcy, so she enrolls with a credit card settlement company XYZ. Here are the 4 steps that most debt settlement companies use to settle their client's debt:

1. Stop paying creditors: The representative at the credit card debt settlement company asks Jesse to stop paying her creditors and deposit a certain amount every month into a trust account that XYZ creates for Jesse.
2. Handling collection calls: When Jesse starts falling behind on her payments, she will receive collection calls. Because Jesse is enrolled with a settlement company, the calls will be handled by the representative at the credit card settlement company. Jesse doesn't have to handle harassing calls on her own.
3. Negotiation starts soon after: When Jesse has accumulated a certain amount in the trust account, the representative at the settlement company starts negotiating with her creditors one by one.
4. Debt is reduced by 40-60%: Her creditors agree to accept a reduced amount, say around 40-60% of her outstanding bills as payment in full.

While Jesse is paying off her debt she makes sure that any extra money coming is used to pay her bills. Finally, after a period of 2 years, all of her credit card debt has been settled with her creditors.

Whether it's a credit card debt settlement program or one which includes other debts, you should stop paying your creditors. Instead, send in those payments to the settlement company to save towards a lump sum settlement.

Once you have enough funds deposited into the trust account, online settlement companies negotiate with your creditors/CA and attempt to stop all collection efforts. Find out how to negotiate your settlement from the 6 steps in debt negotiation program article.

Credit card debt settlement is quite common. Other unsecured credit cards, medical bills, gas/store cards, personal loans, etc can also be settled. Tax debts, alimony, child support, mortgages, car loans, and federal student loans cannot be settled in a commercial settlement program.

Debt settlement companies charge 25-35% of the forgiven debt balance for their programs. The fees are based on:

• How much you owe
• The number of debt accounts you have
• How much you save by settling bills

It usually takes 2-4 years to complete a settlement program. How long it takes depends on your total debt amount.

Once you negotiate debt settlements with your creditors/collection agencies, your creditors may be able to come after you for the original balance of your debt, depending on your state's law. In any state, if you default on the settlement agreement, you can be sued to collect the settlement amount. So it is very important that once you get a settlement agreement, you keep paying your bills!

How to choose best debt settlement company

In order to find the best debt settlement companies in USA, you need to check out the following:

• Company profile: You need to check the profile and service background of the debt settlement companies you are considering and choose the one that suits you the best.
• Company accreditations: These include the certifications that the debt settlement companies have obtained so far, such as their Better Business Bureau report. There are other accreditations available for businesses, such as TASC, IAPDA certification etc.
• Program fees and costs: You need to find out what debt settlement companies charge. Compare their fees and choose the best debt settlement companies you can deal with.
• Client testimonials: Look for testimonials and feedback given by past debtors. You can also ask your friends and associates about reputable debt settlement companies they have dealt with.

Pros and cons of debt settlement

Whether you go for credit card debt settlement program or you settle personal loans, payday loans etc, here are the debt settlement pros and cons that you should be aware of.

Pros:

1. Avoid bankruptcy: With debt settlement solutions, you can resolve your debt problems and don't have to worry about losing your home or car as in Chapter 7 bankruptcy.
2. Single payment: Instead of paying multiple bills each month, you'll only have to make a single monthly payment to the settlement company. You avoid the stress of paying debts at different rates and dealing with several creditors.
3. Avoid unfair collection practices: You can avoid unfair collection practices and harassment by debt collectors if you negotiate a settlement.
4. Eliminate extra charges: The debt settlement help company can eliminate late fees and any over-the-limit fees on credit cards.
5. Avoid lawsuit & other legal actions: Your creditors or the collection agencies can file suit to get a judgment lien and garnish your wages. You will be able to avoid collection suits if your debt settlement program is successful.

Cons:

1. Credit score drops: In a settlement program, you're asked to stop paying your creditors until you save enough to make a lump sum settlement. Moreover, you may settle your bills only after your accounts are charged off. Due to late payment or charge-offs, your credit score takes a hit.
2. You may owe taxes: Once you go for credit card settlement or settle other debts, creditors will forgive a percentage of what you owe. As such, the IRS will require you to pay taxes on this forgiven debt which is known as cancellation-of-debt (COD) income.
3. Account status on credit report: Unless negotiated with creditors or CA, the account status on your credit report will be updated as "Settled" which creates a negative impact on your score as compared to a "Paid in full" status.

Debt settlement programs provide an easy way out of debt. However, your credit score is likely to go down when you stop paying creditors and save money for debt settlement. But you can repair your score by using a secured credit card, or a gas/store card. Such cards are easily available even though you may have a poor credit history. Besides, you need to make timely payments on other bills while you settle credit cards and other dues using debt settlement services.

Just in case you don't want to enroll with an online debt settlement company, you can do it yourself. Use sample debt settlement letters to communicate with creditors and collection agencies. Just make sure you understand how the process works and negotiate as best you can.