The Basics of Debt Settlement

Debt Settlement

Debt settlement is a process through which a debtor and creditor reach a mutually acceptable agreement on a single lump sum payment lower than the total amount owed, that will (usually) be considered by the creditor as payment in full for the entire outstanding balance of the loan.

The availability and use of credit cards has grown exponentially in recent decades. It is not surprising that the largest portion of debt settlement negotiations involve unsecured credit card debt.

Debt Settlement Rational

The theoretical rationale behind the debt settlement process is simple. If a creditor has no reasonable expectation of receiving full repayment of a debt obligation because of unforeseen changes in the debtor’s ability to make scheduled payments, acceptance by the creditor of a good faith offer from the debtor to pay at least a portion of the outstanding balance in a lump sum may create real benefits for both parties. The creditor benefits by reducing total loss exposure and receiving an immediate cash infusion. The debtor benefits by improving his or her ability to meet the costs of daily living without incurring additional debt obligations.

The “Cons” of Debt Settlement

  • The debtor’s failure to pay the original debt obligation in full will damage the debtor’s credit rating, and may impair his or her ability to raise capital for legitimate purposes for up to seven years.
  • The debtor, already in financial straits, must find a way to raise a sizable lump sum of money. The cost of raising the lump sum payment can be high, and may divert available resources from other critical uses.
  • The creditor’s balance sheet is impacted by both the loss of the loaned capital, and the loss of anticipated interest income.
  • The creditor also bears the cost of maintaining professional staff qualified to assess the validity of debt settlement requests, and negotiate equitable settlement terms.

Approaches to Debt Settlement

The first decision facing an individual seeking a debt settlement agreement is whether to seek professional assistance or go it alone. Professional assistance can be expensive, and is not a guarantee of success. You may be best off working on your own behalf if:

  • You have a good to excellent credit history
  • You have suffered from a clearly unanticipated change in circumstances (such as a disabling injury)
  • You currently have access to funds from savings or insurance from which to make a reasonable lump sum offer
  • Your overall debt obligations so far exceed your expected future income that a reasonable debt settlement specialist would be sensitive to the advantages of accepting a reasonable “good faith” offer while such an offer remains a possibility

If you are dealing with a major credit card company, and you think you meet the above qualifications, simply dial the customer service number on the back of your credit card, and ask to speak with someone from the settlement department. If your intention is to achieve the best possible win-win resolution of the problem you and your creditor share, you should expect to be treated with courtesy and respect. You may not get exactly the settlement you had hoped for, but considering the savings in time and dollars over the use of a professional service, going it alone may be the best approach for you.

If you choose to use the services of a professional debt settlement company, be aware that the quality and cost of professional services vary widely. Be a wise consumer. Investigate two or three area firms. Get and check references before signing any contract. Look for a larger company that has been in business long enough to have established good working relationships with major credit card companies.

Debt settlement companies can provide an especially useful service for debtors who do not have immediate access to the lump sum payment the creditor will require. The settlement company may establish an FDIC insured special-purpose savings account on behalf of the debtor, and in some cases, the settlement company may supplement accrued savings with loaned funds to achieve the required lump sum payment as quickly as possible.

An established debt settlement company will also be in a position to advise you on the best settlement terms you can reasonably expect.

A few final thoughts

  • Your final debt settlements agreements may end up covering a portion of the outstanding debt – not the entire debt you had hoped for.
  • Credit card companies may also elect to offer lower interest rates or longer payment terms rather than the hoped for debt forgiveness.
  • And, to add insult to injury, if your settlement agreement does result in debt forgiveness, and you own assets such as a family home, a boat, or investment securities, you may need to report all or a portion of the forgiven loan amount as income on your next federal tax return. See IRS Publication Form 982 for the exciting details.

There are undoubtedly times when a debt settlement agreement can make a huge difference to an individual or family that has experienced an unexpected misfortune. For the undeserving, however, the process is unlikely to be an enjoyable experience.