Debt Settlement

A debt settlement, also called debt negotiation, is an option for those who may be considering bankruptcy due to financial hardships and unmanageable monthly payments.

Debt settlement offers an alternative to bankruptcy by reducing the total amount of unsecured debt owed, whereas bankruptcy is a last resort. Creditors agree to cancel part of the debt and accept a partial sum as total payment, which makes this process different than a consumer credit counseling service (CCCS). CCCS only negotiates lowering the interest amounts, and, as a result, consumers pay back their total amount of debt, plus interest, plus fees to the company sometimes as much as 150% more than what they entered into the program.

Many consumers may contact the credit card companies and try to negotiate on their own since creditors are willing to listen when an account is past due; however, this does not always reduce the debt balance and often consumers are too emotionally involved to negotiate the best debt account settlement possible. Furthermore, credit card companies tend to use intimidating tactics and target these emotions making a bad situation worse, thus shaming the debtor to pay the full amount.

Debt settlement companies work on behalf of the consumer through a structured program that enables them to reduce about half your debt in three years or less.

Brief History of Debt Settlement

Since there have been lenders, there has been debt settlement. The concept has been around for centuries. Items are borrowed; items are then returned. If items are not returned, the borrower becomes the debtor—one who owes. Maybe the item gets broken or lost and can not be returned, the debtor has two choices: ignore the lender or communicate with the lender to work out an agreement to replace or payback the item. The first option can create more problems and possibly ruin one’s reputation. The latter option is ethical, honest and forgivable. Debt settlement is the idea of forgiveness.

The late 1980s and early 1990s produced a large market for debt settlement due to bank deregulation and economic recession. Many debts crossed over to the loss side, which alerted banks to invest in a debt settlement department in an attempt to recover some funds before those companies filed for bankruptcy and were successful in collecting 25% - 65% of unpaid balances. Some businesses hired an attorney to settle their debts, but attorney’s fees easily offset any savings to the businesses if they attempted to pay off the debt themselves.

Third party commercial debt settlement companies began to emerge and represented businesses in jeopardy of having to file bankruptcy rather than business having to hire a law firm. Then, consumer debt reached an all time high in the late 1990s and banks decided to capitalize on the statistics by not cooperating with Consumer Credit Counseling agencies, which negotiate reducing the interest rates for their clients. Third party negotiation companies started appearing, offering consumers to not only get out of debt, but also save money.

New concepts sometimes create unprofessional practices due to inexperience, so the Federal Trade Commission investigated and removed any unethical debt settlement companies and continues to keep a close eye on this industry. This concept could have been lost if it wasn’t for conscientious entrepreneurs aligning with the already established and reputable commercial debt settlement companies, who took over the companies marketing to the general consumer and did the negotiations for them. Although debt settlement has been around for years and years, debt settlement companies are fairly new with the first few companies beginning as recently as 1998.

Debt settlement companies are a for profit industry but, unlike consumer credit counseling, are not supported by the credit card companies. Rather than trying to reduce interest rates and dispersing monthly payments, debt settlement reduces the entire balance and settles the accounts from 30 to 50 cents on the dollar, saving the consumer money in a much shorter amount of time, generally three years or less. Industry professionals formed the United States Organization for Bankruptcy Alternatives (USOBA) in 2004 to not only sustain it but also standardize industry practices and procedures. The following year gave birth to The Association of Settlement Companies (TASC), who succeeded in challenging the unfair and ambiguous debt settlement laws in Texas. TASC upholds industry principles, protects the consumer and is the debt settlement companies’ lobbyist on federal and state levels.

Debt Settlement Process

Upon enrollment with a debt settlement program, the debtor agrees on a comfortable monthly amount to be drafted from one account and deposited into a savings account. The debtor signs over limited power of attorney to the debt settlement company, who negotiates on behalf of the debtor. Once enough funds for a settlement have accumulated, an agreement is made, payment is arranged and the settled account is now documented as “settled in full” or “paid in full.” This process continues until all of the debts are settled and the debtor becomes debt free having saved 30% - 50%. Again, debtors can try this process on their own, but most debt settlement companies invest in the proper certification, training and preparation to deal with the often times harsh credit card companies.

Debt Settlement Compared to Debt Management Plans through CCC (Consumer Credit Counseling)

Debt settlement programs and debt management plans are often confused with each other, but their processes and results are different.

Debt management plans (DMP), serviced by the non-profit consumer credit counseling agencies, negotiate lowering the interest rates. The balances are consolidated into one monthly payment to the CCC who then distributes part of that payment to each of the creditors. Depending on the amount of debt, this process could take up to 60 months or longer. Debt management plans usually charge a set-up fee and a small monthly fee, and they do have non-profit status. They do the paperwork writing proposals to rework your payment plans. With the debt management option, a debtor pays back the total amount of debt, plus interest, plus fees. Do the math. Multiply the monthly payment by the length of the program to calculate the exact payback amount. Sometimes it is as much as 150%!

Debt settlement is a negotiation process where the entire amount of debt is settled for less than the original balance. Upon enrollment of a debt settlement program, the debtor has a manageable monthly amount drafted from his or her own checking account and placed into a Special Purpose/Trust account, which is in the debtor’s name and is FDIC insured. You will receive monthly statements just like bank statements to monitor the activity as funds accumulate. This process continues until there are sufficient funds for the debt settlement company to negotiate the first settlement. Once settled, they move on to the next account, then the next until all report a zero balance and both parties are satisfied. Accounts are usually settled on an average of 30 – 50 cents on the dollar and programs are no longer than three years.

Types of Debts Eligible for Debt Settlement

Any unsecured debts such as credit cards, retail and gas cards, personal loans, medical bills, past due utility bills (if you are not relying upon the utility) and collection agency bills are eligible to include in a debt settlement program. Home, car, payday and most student loans are secured debts and can not be negotiated through debt settlement. A debtor must have between $7,500 and $10,000 of unsecured debt to qualify for the program and can complete the program in one to three years depending on the total amount entered. There should not be a penalty for finishing early, in fact it is encouraged, and is achieved by increasing the monthly payment if and when extra resources become available.

Debtor’s Incentives

Even though the minimum payment is made on time every month, high interest debt balances tend to stay at the same amount because only the interest is being paid. A debtor will be in debt for decades, not to mention paying up to 29% more than what was originally owed. Debt settlement helps to pay off debts in a short period of time and save the debtor thousands of dollars through the negotiation process. Debt settlement is also an alternative to bankruptcy, and, although debt settlement is an aggressive approach, it is not as damaging as what a bankruptcy holds, which remains on one’s credit file up to ten years.

Creditor’s Incentives

In the debt settlement program as funds are being built up in an account, the payments to the creditors are not being made. This accomplishes three things crucial to the negotiation and settlement process:
    1) A lump sum has to be reached to establish leverage;
    2) it builds up the client’s track record of responsibility and consistency;
    3) the accounts are stamped as a Charge Off meaning it has crossed over from the profit to the loss side.
Creditors would rather recover some funds than no funds, and if a client files bankruptcy, the creditor receives nothing as repayment. Creditors also would rather not deal with collection agencies or collection attorneys, who charge high commissions on any payback amounts. In addition, these calls and/or letters can push the debtors into filing for bankruptcy in which case no funds can be collected.

Disclaimer:   Debt Consolidation Deals, Inc. does not provide legal, investment or Tax advice. If a client needs legal services or legal expertise, they must seek the advice of a licensed attorney. Individual program results may vary.