How Does Debt Settlement Work

how does debt settlement work
by LSE Library

How Does Debt Settlement Work

Debt settlement companies exist to help people clear debt, they charge a fee up front and will negotiate with your creditors to achieve much reduced settlement figures that can save you up to 60% of your debt, except that it is never really 60% as you will find out later on. Debt settlement companies always use the same pattern or steps during the settlement process as they are pretty much standard throughout the industry, below is an example of how the settlement process works:

Credit card debt settlement: Example;

A debtor has a debt of $ 50,000 over four credit cards and is struggling to make even the minimum payments each month. A credit counseling service has already attempted negotiating with the creditors but the reduced payments were still too high for the debtor to pay. Bankruptcy is an option, but the debtor does not wish to go down this route as it will destroy his/her credit rating for at least the next seven years, nor does the debtor want to go to court, which would be inevitable if this path was chosen.

Another option, and the one the debtor opts for, is to work with a credit card debt settlement company who advises that the following four steps are taking in order to get rid of the $ 50,000 credit card debt:

Refrain immediately from making any further payment to creditors: The debt settlement company asks the debtor to stop paying his/her creditors with immediate effect and instead to start depositing a set amount each month into a trust account created by the company.

Collection calls are passed on: Once payments begin to get behind the credit card companies will start to call the debtor with requests for payments these are effectively passed on to and handled by a representative from the debt settlement company.

Negotiation begins: As money is continually being paid into the trust account, the debt settlement company representative will begin negotiations with the creditors.

Settlements of between 40-60% are acquired one by one: Part of the negotiation process is getting the credit card companies to accept the fact that the debtor cannot afford to pay the individual debts in full and as a result they agree to accept a much reduced amount, often between 40% to 60% of the outstanding debt.

These settlements do not happen all at once, but as they do the debtor is able to pay them off using the money deposited in the trust account.

It is important however, that any extra funds the debtor finds are deposited into the trust account also. It is completely possible that this debt could be completely cleared in as little as two years, depending on how successful the negotiations have been.

It is irrespective whether it is a credit card debt settlement program or one that includes other forms of debt the initial thing you should do is to stop paying your creditors and forward payments to your debt settlement company instead, without doing so you risk not having funds in place when an agreeable settlement is offered.

There are certain debts that you can be settled with these techniques and those that can’t as they are excluded from settlement programs:

Debts that can be settled:

• Unsecured Credit card debt

• Medical Bills

• Gas/store cards

• Personal loans

• And basically anything credit that is unsecured

Debts that can’t be settled:

• Tax debts

• Alimony,

• Child support,

• Mortgages,

• Car loans

• Student Loans that are covered by federal insurance

How much can I expect to pay for a settlement service like this and how long will it take to clear my debt?

The usual fee that a debt settlement company charges is based upon the size of your debt, the number of accounts that are being settled and the amount you will actually save through the settlement company’s efforts. It usually equates to between 25-35% of the balance that is forgiven by the creditors.

Therefore, if we use the example above and the debtor saved 50% and the settlement company charges 25%, the charge will be $ 6250. This would mean that the actual settlement saving to the debtor is around 32%.

The whole process can take as little as 2 years but could extend to 4 years, but this is mainly dictated by the size of the debt being settled.

Once my debt is cleared is it really…cleared?

Generally, once both sides have agreed upon a settlement and the debt has been paid off, as per the agreement, most creditors will not pursue you for the remaining balance. However, in certain states creditors still retain the right to sue under certain conditions. It is prudent to find out whether suing after settlement is illegal or not in your state.

And finally, two things are certain in life…death and taxes!

Unfortunately, any proportion of debt that has been forgiven by creditors is called ‘cancellation of debt income’ and under IRS guidelines is still taxable! 

For information on other debt consolidation options as well as debt settlement, visit credit card consolidation loans site; where you will also find information on how you can clear your debt in as little as three years using techniques that the financial institutions do not want you to use!

Do Debt Settlement Programs Work? — We’ve all seen commercials from debt settlement companies claiming to save you 50, 60, or even 75% on your overall debt, all while somehow improving your credit. Using imagery like the American flag, and even news footage of President Obama, they encourage viewers to use debt settlement as a shortcut to dealing with their financial problems. However, do these services actually help people? Watch this week’s webisode from Cambridge Credit Counseling Corp. to learn more. Host President and CEO, Christopher Viale.

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