Complete Guide to Debt Settlement

Find out if a debt settlement is an option for you. See if you qualify for a free consultation with a leading debt relief firm.

What is debt settlement?

Simply put, debt settlement is a restructuring or reorganizing of your debt that helps you pay off what you owe more easily. It involves negotiating to settle your debt for less than the full amount you owe. A debt settlement should lower reduce your debt and make your monthly payments more affordable.

There are a variety of reasons that you may need debt relief. Often it’s due to circumstances beyond your control, such as the loss of a job, a death in the family, or a medical emergency.

Whatever the reasons for your current financial difficulties, a debt settlement can help make your situation more manageable.

  1. 1. What types of debt can be handled with debt relief settlement?

    Debt settlement programs can handle most types of unsecured debt, such as credit card debt, medical bills, personal loans, utility bills, cell phone bills, and private student loans. However, federal student loans are not eligible for debt relief settlements.

    If you have secured loans like mortgages or auto loans, lenders may work with you by refinancing or reducing the interest rate you pay on your loan. However, it is unlikely creditors will accept a debt settlement for a secured loan because these lenders have the option of seizing your property to satisfy your debt instead of settling for less than the full amount owed.

  2. 2. Can you negotiate your own settlement with creditors?

    You always have the option to negotiate a settlement with your creditors on your own. You may find, however, that negotiating with creditors is a messy affair. It takes a great deal of time and patience to negotiate a settlement.

    Often, finding a debt relief company to do your negotiating for you will result in a better deal for you and a quicker resolution to your financial worries. Good debt relief companies know what works with creditors and are not timid when it comes to negotiating the best possible terms on your behalf.

  3. 3. How do debt relief firms negotate a debt settlement?

    Once you begin working with a debt relief firm to negotiate a debt settlement with your creditors, it is a good idea to let your creditors know the name and contact information of the debt relief firm. In some cases, this may stop the collection calls you receive from creditors, at least until they verify the information you provide.

    As your debt relief firm begins its work of negotiating with your creditors, the firm will require that you put a certain amount of money each month into a dedicated, FDIC-insured bank account. This bank account will be in your name, but it will be overseen by a trustee or account administrator.

    The goal of your debt relief firm is to lower the principal balance owed on your account. In some cases, debt relief firms can convince a creditor to accept up to 50 percent less than the amount you currently owe to settle your debt in full.

    After consulting with you about your current financial situation and your ability to make future payments, your debt relief firm will make a formal proposal outlining a settlement offer to each of your creditors. Your creditors then have the right to decide whether to accept or reject the settlement offer.

    It is important to remember that your creditors have no legal obligation to accept a settlement offer. However, some creditors are willing to negotiate if they feel that collecting the full amount owed is not likely to happen or if they feel that hiring a collections agency or pursuing litigation against you will cost more than they are willing to spend to handle the matter.

    Once a settlement agreement is reached, your debt relief firm will make sure that all agreements are in writing and signed by both you and your creditors. This ensures that there is no misunderstanding among all interested parties.

  4. 4. How long does debt settlement take?

    There is no set time-frame to settle a debt with creditors. Your debt relief firm will submit proposals to your creditors. Typically, your creditors will respond to these proposals within a few weeks, though some creditors may take more than a month to reply.

    The length of time it takes to pay your creditors depends on how much debt you owe and what the settlement agreement specifies. Once you have reached a settlement agreement with your creditors, your debt relief firm should be able to tell you exactly how long it will take to settle your debts according to the agreement.

    In most cases, debt relief firms try to help you get out of debt within two to five years. If that is not possible through debt settlement, you may need to consider bankruptcy as an alternative.

  5. 5. What effect does debt relief have on your credit?

    Even though debt relief is a way out of debt, it will have an adverse impact on your credit. Because you are not making regular payments to your creditors while your debt relief firm is in the process of negotiating your settlement, your payments will not be considered as current.

