Debt settlement is a financial agreement where the lender agrees to accept a lump-sum payment from the borrower to settle an outstanding debt. The payment is for a significantly lower dollar amount that what was owed, making it one of the most attractive debt-relief options available.
You can hire a debt settlement company who will negotiate with your creditor for a fee, or you can cut out the middleman and do it yourself.
Debt settlement is commonly used when the borrower can no longer afford the high interest on credit card debt, coupled with the amount owed. For example, if you owe $20,000 on a credit card that accrues 20% interest in annual percentage rate, you would owe another $4,000 in interest alone over a calendar year’s time.
The size of the debt, along with the compounded interest and late payment penalties, leads to borrowers being inundated with massive amounts of debt they can’t afford.
Negotiating a debt settlement with a creditor can, at times, knock off over half of the amount owed. Paying just 50% of a debt is the optimistic goal of every debt settlement negotiation. It’s a smart risk when you owe more than $10,000 and are delinquent on payments.
If you want to settle the debt without hiring a debt settlement company don’t be afraid to take it on! Do it yourself debt settlement is like lawn care: it’s a little work, but in the long run it can save you a lot of money.
DIY Settlement vs Debt Settlement Companies
The major difference between debt settlement companies and DIY settlement is the amount of time and money the process will take. Working with a debt settlement company can take 3-5 years to complete. Doing it yourself involves only you and the creditor when you cut out the third party. This saves you money from paying a percentage of the settlement to the third-party settlement company.
The risk is you are inexperienced and don’t have the third-party expertise. However, hiring a debt settlement company does not mean you will come away with a flattering offer. Debt settlement companies are known to have inconsistent results when it comes to helping their clients.
If you do it yourself, you negotiate the debt settlement on your terms without the cost of hiring someone who you can’t afford.
4 Steps for Successful Debt Settlement Negotiations
Step 1: Assess Your Current Financial Situation
Lay out a plan on how to tackle your financial situation. Find out who you owe, how far behind are you on the payments, and how much money you have to negotiate with. Sometimes it is better to continue on-time payments while building a large enough sum to complete the process of debt settlement.
If you are delinquent on your payments, create a separate bank account where you can set aside money to pay a one-time lump sum to your creditor or a shortened payment plan. When negotiating, you need to come to the table with at least 50% of what you owe for the creditor to seriously consider offering a debt settlement.
Step 2: Figure Out Who Your Creditors Are and Learn Your Rights
Look up the policies for your specific creditor and find out what policies they have set. The creditor has no obligation to settle with the you. If the creditor avoids debt settlement, you may have to wait until it is sold to a different collection agency for the chance to settle the amount owed.
If the creditor believes they are unlikely to receive the full payment, you have a great chance at debt settlement. The older the debt is, the better the chance you will succeed with a debt settlement offer.
Get a copy of the Fair Debt Collection Practices Act (FDCPA), which spells out what collection agencies can and can’t do to collect a debt. There are plenty of provisions that protect you from being harassed.
For example, if the collection agency is after you about an unpaid debt, there are specific times of day they can and can’t call. They can’t visit you at work. They can’t lie about your debt or the penalties you will incur for not paying. If they violate any of the rules, you can sue. First, you must know the rules of the game, so look up the FDCPA.
Step 3: Talk to Your Creditors and Set Your Terms
Know exactly how much you can afford. This is an obvious starting point, but one commonly overlooked by people too anxious to settle their debt. They jump into negotiations, get 20% knocked off their principal and start rejoicing, only to find out that’s still more than they can afford.
Determine how much a month you can pay and stick to that throughout the negotiation process. It is not unreasonable to think you can get the principal reduced by a substantial amount. Whatever amount you settle on, be sure you can comfortably afford it. Try to negotiate away the late fees that have been assessed for lack of payment. These fees are what can ultimately tank your credit score.
Step 4: Make an Agreement & Pay off Debt
Ask for a written agreement before you do anything. Read it over carefully and understand payments, due dates and penalties before you sign it.
Be patient. Collection agencies are good at intimidation. They rush debtors into a process with subtle, and sometimes not-so-subtle, threats about the consequences for not paying. Play the negotiating game at a slow pace. Make them explain everything to you in detail. If you drag the process out long enough, they may improve their offer to get something out of you. Patience definitely pays off.
After you have negotiated the agreed upon price, you will need to pay the settlement figure either in a lump sum or with a payment plan. Once you have done that, you are no longer in debt to the creditor.
Risks of DIY Debt Settlement
You may not be as great a negotiator as you thought. Debt settlement companies built their business around being able to save you money. They do not get their money without you saving yours. The creditor may low ball you, costing you thousands of dollars. It is up to you to find out what is the best option for your specific financial situation.
A drawback to debt settlement is that it stays on your credit report for seven years, discouraging any lenders (home, auto, credit card, etc.) from giving you more credit. It also damages your credit score by 75-100 points, meaning that if a lender gave you credit, they would do so at a very high interest rate. For example, a 5% car loan might cost you 18% -20% because of debt settlement. That would be thousands more you must pay for a car because you have debt settlement on your credit report.
DIY Debt Settlement Alternatives
If you’re not delinquent to the creditor, but still struggling to pay the monthly bills debt settlement is probably not the best option. A better option could be a debt management plan, which actually could help your credit score, and get your debt paid off in the same 3-5 year time span as debt settlement.
Accruing late fees while not paying the delinquent debt will harm your credit score. DIY debt settlement has its advantages and disadvantages. You can save money, but if you don’t have a plan of how to tackle the debt with the creditor than it may not be the option for you.
In order to negotiate an offer for debt settlement, you need to have the money saved up to satisfy the settlement agreement. That may not need be possible for you at this time.
If you are still unsure about your financial situation talk to a nonprofit credit counselor who can discuss ways you can obtain a debt settlement. Another option is debt consolidation or a last resort, is filing for bankruptcy.
If you make a plan, and save money to execute the plan, you will be well on your way to being debt free.
About The Author
Luke Fay is a December 2019 graduate of Florida State University with a B.S. in Sport Management. He learned quite a bit about personal finance at FSU, specifically how to scrimp by on next-to-nothing. He has since found out that scrimping doesn't end just because you graduate. He will share his inexpensive ways of getting by with Debt.org readers. When there is time, he enjoys watching sports, going fishing, and travelling the state of Florida.