If creditors are receiving regular, monthly payments they have no incentive to negotiate a reduced balance. When the debtor can no longer make the payment, because of layoff or medical hardship, creditors are more open to negotiation. The balance owed is still growing from late charges and interest fees, and nothing is coming in. At this point, creditors are concerned about getting any of their money back.
There are many avenues for debt relief a consumer can take. He can research advice from websites, hire attorneys or hire credit counseling or debt settlement agencies. Debt settlement companies work in one of two ways: They either take a fee up front, or take a percentage of the monthly installment the debtor makes to a savings account used to negotiate lump sum payments. The second option can reduce the incentive to pay off creditors quickly. One expert advises consumers to look for companies that charge only after a settlement is made, and charge about 20 percent of the amount by which the outstanding balance is reduced.
The concept of settling debt has been around for thousands of years. It became very prominent during the late 1980s and 1990s as a player in the financial world of America. Because of bank deregulation and the following economic recession, consumers who had borrowed extensively were placed in financial hardship. Banks established special departments staffed by personnel authorized to negotiate with defaulting cardholders, to staunch the loss caused by charge-offs. Their goal was to recover funds that the bank would lose if the debtor filed for Chapter 7 bankruptcy. Typical settlements ranged between 25 and 65 percent of the outstanding balance.
In 2005, new bankruptcy legislation was passed that made the situation even worse for the average American. This legislation includes an Internal Revenue Service (IRS) “means test.” If the debtor fails this test, Chapter 7 is not an option and they must file Chapter 13, which requires they pay anywhere from one to 100 percent of their debt, in payments determined by the court, using guidelines from the IRS. Repayment periods are 3 years for those BELOW median income and 5 years for those ABOVE! So, the less you earn, the shorter the time period to pay off your debts. Penalties for failing to meet the court mandated budget can be severe.
How it works
A debtor finds a reputable debt settlement company, and that company negotiates with creditors on their behalf. The debtor stops making payments to the creditor, and instead puts those payments in a savings account. When the balance of this account has grown to a large enough amount, the settlement company contacts the creditor and negotiates a lump sum payment. They reduce the overall debt for the debtor, and the creditor is assured that the debtor will not file bankruptcy, in which case the creditor stands to lose it all.
Only unsecured debts can be handled this way. Student loans, mortgages or auto loans cannot. Recently student loans have been enabled to attach wages, even those that are not federally funded. Student loans are exempt from Chapter 7 bankruptcy protection as well. Some individual creditors, like Discover Card, tend to strongly resist negotiations. Tax liens and domestic judgments are also exempt from debt settlement.
The drawbacks are these: Credit reports will show evidence of debt settlement, and FICO scores will drop. There is a possibility of lawsuits whenever debts are unpaid. The type and amount of specific debts may affect the success of negotiations. Tax liens and domestic judgments are also exempt from debt settlement.
It is not in the creditors interest to force borrowers into bankruptcy, because they may receive governmental protection against all debts.
Debt Settlement Companies
When a consumer enters debt settlement, his best case scenario is to have a lump sum with which to pay off his creditors. This can be taken from a 401K, especially if the interest earned is less than the interest charged on the unsecured accounts. A savings account, a second mortgage, or family members are also good options for this lump sum.
The second option is to build up the funds gradually over time. When enough funds are saved, the negotiation process begins with each creditor individually. Debt settlement companies usually settle with the credit card company for an average of 35%-50% of the existing balance. The account can be kept by the credit card company, or they can sell it to a collection agency. If this occurs, the collection agency has paid an average of $0.034 for the debt, and it can still be negotiated.
Debt settlement companies have built relationships with the staffs of credit card companies over the course of daily business, and settlement agreements are often very fast. When the debtor has paid the agreed settlement, the debt settlement company takes a percentage of the savings of the forgiven debt as the fee.
Creditors want to recover their money. If a debtor chooses to enter bankruptcy and is approved for Chapter 7, they will recover nothing. Even in Chapter 13 they may not recover 100% and it will add potential years to the payoff time. They can often recover more through other collection procedures. Collection agencies and attorneys charge high commissions on anything they recover, often up to 40%. When a creditor gives up on internal collection they often sell a group of debt, or portfolio, to a bad debt purchaser for between 1 and 7 cents on the dollar. Given the other options, debt settlement, at an average of 50% of the original debt, is very attractive to creditors.
In our present economy, many more credit card companies may be willing to settle debts rather than add to their huge charge-offs.
If debt settlement may be best for you, there’s NEVER been a better time to get out of debt!