The Purpose
Debt settlement is a means for resolving debt obligations
through partial payment to a creditor. A creditor may be willing
to accept a portion of the debt to satisfy the obligation.
Sometimes the costs of pursuing a judgment are so high that the
creditor would rather accept a reduced payoff in order to clear
the account.
When to Settle
The first step to settling debt is understanding when it is
your best option. All of your credit card and unsecured loan
accounts must be in collections. If any of your unsecured debt
accounts are still with the original creditor, then you should
consider
alternatives to debt settlement instead. If your accounts
are about to be charged off, find out how to send a minimum
amount in order to delay charge-off for another 30 days. You will likely
have more attractive options when your accounts have not yet
been turned over to an outside collection agency or attorney.
If all of your unsecured debt is assigned to collections,
then you might want to consider settling. However, if an account
is so old that the statute of limitations has expired on the
account, then settling could actually do more harm to you. Each
state has its own legal statute of limitations on written
contracts, and some differentiate revolving debt accounts from
other types of contracts. To be sure, you should consult
qualified and licensed legal counsel to determine whether you
are still liable for an old debt.
How Debt Settlement Companies Work
Debt settlement companies tout their services as ways to
eliminate your debt typically in less than 3 years, and for a
fraction of what you owe. They usually look for debtors owing
$10,000 or more. This is how a typical debt settlement company
operates. This example assumes debt of $20,000:
- When you have enough debt to qualify, you sign a
contract to pay a monthly payment to the debt settlement
company. They would quote you an amount that might pay half
the debt over 36 months.
- They come up with $278 plus a $35 fee for a total
monthly payment of $313. Usually your first monthly payment is a fee.
COST TO YOU: $313
- Each subsequent payment of $313 would be made toward your
trust account with the settlement company, and they would deduct
a fee of $35 each month. COST TO YOU:
$1,260
- You make monthly payments until one of your creditors
agrees to settle. Assuming all settle for 50% of the
balance, you would pay at least $10,000. For this example,
we will ignore the additional fees and interest that would
still be accruing on your debt balances.
COST TO YOU: $10,000+
- Most debt settlement contracts include a final fee of
25% of the "savings." COST TO YOU:
$2,500
- You will receive Form 1099-C from any collector where
the debt is settled for an amount of at least $600 below the
balance. Unless you can prove insolvency, you must pay taxes
on this forgiven debt. You should consult with a
qualified tax advisor to understand how this might affect
you. Since the most common federal tax bracket is 25%, we will use
that for this example. State taxes could be additional. COST TO YOU:
$2,500+
For this example, you would end up paying a whopping
$16,573, plus additional
interest charges and fees. Keep in mind that using a debt
settlement company means that nothing is being paid on your debt
until settlement occurs, which means that normal collection
attempts by debt collectors may continue. This can include
harassment (even though it is illegal), judgments and possibly
garnishments from your paycheck.
In addition, your credit is substantially damaged. It
reflects the late payments, collection accounts, any public
records (like judgments) and settlements for less than the full
amount.
If you are comfortable with these costs and just want to find
a reputable debt settlement company to work with, then look for
one that is in good standing. If you would rather avoid some of
these unnecessary costs, then you might try
settling debt on your
own.
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