According to the Federal Reserve, credit card debt in the U.S. is at $960.8 billion. Fifteen percent of American households carry over $10,000 in credit card debt alone (source). So, if you are swimming in an ocean of debt, you have company.
But what happens when you are no longer swimming? What if you are sinking instead? If your debts are no longer manageable, you may need to start thinking seriously about some form of debt settlement to get your finances back on track.
How does debt settlement work?
Debt settlement is a process in which you offer your creditor less than what you owe to pay your debt in full. For instance, suppose you owe your credit card company $12,000. Because of circumstances beyond your control, you cannot afford to pay $12,000. You may even be hard pressed to pay your minimum monthly credit card bill. If things are really tight, you may be missing payments or making late payments often. With a debt settlement, you could offer your credit card company a lump-sum payment of $7000, with the provision that the credit card company will forgive or erase the rest of the debt and mark your account as paid.
In some cases, your credit card company may agree to this. Why? Simply put, the company may decide that you are likely to default completely on your outstanding balance, which would mean that the company would not be able to collect any of the money you owe without a lengthy and potentially costly legal collections process. Even worse for the credit card company, you might file for bankruptcy, making it highly unlikely that the company will recoup any of the money you owe. It is often the threat of impending bankruptcy that encourages your creditors to work with you via debt settlement.
Something is always better than nothing. Your creditors may decide that the old adage is true: “A bird in the hand is worth two in the bush.” If your creditors are convinced that you will not or cannot pay your full debt amount, they will be more likely to accept pennies on the dollar as repayment. That is the premise of debt settlement.
What is a debt settlement program?
If you do not know how to negotiate on your own behalf or if you just want someone else to negotiate for you, you may choose to work with a debt settlement company. Once you hire such a company, you will be enrolled in a debt settlement program.
Here is how a typical debt settlement program works:
- Your debt settlement company will ask you to stop making payments to your creditors.
- An account will be set up in your name into which you will make deposits. The money that accumulates in the account will be used by your debt settlement company to negotiate with your creditors.
- Once you have a sufficient amount of money built up in the account, your debt settlement company will begin the negotiation process.
- When your creditors agree on the proposed settlement, your debt settlement company will transfer the funds from your account to your creditors and your creditors will close your outstanding debt account.
This process does not happen overnight. On average, it may take 2 to 4 years for your debts to be settled. However, compared to how long it would take you to pay off the full amount you owe on credit cards by only making minimum payments, 2 to 4 years is a small amount of time.
What are the drawbacks of debt settlement?
Not everything about debt settlement programs is rosy. There are a few disadvantages to this approach. First, your creditors are under no obligation to settle with you for less than the full amount you owe. So, there is a chance that your debt settlement program will not handle all your unsecured debt.
Additionally, debt settlement programs do not handle any type of debt secured by collateral, meaning that you will still owe the full amount for any secured loans. Even when successful, debt settlement hurts your credit because it impacts your payment history adversely. Since your debt settlement company will advise you to stop making payments while they negotiate with your creditors, you will be racking up late fees and penalties, which have a negative effect on your credit.
You may still receive some unwanted calls from collections agencies or creditors until a settlement has been reached. Your creditors may also initiate garnishments to collect amounts due. Lastly, once a settlement is reached, you may be taxed on the amount of your debt that is written off by your creditors. Depending on what that amount is, your tax liability could be significant.
How is your debt settlement amount determined?
Since a debt settlement is negotiated between you or your debt settlement company and your creditors, there are no rules set in stone regarding how much of a settlement you may be able to negotiate. The final amount of your debt settlement is decided between you and your creditors.
Historically, most unsecured creditors will settle for around 30 to 50 percent of the debt. (source) It is important to know this going into your negotiations, since you do not want to offer more than actually needed to satisfy your creditor.
How can you negotiate with your creditors for a lower debt settlement?
When you decide to negotiate a debt settlement, there are some general rules of negotiation to remember.
First, you must remember that the process takes time and effort. It would be a rare occurrence to come to an agreement on your first try. Creditors are in no hurry to accept less than the full amount for your account, so you will have to be assertive if you choose to negotiate on your own. While you do not want to be rude, you do want to be firm when discussing your circumstances. Even though you are distressed by your financial situation, try to avoid being overly emotional when you talk with your creditors.
Before you make contact with your creditors, have all your facts straight. Review your monthly expenses and income. Based on that, figure out how much you can reasonably afford to pay your creditors. During the negotiation process, remember that it is your job to get the best possible settlement for you. Conversely, it is the job of your creditors to get the best possible settlement for them. Likely both parties will have to give a little. The trick is to make sure that you give the right amount for your best interests.
The thing your creditors most fear is that you will file for bankruptcy. Thus, it is a good idea to use that knowledge to your advantage. Hinting at the possibility of bankruptcy as a solution to your financial hardship will likely make your creditors pay a little more attention to your offer. The more convincing you can be about the financial hardship you are experiencing, the more likely your creditors are to work with you to find a solution.
Since the average debt settlement ends up at anywhere from 30 to 50 percent, you will want to make your first offer on the low side to give yourself some wiggle room. For instance, if you owe $10,000, you might offer $2000 as a starting point. Your creditor will likely refuse your offer, but you can always work your way up as you make counteroffers. It never hurts to start small.
What can you do if you need help to get the best debt settlement agreement possible?
If you do not have the time, patience, or skill set for great negotiations, you can always negotiate through a debt settlement company. There are significant advantages to doing so.
- Debt settlement companies employ professional negotiators who have experience in negotiating even in challenging circumstances.
- They will not be intimidated by your creditors.
- They will not respond emotionally to the situation.
- They will focus on saving you the most amount of money and will bring all their expertise to bear on your behalf.
- If they have been in the industry for more than just a short while, they most likely will already have relationships with major credit card companies and other major creditors.
- They understand fully how the negotiating process works for each creditor.
Once an agreement is made, your debt settlement company will also ensure that it is put in writing and properly signed and executed by both you and your creditors. This eliminates any legal problems down the road and provides you with added peace of mind.