What is Debt Settlement?

Debt settlement is sometimes confused with debt consolidation, in which borrowers are take out one big loan to pay off their smaller debts for one low monthly payment  and the whole amount of debt remains intact.

Debt settlement, also known as debt arbitration, debt negotiation or credit settlement, is a process to reduce debt in which the debtor and creditor agree on a reduced balance that will be considered as payment in full.

A person may negotiate a debt settlement two ways:  A individual debtor can negotiate on his/her own behalf with each creditor to reach a settlement, or the individual can retain a debt reduction company to negotiate for them.  These companies typically advise their clients to stop paying their bills and instead save up cash, which the company will then use to negotiate lump-sum settlements.

THERE ARE MANY CONSIDERATIONS BEFORE RETAINING A DEBT REDUCTION COMPANY, INCLUDING:

  • Fraud. Some companies offering debt settlement take big fees upfront and then disappear. Others companies do not have the experience to negotiate effective deals. Either way, the result is the same: money lost at a time when you can afford it the least.
  • Lower credit score.  Failing to pay your bills on time will lower your credit scores. Settling a debt for less than what you owe will reduce it even more.
  • Lack of regulation. This area is completely “buyer beware”.  The federal government doesn’t regulate debt settlement companies.  However, the Federal Trade Commission is considering imposing some rules. Very few states regulate the industry.
  • Taxes. The amount forgiven in settlement typically is considered taxable income by the IRS. So if you’re in the 25% federal tax bracket, you could owe $2,500 for every $10,000 in debt that’s forgiven.
  • Cost. Some companies charge 14% to 18% of the total face value of the debt you want settled, while others charge a large percentage of the amount they actually settle for you.

A NOTE TO HELP YOUR CREDIT SCORE:

While negotiating with lender for a reduced amount, ask the lender to label the account afterwards as “Satisfied”, or “Paid in full” rather than “Settled”.  It will reflect more positively and favorably on your credit report to see the words “Satisfied” or “Paid in full”, than “settled” which is considered derogatory.

Whether to file for bankruptcy or debt settlement are decisions that will impact your life for years to come.  Get all the facts and options first.  Consult a Utah attorney for the best options for your individual financial situation.