A Guide to Debt Settlement
Written by Veronica Li, Dongmiao Cui   


Debt settlement is a way of negotiating with your creditors- either by yourself or through a company- over the amount of debt you owe so that you can pay back less than your actual debt. Creditors benefit from debt settlement because they can still collect a portion of your debt, rather than getting completely empty-handed. As a consumer, you should emerge debt free after going through a debt settlement process. For these reasons, debt settlement has been considered as a viable alternative to filing bankruptcy.

Pros

The biggest advantage of debt settlement is that you only need to pay back a fraction of your debt. This can possibly save you a significant amount of money. Moreover, your resolved debts will not be subject to collection or other legal actions.

Another benefit is that you can become completely free of debt within two or three years. Even though debt settlement could have hurt your credit rating, you can start rebuilding your credit again relatively soon. Meanwhile, you will have more disposable income to pay for other life expenses such as utilities, food, education and insurance, etc.

Some creditors may even agree to remove negative information on your credit report. During negotiation, you should clarify with your creditor about whether debts appear in your credit report as “settled” or “paid in full”. Only the latter could save your credit score.

Cons

However debt settlements only apply to unsecured debts, which means that auto loans and mortgages loans are excluded.

Its benefits also come at a cost. First of all, your forgiven debt will be regarded as income so you will owe taxes on it.

Secondly debt settlement cannot save your credit rating. This is simply because creditors do not agree to settle debts unless they are a few months past due. Consequently you need to stop paying your debt for a few months at first to be eligible for a debt settlement program. Such late payment will be reported to the credit bureaus, and show up in your credit report. As a result, debt settlement could hit your credit score badly, dragging down your score up to 125 points.

Thirdly debt settlement is not cheap either, especially when you seek assistance from a debt settlement company. Not only do debt settlement companies charge monthly fees and other administrative fees for their services, but they will not repay your creditors on your behalf until you have accumulated enough money to settle your debt. Consequently you will still be responsible for paying interest charges and late fees to your creditors for overdue payments. In this case, you will not save much money at all while your credit score keep taking severe hits.

If you want to settle your debt, you can resort to a debt settlement company or do it by yourself.

Debt settlement companies

Debt settlement companies make profits by charging you a large fee up front or taking monthly fees from your bank accounts for their service. They typically deal with your unsecured debt such as credit cards, medical bills, utility bills, and personal loans. Most debt settlement companies follow the same general procedure:
  • Consultation - A representative will assess your financial situation to determine whether or not you qualify for a debt settlement program. If you do, he/she will then work with you to create a customized debt settlement plan.
  • Monthly set-asides - After determining what you can afford, you and your consultant will agree on a sum of money that you will set aside each month. This gets put into a third-party savings account for the duration of your plan. The point of this special account is to prevent that money from being spent elsewhere, for purposes other than your debt.
  • Negotiation - Once you have accumulated enough funds in your account, debt negotiators from the debt settlement company will then negotiate on your behalf with each of your creditors to settle your unsecured debt.
  • Payment - Payment to your creditors will be made in the form of a lump sum. Upon completion of the debt settlement process, your creditor accounts should reflect a zero balance.


Debt Settling DIY- When should I do it myself?

Debt settlement companies, first and foremost businesses, profit from their clients. So hiring professionals to settle your debt on your behalf could be costly. To save money and to avoid debt reduction scams, you can consider negotiating your debt with your creditors directly. This guide will provide you with step-by-step instructions on how to do this by yourself. Although they are difficult to be persuaded, many of your creditors do want to work with you to pay off your debt.

Step 1: Knowing your debt

Only debt that is past due can be negotiated. So you need to make sure the debt you owe is not current. If your payments are up-to-date, you will have to be at least 3 months late to begin settlement negotiations.

Next, you will need to decide which debts to settle. There are two types of debt—secured and unsecured. Debt settlement typically involves unsecured debt more than $ 1,000, which is any loan or debt that has no underlying tangible assets or property. The most common types of unsecured debt include credit cards, medical bills, utility bills, and personal loans. It is best to settle debt with high interest rates first, because they have the most dramatic effect on your monthly budget.

Step 2: Preparation

Before you call your creditor to make settlement arrangements, you need to gather all necessary documentation, which includes:
  • Your recent bills and the amounts owed
  • Your credit report
  • Your records of all penalties and interest
Be aware that every creditor/collection agency has its own policies and settlement limits. Credit card companies usually have more patience dealing with you up front than collection agencies. They should be willing to negotiate with you even if you are really behind on payments, perhaps 4-5 months late.

Step 3: Making the call

When you call the creditor, you should ask to speak with someone who is in charge and has the authority to make settlement arrangements. Firstly make it clear you are willing to make a payment or are interested in a settlement. Secondly, explain why you have been unable to make your payments. Then if possible, specify your plan to settle the debt and make an offer. It is also a good idea to mention that you are seriously considering bankruptcy if you cannot get rid of this debt, as that means creditor will not get their money back.

Step 4: Settlement

In general, you should aim for a settlement that is 30-50% of the balance that you owe. If your delinquent account has been passed on to a collection agency, your room to negotiate will be smaller. There are several different ways companies can report your account status to credit bureaus after your debt has been settled. It is important to get a good account status because there may be lingering negative repercussions. Below is a list of status in order of preference to you:
  • Paid as agreed
  • Paid (with no negatives such as charge off, repossession, late notations)
  • Settled (better than Paid—Charge off or Paid—Repossession)
  • Paid—Charge Off, Paid—Collection, Paid— __ days late
If they are not willing to accept your offer, politely hang up, and try again a few days later. Since most calls are usually monitored and recorded, using profane language will only make matters worse. If they accept your settlement offer, ask for the agreement in writing before you pay a penny. This letter will protect you from any future claims by this creditor. When talking to different representatives, makes notes about who you spoke with and what they did/did not agree to.

Step 5: Other options

If you do not have luck negotiating by phone, you can send them a letter detailing the reasons why your payments are past due, how much you owe in total, and how you plan to settle/pay off your account. You should also include a credit report showing that they are not the only creditor whom you owe money to, as well as a monthly budget that confirms you are not making enough income to make payments.

Step 6: Payment

After you have received the settlement letter in writing, promptly pay the agreed upon amount by money order, Cashier’s Check, or electronically. Make your payment according to the creditor’s terms. They usually require a partial payment of the settlement in a matter of days. Afterwards, you will have more time, sometimes up to a month, to complete the settlement payment.

Step 7: Follow-up

Check your credit report in 60-90 days to verify that it has been updated as agreed. Make sure this information has been changed. If it has not, send a copy of the settlement letter to your creditor and request the change to be made in accordance with the agreement.

Tip1: It’s likely that your creditor might turn off your request the first time. But don’t be discouraged. You can try again after a 2 or 3 days.

Tip2: Don’t argue with creditors/collectors or use profane language.

Tip3: Keep detailed and clear records of whom you speak to and what is agreed. Also keep copies of all documents.



 
Last Updated on Sunday, 15 April 2012 02:55