What Is Debt Settlement?
What is debt settlement? It is an aggressive approach to reducing someone’s debt. It is used for people who have a large amount of debt and are having so much trouble that they are thinking about filing for bankruptcy. Debt settlement agencies will negotiate with the creditors to settle the amount of the debt to a lower amount than what is owed. The debtor will save the money for a lump-sum settlement payment.
After the debt is settled, the creditor will send a letter stating the debt obligation was fulfilled, and will report to the credit bureaus that the debt has been, “Settled for less than full amount”, “Paid” or “Settled”. Creditors will usually only settle for less than owed when the debtor is under serious financial strain because if the debtor chooses to file bankruptcy, then the creditor gets nothing. If no financial hardship is evident the creditor may choose to take legal action.
A debt settlement is usually reached when a debtor is unable to fully meet his/her debt obligations due to financial hardships and attempts by the creditor to collect on the debt have failed. The creditor agrees to cancel part of the debt and accept the remaining sum as full repayment. Debt settlement is also called debt negotiation. Technically speaking, a debt settlement is the agreement while debt negotiation is the process through which both parties reach that agreement.
Consumers who use debt settlement are those who are experiencing legitimate financial hardships, cannot afford to repay their debts through debt management plans offered by consumer credit counseling agencies and who also want to avoid filing bankruptcy. For this reason, debt settlement falls between consumer credit counseling and bankruptcy.
Debt settlement programs are provided by third party debt resolution firms who set up payment plans, and then negotiate settlements on behalf of the consumer. Typically, debt settlement programs are able to lower monthly payment contributions to approximately half of the typical minimum monthly credit card payments, and get consumers debt free in a short period of time.
Whether a debtor enrolls in a professional debt settlement program or negotiates settlements directly with creditors, the process is the same. The settlement company will require the debtor to sign a limited power of attorney, so they can negotiate on their behalf. The debtor will save up and set aside money to build up a settlement fund. Once enough funds to make a reasonable settlement offer accrue, the debtor or his/her professional debt negotiator will negotiate with the creditor for a reduced payoff amount, typically between 25% and 50% of the outstanding balance.
Once the creditor agrees to a settlement amount, payment is arranged and the account is considered settled-in-full (as opposed to paid-in-full). The debtor continues saving up and setting aside funds into the settlement fund to accrue enough funds for negotiating a settlement for the next willing creditor. Essentially, the process is a cycle of saving up and setting aside money, negotiating a settlement and paying the settlement.