A Debt Settlement program is a financial program in which you negotiate with creditors to pay less than what you owe (typically on credit cards), agreeing on a reduced amount as "full payment" of the original debt.
It is a process that is usually carried out through an agency or financial institution. The idea is to settle the debt by paying only a portion of it. Typically, negotiations aim to pay between 10% and 50% of the original debt, but it is possible to negotiate up to 80% less.
Although it is a program we do not recommend (for reasons discussed below), it can be one of the few alternatives for certain debt problems that reach the point of financial desperation. It could work if you have very high credit card debts and paying them is absolutely unfeasible, but you do not want to go through the legal process of bankruptcy.
How it works
The exact Debt Settlement process can vary depending on different factors, such as whether the debt is already in collections or is still with the original lender, whether contact is initiated by the debtor or a professional agent, and the state in which the debtor lives, as some states have stricter rules than others.
Although it is possible to carry out this process on your own, if the decision has already been made to undertake the program, our suggestion is that it be done through a debt settlement company or a debt settlement attorney.
The overall debt settlement process is relatively simple and usually takes between 12 and 48 months. However, some debts can only be negotiated after a certain period of time has elapsed since the last missed payment, which could be 90, 120, or 150 days.
Financial assessment
First, a financial assessment is conducted. A credit counseling agency analyzes your economic situation and determines if the program is right for you. This assessment is usually free and is conducted over the phone.
We invite you to consult with our team before contacting the agency directly; our consultants will clarify all your doubts and will be available to you throughout the process.
You can contact one of our consultants via chat or schedule a call through our WhatsApp. It is completely free; if you want to know more about this consulting service, go here.
Signing the agreement
If the Debt Management program is the best option, the agency proceeds to draft an agreement that must be signed by the debtor.
💡 Before signing the agreement, you can consult with the team member who initially helped you to confirm that the agreement actually benefits you.
Suspension of payments
Generally, most people do not have enough cash to offer a settlement to creditors. To save a significant amount, the settlement company will ask the debtor to stop paying their credit cards and instead save that cash in an escrow account.
This can result in creditors harassing the debtor to pay the outstanding balance.
The idea is to find a monthly amount that the debtor can save to reach an ideal sum, allowing the settlement company to negotiate with lenders and reach a settlement agreement.
Although effective, this strategy carries a significant negative credit impact because stopping payments on your cards will cause missed payments to be reported to your credit history.
Negotiation
Once sufficient funds are accumulated to make the settlement offer, the company contacts each of the creditors to negotiate.
If they reach an agreement where the creditor accepts the lower amount owed as full payment, the debtor signs a formal settlement offer, and the cash saved in the escrow account is used to pay the negotiated balance, which is typically between 10% and 50% of the original debt, although it is possible to negotiate up to 80% if the debtor's situation qualifies.
Following the agreement, creditors cease harassment to collect their debt.
Settlement
Once the settlement payment is made, the accounts will appear on the debtor's credit report as "Settled," but they can also be reported as "paid as agreed" or "not paid in full."
This is a negative mark because, ultimately, the original debt was not paid in full.
Why would a lender accept a settlement offer if it is ultimately less money than what is owed?
It must be made clear that these types of programs do not exist out of the benevolence of lenders. If a person is absolutely unable to satisfy their debt because it is simply unfeasible, they have the alternative of declaring bankruptcy.
When a person declares bankruptcy, there is a possibility that the lender will not recover any of their money. That is why they prefer the chance of receiving something rather than receiving nothing. Their best option is to show flexibility and allow the debtor to pay a fraction of the total amount owed.
This does not mean that all lenders will prefer something over nothing; it is possible that during negotiations they may be reluctant to reduce the balance owed and prefer to try their luck at a 341(a) meeting.
Benefits of the Debt Settlement Program
Reduction of the total amount owed: The main benefit is that you can pay less than what was originally owed, sometimes significantly less.
It is relatively fast: Compared to other alternatives, settlement is usually a faster solution to high debt problems.
Bankruptcy is avoided: Although settlement leaves a negative mark on your credit, it is less negative than bankruptcy, and the process is usually less stressful.
Credit can recover faster: As with any adverse event that affects credit, the negative impact of debt settlement dissipates over time. But unlike bankruptcy, which can have permanent repercussions on credit history, the drop from debt settlement can be reversed in a few years.
Disadvantages of the Debt Settlement Program
Program costs: Settlement companies typically charge between 15% and 25% of the enrolled amount or between 30% and 45% of the saved amount. For example, a person with a debt of $25,000 would pay between $1,500 and $2,500 to participate in a settlement program, assuming a settlement of $15,000 is negotiated. These service fees are generally included in the monthly payment the debtor must make.
Higher monthly amount: It is common to require saving more money month-to-month compared to other debt relief methods, such as a Debt Management Program or Bankruptcy.
Negative mark: Having an account reported as "Settled" is a negative mark that can last up to 7 years on your credit history.
Late payments remain reported: Even if an agreement is reached and part of the debt is paid, any late or missed payments before the settlement offer was accepted will remain on the credit report. This is one of the less favorable aspects of this program.
There is no guarantee of reaching an agreement: Creditors are not obligated to accept a settlement offer, and some may prefer to sell the debt to a collection agency or try their luck in a bankruptcy proceeding if the debtor decides to take that route.
Possible taxes: The IRS considers more than $600 of forgiven debt as taxable income, so in most cases, a successful settlement will likely have tax implications.
Impact on credit
This is a program that has a considerable negative impact on credit. The "Settled" report is in many ways similar to the impact of bankruptcy, although at a milder level, but it is still negative. Likewise, it is something that must be accepted since, in the end, the original debt was not really paid, only a portion of it.
However, the missed payments that were reported as money was being saved for the settlement are defaults that will remain on your history even after the settlement. This can feel unfair since suspending payments is practically part of the strategy of the settlement program, and they should be removed because, in essence, the money was still intended for that debt, it was just accumulating in a separate account.
Although it is possible to rebuild credit, these factors are something to keep well in mind.
Why we would not consider it
If you are at a point where debt has simply become impossible to manage and paying it is unfeasible due to the high amounts, this is a program that could be considered as a last resort before considering bankruptcy, as long as the implications of it are understood.
That being said, we do not like the method applied to solve the debt problem and would prefer to prioritize the Debt Management program as much as possible, even if it requires more time.
However, it is also understandable that there will be situations in which it is simply impossible to manage the debt, mainly due to its size. It is no longer a question of saving interest or negotiating a payment plan; it is a question of paying what is possible and getting out of the problem.
In those situations where the only options are bankruptcy and debt settlement, the settlement program probably makes more sense.
We would only consider this program if:
• Our credit is already damaged. At this point, we have nothing to lose.
• The debt problem is related to the total amount and not just the interest or minimum payments.
• The amount of the debt is considerable. At least between $5,000 and $10,000 per account, otherwise lenders may not even be open to negotiation. Additionally, there are better alternatives to get out of those debts.
• I want to avoid going through the legal process of bankruptcy.
• I have a steady source of income. Otherwise, I will probably not have the ability to save an amount to settle the debt.
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