How Does Debt Settlement Really Work?

If you are struggling to pay off your credit card debt, medical bills, or other unsecured debt, you may be wondering if the advertisements you see on the TV, radio or the Web are for real. The main questions consumers ask are “Can I really get out of debt for a fraction of the cost and pennies on the dollar? Will debt settlement help me get out of debt quickly, legally and safely? What are the effects on my credit rating and future ability to get a loan?

Below you will see a variety of questions and answers that we wanted to share with you. These are among the most commonly asked. By reading on, it is our hope that you’ll be able to make an intelligent decision as to whether debt settlement is the right choice for you.
What Is Debt Settlement?

Debt Settlement (also referred to as debt negotiation, negotiated debt settlement or sometimes incorrectly called debt consolidation) means that your debt is negotiated down and paid off in a lump sum. In some rare cases, multiple payments are utilized to pay off the debt, settling the account in full. In most cases, when you hear that debt can be paid off for pennies on the dollar, you are being misled.

Settlement is one of the most effective choices available to consumers. It’s a great choice if you have more debt than you can pay off in a 2 – 3 year time frame or are experiencing a financial hardship that has you falling behind (or just about to be) on your monthly payments. Why would creditors choose to settle debts rather than simply charge you interest and late fees over and over again? Well, it’s really a matter of dollars and good sense. Creditors know that if you get into such a bad financial position that you can’t pay your monthly payments, you may decide to declare bankruptcy or simply do nothing. In this case they may get nothing! Therefore, they are usually very willing to settle for a lower amount, given your hardship, than risk getting nothing at all, especially with a bankruptcy among the alternatives.

Is Debt Settlement a Better Choice Than Bankruptcy?
Bankruptcy may allow you to eliminate most of your debts quickly and this is typically referred to as a “Chapter 7 Bankruptcy.” In other cases, you may be required to pay back a percentage of your debts over time. This is typically referred to as a “Chapter 13 Bankruptcy.” Bankruptcy also offers legal protection under the court so that you don’t have to worry about being sued or harassed by creditors while completing the bankruptcy process. While most reputable debt settlement firms will work to drastically and effectively minimize creditor calls and harassment, debt settlement does not provide the guaranteed legal protection that bankruptcy does.

Chapter 7 bankruptcy is not an option for everyone and it has gone through some changes since the bankruptcy reforms of 2005. Unlike the not so distant past, it has become more difficult to qualify for full liquidation (forgiveness) of your unsecured debts. Chapter 13 bankruptcy requires five years of court-ordered payments to a trustee, and may require you to surrender some of your assets.
However, as getting all of your options will help you make a more informed decision, speaking to a bankruptcy attorney may be a worthwhile discussion. Most reputable debt settlement firms can refer you to a trusted bankruptcy attorney if you have detailed questions or if they determine that you might be better served by speaking to them instead. Typically, if you are in such a financial state of hardship that you can’t even make your minimum monthly payment into our program, speaking to a bankruptcy attorney is highly recommended.

What Makes Me a Good Candidate for Debt Settlement?
There are a few factors that a well-trained debt specialist can go over with you in more detail. In general, if you can afford to pay back your debts on your own by paying more than the minimum payment every month without hardship, its probably the best route. It will not impact your credit score (and may improve it), and it will likely be relatively pain free. For those in true (or soon to be) financial hardship, debt settlement from a trusted and time-tested organization is a better option. If your total unsecured debt balances are less than $10,000, Consumer Credit Counseling is an excellent choice as your payments can be consolidated into just one, and typically, interest rates are reduced on your accounts. However, be warned. Many counseling programs have a very high drop out rate, can last up to 5-7 years, and you end up paying back 100% of the debt you owe, plus any new interest.

Will Debt Settlement Affect My Credit Score?
If you are current on your payments, it is very difficult, if not impossible to settle your debt. Creditors typically want to see that you are in a hardship situation before they are willing to negotiate. Therefore, you will have to voluntarily stop paying your unsecured debts; allowing them go into delinquency before settlement. In addition, you cannot pick and choose which debts you wish to settle in most cases. Your creditors and/or collections agencies may review your credit report, and most will be unwilling to negotiate when they see that they are being offered less than what is owed to them while others are being paid on time as agreed. Secured debts, such as a home loan or car loan are collateralized; you should continue to pay these accounts on-time to avoid repossession or foreclosure proceedings.

By not paying your creditors, your credit will be adversely affected by debt settlement. However, having to experience this circumstance is almost always better than dealing bankruptcy, especially on your credit rating. During your debt settlement program, your total balances are being lowered over time as they are settled in full - a great start to recovery! There is no reason why your credit shouldn’t rebound upon graduation from your debt settlement program. And while no reputable debt settlement firm should guarantee and form of credit score improvement, case studies of previous clients are a great way to see proven examples of the results experienced by consumers just like you.

Can I Just Settle My Debts By Myself?
If you have just a couple debts or under $10,000 in debt, you could to try to talk to your creditors directly to settle the accounts yourself. There is a lot of information publicly available to assist with this, but word to the wise: If you owe over $10,000 in debt, have several accounts you need to settle, or need the structure and the guidance of a knowledgeable professional, you should seek out the assistance of a knowledgeable debt settlement firm.

Debt settlement is by no means an exact science. And it’s difficult for an individual lacking experience with creditors to determine whether a settlement is fair or not. In addition, you have to directly handle all creditor calls and the harassment that comes with the job. Many people are simply unable or uninterested in handling that kind of pressure, especially with the daily complexities of managing a job, household or family at the same time.

