The average American household has over $15,000 of credit card debt. Many of these families are struggling to make the minimum monthly payments, and some are using plastic to cover daily living expenses such as groceries, transportation costs, and medical co-pays. Despite improving economic conditions, more and more credit card users are receiving phone calls and letters from creditors that their payments are past due.
If you have too much debt and stress, now is the time to stop this destructive cycle and get the help you need from a debt reduction program. This article teaches you the principles of debt settlement, one of the most popular forms of debt relief.
What is debt settlement?
Debt settlement–also known as debt arbitration, debt negotiation, or credit settlement–is a debt relief approach where negotiators communicate with creditors on your behalf to settle your debts to reduced and agreed-to amounts. Only unsecured debt-credit cards, medical bills, and personal loans-can be negotiated. You cannot settle mortgages, rent, utility bills, cell phone and cable charges, insurance premiums, car loans, student loans, alimony, child support, taxes, or criminal fines.
Once you enroll in a debt settlement program, your negotiation team opens a trust account for you. You must deposit up to 50% of your unsecured debt into the account over a period of 24-60 months. This money is used to settle your debts with creditors. Because the average debt settlement firm is for-profit, you must also pay the company a 15-25% service charge. This fee is based on the original amount of your unsecured debt or the amount negotiated, depending on the debt settlement company.
Most debt arbitration companies use a third-party escrow service to “warehouse” the money that they will later use to fund the settlements they negotiate for you. The most common escrow company is Global Client Solutions. Sending money to your trust account is generally done through ACH on the same day each month. If your checking account is with a bank where you also have a past-due loan or credit card balance, it is suggested that you use a different bank for your debt settlement program.
Here are three things that a debt arbitration company must tell you before you enroll in their program:
1. You must be given an “upfront estimate” in writing of all costs associated with settling your debts to reduced and agreed-to amounts.
2. You must be given an “estimated timeframe” to reduce your debt.
3. You must be told that debt settlement can adversely affect your credit score.
Here are some examples of what a debt settlement company cannot tell you:
“We can eliminate 50-70% of your debt.”
“We can settle your debt to pennies on the dollar.”
“We can cut your debt in half.”
“Debt settlement will not affect your credit score.”
“Calls and letters from creditors will stop once you enroll in a debt settlement program.”
“Debt settlement does not affect your taxable income.”
“Once you join a debt settlement program, you will no longer have to communicate with your creditors.”
If you are considering debt settlement, here is what you need to know first:
1. Debt settlement will not solve your careless spending and savings habits. The only way that you will ever achieve lasting financial freedom is to apply the dynamic laws of financial recovery to your everyday life. These smart-money principles will help you to establish spending and savings habits that are built on solid bedrock. They are discussed in a separate article entitled “The Dynamic Laws of a Successful Financial Makeover.”
2. Debt settlement should not be confused with bill consolidation, another form of debt reduction. Bill consolidation-also known as interest-rate arbitration-takes your high-interest credit cards and loans and consolidates them into one, low-interest loan that you can afford. In other words, you’re taking out one loan to pay off many others. Bill consolidation does not reduce the outstanding balances that you owe to creditors. It only lowers your interest rates.
3. One of the primary reasons that people choose debt arbitration is to avoid filing for bankruptcy protection. Here are five reasons why the consequences of bankruptcy can be overwhelming:
Bankruptcy stays on your credit report for 10 years and adversely affects your credit score.
Bankruptcy will follow you for the rest of your life. For example, many loan, credit card, and job applications ask if you have ever filed for bankruptcy protection.
Bankruptcy cannot eliminate alimony and child support obligations as well as criminal fines.
Except in very limited circumstances, bankruptcy cannot wipe out student loans.
Bankruptcy cannot prevent a “secured creditor” from repossessing property. According to Nolo.com: “A bankruptcy discharge eliminates debts, but it does not eliminate liens. So, if you have a secured debt (a debt where the creditor has a lien on your property and can repossess it if you don’t pay the debt), bankruptcy can eliminate the debt, but it does not prevent the creditor from repossessing the property.”
