Debt Negotiation Programs
Debt negotiation/debt settlement companies contact your creditors and attempt to negotiate a settlement of your debt for less than the full balance you owe. In recent years, this form of debt management has grown increasingly popular.
Debt Negotiation/ Debt Settlement
Creditors usually require a lump sum payment to settle a debt, so you will need to have either the means to pay a lump sum or be willing to enter into a monthly payment plan with a debt negotiation company. The debt negotiation company typically holds your payments in escrow and attempts to settle with your creditors once there is enough money available in your escrow account. The monthly payments you make to the debt negotiation/debt settlement company can be quite steep depending on the amount of your debt and the number of years of your debt negotiation plan, and you’ll probably have to rely on an estimate of the amount of money and payments needed to settle all of your debt. (The majority of programs have to be completed in 3-4 years.)
Be aware that there are no guarantees the debt negotiation firm will be able to reach a settlement with all of your creditors. Results vary for each individual. Most types of unsecured debts, particularly credit card debt, can be included in a debt settlement program. However, there is no way to force your creditors to accept the settlement you and the debt negotiation firm offer. You are merely asking your creditors to forgive a portion of your debt in return for payment of the remaining portion of the debt with a lump sum payment.
Why would a creditor choose voluntarily to accept less than what you owe? Because they realize that getting something is better than getting nothing. For that reason, they are likely to accept settlement offers from people with a lot of bad debt on their credit and who appear to be good candidates for bankruptcy. The creditors know that most unsecured debts are completely dischargeable in a Chapter 7 bankruptcy, and that they probably would not be entitled to any money should the debtor file bankruptcy because the vast majority of Chapter 7 bankruptcy filings are “no-asset” cases in which no assets are available to satisfy unsecured debt. When considering acceptance of your debt settlement offer, creditors may require that you provide them with documents showing your assets and income so they can determine whether to accept the settlement. There is always a danger when providing creditors with this sort of financial information because there is a possibility the information you provide could give the creditor a reason to sue you.
If a creditor accepts your debt settlement offer, you will typically end up paying 40-60% of the debt. Settling creditors usually require payment of the full settlement amount within a short period of time. Therefore, someone with $10,000 in debt and $6,000 available for payment of that debt in either their bank account or an escrow account with a debt negotiation firm may be able to settle their $10,000 debt with a one-time payment of $6,000, resulting in a debt reduction of $4,000. However, there can be tax consequences when you settle your debts, and the person in the example above could potentially be taxed on the $4,000 debt forgiven by the creditor. In addition, persons who utilize debt negotiation firms will also have to pay that firm a fee for their services.
Debt negotiation is a viable option and can help some individuals, but like many debt management options, there are firms who do not act in the best interests of their customers, and you should be very thorough in making sure you are working with a reputable firm.
The Pros and Cons of Debt Negotiation
|Significantly Reduces Debt
If you are able to offer a substantial lump sum payment to a creditor, you may be able to have up to 60% of your debt forgiven, particularly if you are able to demonstrate to the creditor that payment of 100% of your debt would be an extreme hardship.
|Once Paid, the Entire Debt Is Gone Forever
Your creditors will never be allowed to try and collect the portion of debt that was forgiven.
|Won’t Become Part of the Public Record
Arbitration and negotiation never become part of the public record, although they will be reported negatively on your credit report.
It is possible to enter into a debt negotiation plan with payments lower than what you would be paying if you were paying all the minimums on your credit card balances.
|End Creditor Harassment
If the debt is already in collection, the debt negotiation firm requires that the collector contact them in the future to discuss your debts. Most firms also request that your original creditors do the same, but they cannot force the creditors to do so.
|Damage to Your Credit Rating
A debt settlement will be reported on your credit report and may significantly lower your credit score (although settled debt is usually considered an improvement over a significantly past due debt on your credit report).
|Not All Debts Are Eligible
Some types of debts are not eligible for debt settlement programs. Student loans, taxes, auto loans, and mortgages typically are not eligible.
|Not All Creditors May Accept the Offer
Although some of your creditors may be willing to accept your debt settlement offer, it may be difficult to convince all of your creditors to accept the offer. Creditors’ internal policies towards debt settlement plans can differ greatly, and when you are dealing with a large number of creditors there is a significant likelihood that not all creditors will accept the settlement plan. Even if all of your creditors do accept the plan, they are still permitted to file a lawsuit if you are in default of the original terms of the plan.
|Possible Tax Consequences
The portion of the debt that is forgiven by your creditors may be counted as income and affect your tax liability. Consult with a tax specialist before entering into a debt settlement agreement.
|Creditor May Require Additional Documentation
Creditors may require detailed statements regarding your finances and assets to determine if you are eligible for their program. There is some risk in providing that information to creditors, who may be able to use the information against you in a lawsuit.
|Long Amount of Time to Obtain Relief
Typical debt settlement plans last 3-4 years, although plans can be completed much more quickly if you have a large amount of money saved before enrolling in the program.
|Debts Keep Increasing
Debt settlement firms typically advise you to stop sending money to your creditors, so it’s likely that additional late fees and interest will be added onto your total existing debt.
Consider Debt Negotiation If…
- Paying your debts back in full would be a verifiable hardship
- Your accounts are delinquent
- Your budget shows enough disposable income to afford monthly debt negotiation payments, or
- You are able to offer your creditors a lump sum payment