1. What is the business logic behind debt settlement companies?

Debt settlement is a way of negotiating the amount of debt one owes so that the amount paid is less than that which is owed, but is accepted as full payment of the debt. Creditors benefit from this because they have the opportunity to collect a portion of that which is owed, instead of leaving completely empty-handed. For the consumer who cannot afford to pay off all his/her liabilities, he/she should theoretically emerge debt free after going through a debt settlement process. For these reasons, many consumers see debt settlement as a viable alternative to filing bankruptcy.

2. How does debt settlement work?

Most debt settlement companies follow the same general procedure:

1. 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.
2. 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.
3. 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.
4. 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.

3. What types of debt can debt settlement companies help reduce/settle?

Debt settlement companies typically deal with unsecured debt. This is any loan or debt that has no tangible assets or property attached to it. The most common types of unsecured debt include credit cards, medical bills, utility bills, and personal loans. 

4. What are the advantages of debt settlement?

You can be debt free in just a matter of months, by paying back only a fraction of that which is actually owed. It is a feasible alternative to filing bankruptcy, which will remain on your credit report for 10 years. Not to mention, filing for bankruptcy itself is quite expensive nowadays. 

5. What are the disadvantages of debt settlement?

First, debt settlement like bankruptcy is not cheap. Not only do debt settlement companies charge monthly fees and other administrative fees for their services, but the client is also responsible for paying interest charges and late fees to his/her creditors for overdue payments. To ensure that monthly payments are made to the third-party savings account, debt settlement companies will often advise their clients to stop paying their creditors immediately. As a result, they will continue to accrue late fees and interest charges even after they sign on with a debt settlement company. Consequently, their credit score will take a severe hit. Finally, in the time it takes one to accrue sufficient funds for debt settlement, the client is not protected from legal actions a creditor may choose to take against him/her.

6. What are my other options?

Often times there are no guarantees to settlement results. Not only do results vary for each individual, but also from creditor to creditor. Debt settlement is itself a very risky business and will undoubtedly shatter your credit report. What then are the options for those who do not want to choose bankruptcy, or don’t have the time to embark on the risky task of debt settlement? How about those who have debt, but do not meet the minimum requirement of unsecured debt that many debt settlement companies often ask?

Many individuals have taken the liberty of contacting and negotiating with their creditors directly, instead of hiring professionals who make money from doing business with you. This way, you may be able to avoid a huge credit hit and/or potential legal actions that may be taken against you. Although this is not an easy process, many creditors will work with you to hammer out hardship terms with you so that you can pay off your debt. For example, creditors may reduce interest and waive late fees by not reporting your credit as past due. Why do creditors want to work with you? Because they know they are getting the short end of the stick with you as you are with them when the debt settlement company is the middleman. See A DIY Guide to Settling Your Debt for more details.

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