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| A Quick Guide to Debt Settlement |
Submitted by:
Ray / Tip Hero 04/23/2009 12:24 AM
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With more people finding themselves struggling with debt as the economy weakens, there has been an explosion in the number of debt settlement firms offering quick and simple fixes to people's debt woes. You've probably seen their ads offering to get debt reduced by up to 60% and have you debt free within 12-24 months, guaranteed.
There have also been a growing number of complaints against debt settlement firms by states attorney generals. Many of these firms prey on people who are dealing with gut wrenching financial situations and are vulnerable to charlatans offering simple solutions for a fee. We decided to take a closer look at debt settlement.
What is Debt Settlement?
Debt settlement is the process of negotiating with your creditors to reduce your debt, often for a lump-sum payment. The process typically goes like this:
1. You hire a debt settlement firm to represent you.
2. You stop paying your bills and put the money that would have gone to pay your bills into a fund that will be used to offer a lump-sum payment to your creditors.
3. Your debt settlement firm negotiates with your creditors to accept x cents on the dollar to close out your debt.
Some creditors will choose to settle, figuring it's better to collect 50 cents on the dollar than nothing at all. The process typically takes many months, as you need to build up enough of a lump-sum payment to entice your creditors to settle.
Debt settlement is different from debt management, which is the typical process you find at consumer credit counseling, whereby credit counselors work to come up with a payment plan and then pitch it to your creditors. These plans include interest rate reduction and fee waivers but do not reduce the principal of your debt. The creditors collect 100 cents on the dollar and forego a certain amount of interest and fees.
What Do Debt Settlement Firms Do?
These are firms that negotiate debt settlements with your creditors on your behalf. Debt settlement firms typically charge an upfront fee, a monthly fee taken directly from your checking account, and some sort of success contingency fee based on a percentage of the amount they were able to reduce your debt by (for example, if they were able to reduce your debt by $20,000 and they had a 10% success fee, you would pay them $2,000).
Potential Pitfalls:
You almost always have to stop paying your bills and sometimes have your debt transferred to a collection agency. This pretty much hammers your credit rating.
There are no success rate statistics for the debt settlement industry. From much of the anecdotal evidence in articles we've read, it doesn't seem like there is a very high success rate and many people quit before a debt settlement is reached. We've read stories of people spending thousands with debt settlement firms to never have their debt settled and ultimately have to file for bankruptcy.
Some creditors may sue you if they find out you are working with a debt settlement firm.
Some debt settlement firms charge high monthly fees, which essentially incentivizes them to string you along and try to reach a settlement later rather than sooner so they can pocket more fees.
Keep in mind that the warm, caring voice on the other end of the phone at most debt settlement firms is probably being paid a commission to get you into their debt settlement program.
Tax Consequences:
The IRS considers certain debt forgiveness to be treated as income which you have to pay taxes on. It is important to seek the advice of a competent accountant on tax issues relating to debt settlements.
Alternatives:
Consumer Credit Counseling – There are many non-profit credit counseling agencies that will work with you to come up with a payment plan and negotiate on your behalf with your creditors to accept lower interest rates and reduced payments. Realize these agencies don't negotiate debt reduction but work on getting your interest rates reduced and fees waived. The advantage of credit counseling is that it doesn't force you to stop paying your bills (which, as mentioned before, not paying your bills can push your credit score into a nose dive). Some credit counseling agencies are free while others charge small fees.
Bankruptcy – Most people pursue debt settlements because they want to avoid the stigma of having to file for bankruptcy. There are two types of bankruptcies: Chapter 7, which is primarily liquidation, and Chapter 13, which is reorganization. Chapter 7 pretty much discharges all debts once you emerge from bankruptcy, while Chapter 13 sets up a settlement plan to pay off your debts over time. The bankruptcy laws changed in 2005, making it harder for consumers to file for chapter 7 bankruptcy. Bankruptcy typically stays on your credit report for 10 years, while in some cases for 7 years. Bankruptcy law is full of intricacies so you should consult with an attorney that specializes in bankruptcy law.
Next Steps:
If you are facing mounting debts that you are having trouble paying, a good first step would be to contact a non-profit consumer credit counseling service near you. A credit counselor can take a look at your situation and recommend some courses of action. You can also ask them about their perspective on debt settlement services.
If bankruptcy could be on the horizon, it would also be a good idea to speak with an attorney that specializes in bankruptcy law. Many lawyers offer free consultations, but if you can't find one who does and you can’t afford an attorney, you could also look for legal aid services in your community. Most decent-sized communities typically have some form of legal aid societies where lawyers offer consultation and sometimes do pro bono work. You can sometimes find nearby law schools that offer outreach legal clinics, as well.
I would recommend talking with a consumer credit counselor and/or an attorney before approaching debt settlement firms. If you do decide you want to look at debt settlement as an alternative, make sure to do your homework first. Dig deeper and do more research on debt settlement. I've included some articles below to get you started. Just keep in mind that debt settlement often comes with high fees, potential pitfalls, and a not so clear track record.
How to Find a Reputable Debt Settlement Firm
If you do decide to look for a debt settlement service, here are two things to look for:
Debt settlement firms that offer no-to-low up-front and monthly fees and, instead, take the bulk of their fees for successfully negotiating a debt settlement.
Check out the debt settlement firm you plan to use with the Better Business Bureau and the office of the Attorney General for your state to see if the firm has any complaints filed against it.
Additional Articles:
Money Central Article
Wikipedia
NY Times Article
NY Times Article
Dallas News Article
Oregon Live Article
Money Central Article
Article
Photo credit: andres rueda |
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