Jul 20, 2016
Debt settlement is a process of negotiating with one or more creditors to reduce the balances owed by debtors. Also known as debt resolution, the process can benefit all parties, although the scales are tipped on the side of the person who owes money.Get Help Now
How the Settlement Process Works
As a general rule, people who pursue debt settlement can’t afford to pay off all their debts. A successful settlement allows them to walk away without having to pay everything, potentially saving them a lot of money.
The creditor should consider it will receive as much as it can from the settlement and wipe an overdue account from its books.
If the creditor agrees to the partial payment of a loan or credit card debt, in exchange for an immediate lump-sum payment, it will collect on a debt that might have been otherwise uncollectable.
The settlement renders the debt paid in full, regardless that it was only a partial payment of the actual debt. While results are not guaranteed, some consumers have large debts cleared.
Types of Debts Eligible for Settlement
Credit card debt is ideal for the debt settlement process because consumers accrue this type of debt in abundance and the creditors are private lenders, rather than government entities. Additionally, credit card debt isn’t secured by property like mortgages and auto debt.
For federal student loans, debt settlement is rarely an ideal option as the U.S. Department of Education is unlikely to settle for a lump-sum payment of less than what they are owed. The DOE does provide consolidation options — where one larger loan replaces multiple smaller loans — for many of the available federal loans.
Private education loans, which may be backed by banks, are more likely than federal loans to be eligible for settlement.
- Credit Card
- Auto Repossession Balances
- Personal Loans
- Utility Bills
- Mortgage "Short Pay" Balances
- Private Student Loans
- Apartment Leases
- Cell Phone Bills
Who Qualifies for Credit Card Settlement?
Credit card companies usually do not have specific guidelines. However, good candidates are usually those who can no longer afford their minimum monthly payments. Credit card settlement offers debt relief without the stigma or harm of bankruptcy.Find out if you qualify
What if Creditors Won't Settle?
Creditors have no legal obligation to negotiate an outstanding balance on credit cards or other loans. But they can often recover more funds through debt settlements than other collection methods like hiring a collections agency or attorney.View Alternatives to Settlement
Debt Settlement Companies
One way to resolve your credit card debt or other debt is to enlist the help of a debt settlement company. Debt resolution companies often are experienced at negotiating with creditors and may have relationships with major creditors, specifically credit card companies.
The first step in the debt settlement process is for a consumer to reach out to a reputable company that can help. These debt arbitration firms are staffed by credit counselors, people who are accredited in analyzing personal finances. They also have a keen understanding of the current marketplace, including how and why creditors will negotiate a settlement.
Once your finances are detailed, the counselor will check the totality of your debt and then draw up a settlement plan. That plan will be presented to you. It should include details about your monthly payment plan and how the settlement company profits from the transaction.
By resolving your debts, an arbitration company can earn its money in several ways. It should receive fees of a scheduled dollar amount, a percentage of the debt you want settled or an agreed-upon percentage of the amount you save through settlement.
Finding the Right Debt Resolution Company
The Federal Trade Commission (FTC) suggests you look for a number of additional features in a debt resolution company to determine its legitimacy. These features ensure that a company is fair, transparent and professional.
Creditors have no legal obligation to consider any settlement deal, so a debt resolution company cannot honestly ensure an agreement.
A good settlement company will:
- Disclose all program fees and costs before you sign up for a debt resolution program
- Have easy-to-understand written policies about its debt resolution program
- Give you an estimate of how many months or years it will wait before making an offer to each creditor
- Estimate its intended results, but never guarantee a specific settlement amount
- Tell you how much money you must save up before it will begin making offers to your creditors
- Send all resolution offers to you for your approval
Preparing Yourself for Debt Settlement
You’ll start the process by putting away money in preparation for debt negotiations. Your settlement company will tell you the total amount you need to save in advance. You’ll make a monthly payment into a dedicated bank account for several months or years, depending on your monthly budget and anticipated amount to be resolved. The account will be in your name and should be insured by the Federal Deposit Insurance Corporation (FDIC). It will be overseen by a trustee or account administrator.
Negotiating Your Debt
As you build up your account, this money will be used to bargain with your creditors on your behalf. You will have the final say on the terms and how your money will be used to pay off the negotiated amount before accepting an agreement. Once those negotiations are successful, your debts will get paid off one by one.
Signing an Agreement
After you come to an agreement on a credit card settlement, put all arrangements in writing for your records. Be sure you and your credit card company sign the agreement. At this point, the account administrator will be responsible for transferring funds from your account to pay your creditor.
Speak with a tax professional if the debt amount covered by the settlement is more than $600. If so, you likely will be required to pay income taxes on that amount because the Internal Revenue Service can consider forgiven debt as income.
How Debt Settlement Affects Your Credit
It’s important to know that your credit scores have already declined if you’re at the point of resolving your credit card debt or other debt. Although this can be stressful, your top priority should be to get out of debt and get your finances back on track.
Talk to your credit card company about whether it will report your agreement as a settlement to the credit bureaus. If so, that settlement could appear on your credit report for about seven years and may damage your credit score. Ask your credit card company to report the settlement as “paid in full” instead. Once your debts are settled and wiped away and you are keeping your financial house in order, your credit scores will move up.
Alternatives to Debt Settlement
Don’t panic if your creditors won’t settle. You have other debt options: Credit counseling, debt management, debt consolidation, and, in extreme cases, bankruptcy.
In debt consolidation, a borrower takes out one big loan to pay off smaller debts, typically achieving a lower interest rate in the process. A debtor will pay one bill every month instead of several bills, but if they are unable to pay the consolidated, secured debt, there is no more wiggle room.Learn More
In credit counseling, agencies can set up low-interest debt management plans so that borrowers can pay off unsecured debt over time. A debt management program (DMP) reduces your monthly payments so you can eventually pay off your debt in full.Learn More
Personal bankruptcy should always be considered the last resort — and the worst option — for anyone battling debt problems. It will negatively affect your credit, prevent or delay foreclosure on a home and lead to repossession of a car. In addition, filing for bankruptcy can be complex and costly.Learn More
Need help choosing the best debt relief option for you?Get Help Now
- Federal Trade Commission (2010). Settling Your Credit Card Debts. Retrieved from http://www.ftc.gov/bcp/edu/pubs/consumer/credit/cre02.pdf
- Federal Trade Commission (2008). Debt Settlement Industry Standards Fact Sheet. Retrieved from http://www.ftc.gov/os/comments/debtsettlementworkshop/536796-00027.pdf
- Weston, L. (2010). When debt settlement makes sense. MSN Money. Retrieved from http://money.msn.com/credit-and-debt/when-debt-settlement-makes-sense-weston.aspx
- Federal Trade Commission (2011). Knee Deep in Debt. Retrieved from http://www.ftc.gov/bcp/edu/pubs/consumer/credit/cre19.pdf
- The Association of Settlement Companies (2007). The Association of Settlement Companies (TASC) Study on the Debt Settlement Industry. Retrieved from http://www.ftc.gov/os/comments/debtsettlementworkshop/536796-00014.pdf
- Freedom Debt Relief (2011). FDR Training Manual.