    The Federal Trade Commission (FTC) warns that your creditors can still charge late fees and penalties and pursue other collections options while your debt relief firm is working to negotiate a settlement for you. Additionally, the fact that you are settling your account for less than the full amount owed will most likely damage your credit score.

    Some credit card companies will report your agreement as a settlement to the credit bureaus. If that happens, the settlement will appear on your credit report for about seven years. It is permissible to ask your credit card company to report the settlement as "paid in full" instead. If the credit card company agrees to this, your credit scores will not be affected as much. While there is no guarantee that the credit card company will agree, it never hurts to ask for this consideration.

    It is a good idea to check your credit score periodically while you are enrolled in a debt relief settlement program. Check your score before entering into a debt relief settlement agreement, and then check it again after six months. At first, you may see your credit score dip considerably. In time, however, you should see your score begin to rise again as your debt relief firm begins to pay off your creditors.

  6. 6. What effect does debt relief have on your taxes?

    Depending on your total financial situation, the IRS may consider any savings you get from debt relief as income. Creditors can report a settled debt to the IRS. Since the IRS classifies settled debt as income, it is taxable.

    The exception to this is when the IRS considers you to be insolvent. The IRS will give you an insolvency exemption in cases where your total debts are more than the fair market value of your total assets. A tax professional can help you figure out if you meet the qualifications for an insolvency exemption.

Here are a couple of things to consider when looking for a debt settlement company.

Do they have minimum and maximum limits on the amount of debt you can enroll?

Most companies require you to have a minimum amount of debt, which is usually around $10,000. Some lenders, such as Freedom Debt Relief, accept lower amounts. Other companies also have a maximum amount of debt you can enroll, such as $100,000. You will need to find a company with requirements that match your needs.

What accreditations do they have?

There are two main trade associations in the debt relief services industry: the American Fair Credit Council (AFCC) and the International Association of Professional Debt Arbitrators (IAPDA). Members of these organizations must adhere to industry best practices and to the highest levels of operational compliance.

What is their customer service like?

We typically don’t care about the customer service of a company until we run into problems or have questions. It is important to find out ahead of time about the level and quality of support provided by a company. You can do so by researching the support channels they offer (phone, email, live chat, etc.) and by reading reviews from past customers. Look for companies like Debtmerica Relief and Rescue One Financial which are recommended by our community of users. Other debt settlement firms to consider are Pacific Debt and National Debt Relief.

Debt settlement alternatives

In addition to bankruptcy and debt settlement, there are other debt relief programs consider. These include debt consolidation, debt management plans, and balance transfers.

Debt consolidation

Debt consolidation involves combining debt from multiple sources into one loan, resulting in one easy-to-manage payment. Try to get an interest rate that is lower than the average rate of your previous debts. When done right debt consolidation loans can lower your interest payments and help you get out of debt faster. The drawback is that you may not qualify for a debt consolidation loan if your credit is in bad shape.

Balance transfer

If you have credit card debt, a balance transfer can be the fastest and cheapest way to pay it off. A balance transfer involves transferring a balance from one account to another to reduce the interest rate. It is typically a good option if you have a credit card with a high interest rate. You can potentially transfer the balance to a card with a 0% APR promotional period.

Debt management plan

Debt management plans (DMP) are typically created with the help of a credit counseling agency. The agency then presents the plan to creditors and requests lower interest rates and fees. Then, the debtor makes the payment to the agency, which pays the creditors. The plans typically last for four to five years.

Do It Yourself Debt Settlement

Do it yourself debt settlement allows you to negotiate with your lenders on your own behalf. You may be able to:

  • Reduce your overall debt
  • Save yourself from accruing further penalties and interest fees
  • Be debt free sooner than if you made the minimum payment each month
  • Avoid filing for bankruptcy

Do it yourself debt settlement isn’t for everyone. However, if you understand financial issues and feel comfortable negotiating with your creditors, it can be a way to get out of debt and save money.