Hiring a professional debt settlement firm with a good reputation can no doubt save you more money, give you better advice, and get you out of debt in a much less stressful manner, enabling you can move on with your life. Always make sure that you heavily screen who you are working with, and especially make sure that they are a fully accredited organization by a major industry association. TASC (The Association of Settlement Companies) is by far one of the most successful of these. Many if not most legitimate firms will at the very least be a member.

How Will Debt Settlement Affect My Taxes?
In general, in the United States, the IRS considers debt which is forgiven as income. This means if you borrow $15,000 on your credit cards and settle it for $8,000, the $7,000 difference is taxable as income since it is not repaid. However, the IRS will often waive this tax liability if you can show that you were insolvent during the time in which your debt settlement took place. We highly recommend a quick call to your accountant or tax professional for further discussion. You may be relieved with what they have to say!
There are always very clear and real responsibilities when dealing with debt, especially when you don’t pay back 100% of what you owe. However, once you can remove your debt problem from your life, a whole new world of opportunity can open up for you.
TASC’s Top 10 Frequently Asked Questions

TASC (The Association of Settlement Companies) wants you to understand both the potential benefits and pitfalls that may arise out of the debt settlement process and to have reasonable expectations regarding the outcome of your program. Below are the questions which TASC has laid out on its own in its efforts to successfully guide consumers to the most favorable outcome when enrolling in a debt settlement program. We wanted to also include them for you.

1. What is the goal of a debt settlement program?
When you enroll into a debt settlement program, the goal you have set is to negotiate mutually agreeable settlements between you and your creditor(s) for payment of certain unsecured debt(s) described as Enrolled Debts. No specific results can be predicted or guaranteed.

2. What are my responsibilities once I enroll in a debt settlement program?
You will be responsible for saving sufficient funds that you control to fund settlements that your debt settlement company will endeavor to negotiate on your behalf. You and only your will be in control of all settlement funds. Under no circumstances will your debt settlement company have custody or control of the funds you set aside to fund debt settlements.

3. How much will I be expected to save towards my debt settlements?
The savings plan you are expected to follow will be detailed in your Client Agreement. Summaries of the total settlement amount, monthly savings, and the period needed to reach your goal will be prepared based on the goal you select. Those summaries reflect the minimum amount that your debt settlement company has estimated you will need to save to put yourself in a position to reach your goals. Actual settlement amounts, necessary savings and the period required to reach your goal may vary based on creditors actions and other factors.

4. Will all of my creditors and collectors negotiate with debt settlement companies?
Most creditors and collectors negotiate with debt settlement service providers. Debt settlement companies cannot force the negotiations and cannot force creditors to accept a settlement. Debt settlement companies do not make regular monthly payments to your creditors. Your creditors may continue collection efforts on delinquent accounts while you are enrolled in a debt settlement program. Such collection efforts can include phone calls and letters to you, charging off the account, sending accounts to collection agencies or attorneys, lawsuits and even garnishments of your wages if a judgment has been obtained. Debt settlement companies should not claim that they will be able to stop these collection activities as these activities may continue while the company is making its best efforts to negotiate your debt.

5. How long does a debt settlement program last?
Debt settlement programs assume an effort that will continue for many months. The time needed to produce a settlement depends on a number of factors. These may include: (a) your financial hardship, (b) the age and balance of the accounts that you owe your creditors, c) the funds you have available to pay for a settlement and (d) the willingness of individual creditors to enter into debt settlement negotiations. While no guarantees can be given, generally the quicker you save money the sooner you will be in a position to reach your goals. Increased savings will provide you with the option to accept lesser discounts and will also enable you to accumulate funds to reach your debt settlement goals more quickly. However, any settlement must be acceptable to both you and your settling creditor.

6. What do the debt settlement company’s fees cover?
The fees paid to debt settlement companies are intended to compensate the company for its efforts and will only be refundable to the extent they have not been deemed to have been earned in the manner described in the Client Agreement. Debt settlement program fees are not being set aside or held in escrow to fund debt settlements.

7. When does the debt settlement company communicate with my creditors?
Communications with the creditors are handled on a case by case basis. In some instances creditors may not be contacted until several months after you enroll.

8. What will happen to my accounts while I’m in a debt settlement program?
Upon enrolling in a debt settlement program, you are stating that, because of circumstances beyond your control (hardship), you are unable to meet the minimum payments required by your creditors. If you do not make required minimum payments to your creditors, you may be breaking the terms of your agreements with them. Your actions will probably be reported to consumer reporting agencies as late, delinquent, charged-off or past due balances. Your creditor may also raise the interest rate on your account and impose other penalties. Your account balance may continue to grow as your creditor adds accrued interest, late fees, over limit fees and penalties. Your balance may continue to grow until a settlement is reached with your creditor; and, if negotiations are unsuccessful, you could be called upon to pay the entire balance. After settlement your creditor may comment that the account was “settled for less than the full amount” on your credit report. A Debt Settlement Program may have an adverse effect on your credit report and credit score.

9. Is the amount I save on each of my settlements taxable?
When your creditor settles your debt, a savings of $600 or more off what you owed may be reported by your creditor to the IRS as Discharge of Indebtedness income. You may wish to consult your tax advisor to determine whether your individual circumstances may permit you to exclude any such Discharge of Indebtedness Income from your reportable income due to insolvency. For more information on tax ramifications to you personally you may also wish to consult a CPA or Tax Attorney and to refer to the IRS website www.irs.gov IRS Publication 908- “Bankruptcy Tax Guide” and IRS Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness available on the IRS website.

10. Can a debt settlement company provide legal advice?
No, debt settlement companies are not law firms and cannot provide legal advice.