4. If your unsecured debt is $10,000 or more, debt arbitration could save you more time and money than bill consolidation. Here is why: With debt settlement, your unsecured debt is reduced by up to 50% and you will not have to pay added interest on the remaining balance. This is not the case with bill consolidation, where is there is only a reduction in interest rates. As a result, a debt settlement program can have a shorter repayment term than a bill consolidation one.
5. There is no public record that you have ever settled your debts.
6. With debt arbitration, reduced balances appear as “paid in full” or “paid as settled” on your credit report.
7. Debt settlement adversely affects your credit score.
8. Never let a debt settlement company pressure into joining their program.
9. Don’t hire a company that has no interest in your specific financial needs.
10. Before you enroll in a debt negotiation program, review your budget carefully and make sure that you can afford the monthly payments. Don’t be surprised if you have to eliminate certain nonessential expenses.
11. During the debt settlement process, calls and letters from creditors might continue. Enrolling in a debt settlement program does not automatically stop “lawful collection activities.”
12. Debt arbitration can be a gamble because some creditors might refuse to negotiate. In such cases, you are responsible for paying the outstanding balance on the creditor’s terms.
13. As we mentioned above, only unsecured debts such as credit cards and personal loans can be negotiated to reduced amounts. You cannot settle mortgages, rent, utilities, cell phone and cable bills, insurance premiums, car and student loans, alimony, child support, taxes, or criminal fines.
14. You might suffer tax consequences. For example, if you owe $25,000 and settle for $15,000, the $10,000 difference is considered taxable income. The creditor must send you a 1099-MISC reporting a “discharge of indebtedness income.”
15. A debt settlement company cannot represent you in court unless it is also a law firm.
16. Debt arbitration cannot prevent the foreclosure of your house or the repossession of your car.
17. Despite warnings from the Federal Trade Commission (FTC), some debt settlement companies still engage in unfair business practices. The Federal Trade Commission advises: “Before you enroll in a debt settlement program, do your homework. You’re making a big decision that involves spending a lot of your money that could go toward paying down your debt. Enter the name of the company name with the word ‘complaints’ into a search engine. Read what others have said about the companies you’re considering, including whether they are involved in a lawsuit with any state or federal regulators for engaging in deceptive or unfair practices.”
Here are some factors to consider when choosing a debt settlement company:
1. How long has the company been in business? How much consumer and business debt does the company manage each year? How many individuals, families, and businesses does the company counsel each year?
2. Are you assigned to an experienced financial counselor to ensure that your debt settlement program flows smoothly from start to finish?
3. Is the debt arbitration company a member of the Online Business Bureau as well as their local BBB? What are their ratings with both bureaus? What kinds of complaints have been made about their services?
4. Is the company an active member of TASC, (The Association of Settlement Companies). TASC requires that all of its members maintain a stringent set of standards in doing business with consumers and businesses.
5. Is the debt arbitration company a member of Dun & Bradstreet, the world’s source authority for business insight?
This article has taught you the principles of debt settlement, one of the most popular forms of debt relief. Although a debt arbitration program can help you to reduce your debt, it does not teach you how to live fiscally fit. The only way that you will ever achieve lasting financial freedom is to apply the dynamic laws of financial recovery to your everyday life. These smart-money principles will help you to establish spending and savings habits that are built on solid bedrock. They are discussed in a separate article entitled “The Dynamic Laws of a Successful Financial Makeover.”
Gregory DeVictor is a financial consultant and professional writer. He has published over 100 e-books and articles on debt reduction, money management, and financial planning. Gregory is also affiliated with CuraDebt, one of America’s leading debt relief companies. Over the years, he has helped hundreds of consumers to get out of debt and achieve financial freedom.