Consumers Have Debt Collection Rights

Before you even start, understand that you have debt collection rights afforded you under the Federal Trade Commission (FTC). Debt collectors must:

  • Not contact you at inconvenient times or places, such as before 8 a.m. or after 9 p.m., unless you allow it.
  • Not contact you at work if they’re told (orally or in writing) that you’re not allowed to get calls.
  • Send you a written notice within five days of first contact to tell you how much money, the name of the creditor to whom you owe the money, and how to proceed if you don’t think you owe the money.
  • Not harass, oppress or abuse you or any third parties they contact.

Make sure you know your rights before you proceed. If a creditor violates your rights, you have the right to file a complaint with the FTC. Be sure to know the company name, representative name, company address and phone number, as well as dates, times, and topics of discussion.

Prepare to Make that Call

Before you make any calls to your creditors, have the most recent bill in front of you and follow these ten steps:

  • Negotiate a reasonable settlement. Lenders want their money. Naturally, they may refuse to settle, which is their right. However, once the negotiations begin, don’t be afraid to ask for more. Ask them to remove fees and penalties. If they offer three months at no interest, request six. Whatever you do, be honest, upfront, and courteous in all your dealings.
  • Make an upfront payment. As a good faith gesture, you may be required to pay at least half of the negotiated amount up front. So know how much you can reasonably afford.
  • Keep good records. Track the date, time, and each contact’s name along with the general overview of the conversation.
  • Ask to speak to someone in authority. Frequently when you call a lender, you wind up with someone in customer service or collections. They may have limited authority to negotiate. Supervisors are in a better position to negotiate a reasonable payment plan.
  • Put it in writing. If you find that even by speaking with a supervisor you cannot reach an agreement, consider putting your specific request in writing to someone in higher authority.
  • Get it in writing. Once you and your creditor have agreed to a settlement amount, request a letter of confirmation.
  • Clean up your credit report. To maintain your good credit, request that you creditor mark your credit record “paid in full.” They are not required to do so, but it doesn’t hurt to ask.
  • Make your payment on time. Once you have negotiated and agreed to a payment plan or lump-sum settlement, hold up your end of the bargain. However, do not feel compelled to offer your personal bank information for an automatic debit. Instead, send a money order.
  • Know when you need a lawyer. Because negotiations may not go your way, always have a backup plan. That may mean having access to a lawyer.
  • Know when to contact a debt settlement company. In the end, you may realize that going it alone is more difficult than you expected. Find a good debt settlement company to help.

Although debt settlement can take a load off of debt settlement, it is not for everyone. Here is a list of the benefits and the drawbacks of debt settlement.

  • Settle the debt for a percentage of the amount you owe.
  • Can typically resolve all debt in two to four years.
  • Only pay for services after debt gets resolved.
  • Repayment terms are typically better than with a Chapter 13 bankruptcy.
  • Avoid bankruptcy.
  • Heavily impacts your credit report for two to four years.
  • Collection agencies or creditors can continue to contact you.
  • Stays on credit report for seven years.
  • Negatively impacts your credit score.
  • You have to save up a lump sum.
  • You have to settle with each creditor.
  • Debt settlement takes a portion of your savings.
  • Remains on your credit history for 7 years.

Tips for finding a reputable debt settlement firm

  • Not all debt relief firms are reputable, so it is important to do your research before working with a debt relief company.
  • A good debt settlement company will clearly explain the services they offer, the fees they charge, and realistic expectations before they request your personal financial information.
  • The best debt relief firms focus on helping you avoid bankruptcy, stay out of debt, and reduce the number of collection calls you receive during the debt settlement process.

Your debt relief firm should:

  • Clearly explain fees and conditions associated with its services.
  • Explain how much money you will need to put into a dedicated bank account before the firm will begin negotiations with your creditors.
  • Explain how long it will take to get the results you need.
  • Explain the consequences of any settlement on your credit score and taxes.