The average American household has more than $15,000 in credit card debt. Many of these families struggle to make the minimum monthly payments, and some use plastic to cover daily living expenses such as groceries, transportation costs, and medical copays. Despite improving economic conditions, more and more credit card users are receiving phone calls and letters from creditors informing them that their payments are not 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 in which negotiators contact creditors on your behalf to settle your debts at reduced, agreed-upon amounts. Only unsecured debt (credit cards, medical bills, and personal loans) can be negotiated. You cannot pay off 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 settlement team opens a trust account for you. You must deposit up to 50% of your unsecured debt in the account over a period of 24 to 60 months. This money is used to settle your debts with creditors. Because the average debt settlement company 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 firms use a third-party escrow service to “store” money that they will later use to finance the settlements they negotiate for you. The most common escrow company is Global Client Solutions. Sending money to your trust account is usually done via ACH on the same day each month. If your checking account is at a bank where you also have an overdue loan or credit card balance, it is suggested that you use a different bank for your debt settlement program.
Here are three things a debt arbitration company should tell you before you sign up for their program:
1. You must be given a written “initial estimate” of all costs associated with paying off your debts at agreed-upon, reduced amounts.
2. You must be given an “estimated time frame” to reduce your debt.
3. You should be told that debt settlement can negatively affect your credit score.
Here are some examples of what a debt settlement company can’t tell you:
“We can eliminate 50-70% of your debt.”
“We can pay off your debt at pennies on the dollar.”
“We can cut your debt in half.”
“Debt settlement will not affect your credit score.”
“The 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 no longer have to contact your creditors.”
If you’re considering debt settlement, here’s what you need to know first:
1. Debt settlement will not solve your careless spending and saving habits. The only way to achieve lasting financial freedom is by applying the dynamic laws of financial recovery to your everyday life. These smart money principles will help you establish spending and saving habits that are built on a solid foundation. They are discussed in a separate article titled “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 arbitrage, takes your credit cards and high-interest loans and consolidates them into one low-interest loan that you can afford. In other words, you are taking out a loan to pay off many others. Bill consolidation does not reduce any outstanding balances you owe to creditors. It only lowers your interest rates.
3. One of the main reasons people choose debt arbitration is to avoid filing for bankruptcy. Here are five reasons why the consequences of bankruptcy can be overwhelming:
Bankruptcy stays on your credit report for 10 years and negatively affects your credit score.
Bankruptcy will follow you for the rest of your life. For example, many loan, credit card, and employment applications ask if you have ever filed for bankruptcy.
Bankruptcy cannot eliminate alimony and child support obligations, as well as criminal penalties.
Except in very limited circumstances, bankruptcy cannot wipe out student loans.
Bankruptcy cannot prevent a “secured creditor” from repossessing the property. According to Nolo.com: “The 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 recover it if you don’t pay the debt), bankruptcy may 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’s why: With debt settlement, your unsecured debt is reduced by up to 50% and you won’t have to pay additional interest on the remaining balance. This is not the case with bill consolidation, where there is only a reduction in interest rates. As a result, a debt settlement program may have a shorter payment term than a bill consolidation program.
5. There is no public record that you have paid off your debts.
6. With debt arbitration, reduced balances appear as “paid in full” or “paid as settled” on your credit report.
7. Debt settlement negatively affects your credit score.
8. Never let a debt settlement company pressure you to join their program.
9. Do not hire a company that has no interest in your specific financial needs.
10. Before you sign up for a debt settlement program, carefully review your budget and make sure you can afford the monthly payments. Don’t be surprised if you have to eliminate certain non-essential expenses.
11. During the debt settlement process, calls and letters from creditors may continue. Enrolling in a debt settlement program does not automatically stop “legal collection activities.”
12. Debt arbitration can be a gamble because some creditors may refuse to negotiate. In such cases, you are responsible for paying the outstanding balance on the creditor’s terms.
13. As mentioned above, only unsecured debt such as credit cards and personal loans can be negotiated at reduced amounts. You cannot pay off mortgages, rent, utilities, cell phone and cable bills, insurance premiums, car and student loans, alimony, child support, taxes, or criminal fines.
14. You may suffer tax consequences. For example, if you owe $25,000 and you accept $15,000, the difference of $10,000 is considered taxable income. The creditor must send you a 1099-MISC reporting a “debt income discharge.”
15. A debt settlement company cannot represent you in court unless it is also a law firm.
16. Debt arbitration cannot prevent foreclosure on your home or 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 sign up for a debt settlement program, do your homework. You’re making a big decision that involves spending a lot of your money that could be used to pay off your debt. Enter the name of the company name with the word “complaints” in a search engine. Read what others have said about the companies you are considering, including if they are involved in a lawsuit with any state or federal regulator 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 people, families and companies does the company advise each year?
2. Are you assigned to an experienced financial advisor to ensure your debt settlement program runs smoothly from start to finish?
3. Is the debt arbitration firm a member of the Online Business Bureau as well as your local BBB? What are your qualifications with both offices? What kind of complaints have been made about your services?
4. Is the company an active member of TASC, (The Association of Settlement Companies). TASC requires all of its members to maintain a strict set of standards when doing business with consumers and businesses.
5. Is the debt arbitration firm a member of Dun & Bradstreet, the world’s authoritative source for business information?
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 reduce your debt, it does not teach you how to live fiscally. The only way to achieve lasting financial freedom is by applying the dynamic laws of financial recovery to your everyday life. These smart money principles will help you establish spending and saving habits that are built on a solid foundation. They are discussed in a separate article titled “The Dynamic Laws of a Successful Financial Makeover.”
