Most people have a vision of debt settlement that doesn’t match up with reality.
I started seeing debt settlement ads on television and the radio when I first began practicing law in 1995.
What originated as a small industry became a behemoth seemingly overnight as the economy tanked and everyone started realizing they couldn’t possibly pay all their debts.
And as with so many consumer finance industries, information given to the public has long been at odds with the truth.
Time to set the record straight.
You May Be Able To Settle Your Debts – But Not By Much
Debt settlement is real. It occurs when you and a creditor mutually agree to reduce the balance due and treat it as payment in full.
There are laws regulating the business practices of debt settlement companies, including the disclosures they’re required to make and the fees that can charge.
That said, a 2010 letter to the Federal Trade Commission by The Association of Settlement Companies indicated that the average debt was settled for $0.88 per $1.00 owed. In other words, the average person settled for 88.1% of the balance due.
You Don’t Need Someone To Help You Settle Debts
Debt settlement involves sitting down across the proverbial table from someone else and working out a deal to repay your debt for less than you owe.
There are no courts involved, nor any judges or arbitrators.
You are not required to hire someone else to negotiate on your behalf. In fact, I’ve always been of the opinion that you’ve got a better chance at claiming poverty when you’re not paying someone to help you settle the debt.
Debt Settlement Can Result In A Tax Liability
Under the tax laws, creditors and debt collectors that agree to accept at least $600 less than the original balance are required by law to file 1099-C forms with the IRS.
You will receive a copy of the Form 1099-C, Cancellation of Debt, and must include the canceled amount in your gross income unless you meet an exclusion or exception.
Debt Settlement Will Harm Your Credit Score
Whenever you fail to make timely payments to a creditor, your credit score will go down.
Settling a debt for less than the full balance due will also harm your credit score.
That means not only that debt settlement will lower your credit score, but also that your score will decrease while you’re trying to negotiate a settlement with your creditor.
The More Creditors You Have, The Less Likely It Is To Work
It’s a matter of simple logic – the more times you need to negotiate, the more likely it is that you won’t be successful.
If you’ve got to negotiate with one creditor then you may be able to work out a deal. Add a few more creditors to the pile, however, and it may not work out quite as well.
Statistics bear out this logic – debt settlement rarely works out as well as you may hope.
A 2009 survey of U.S. debt settlement companies found that 34.4% of enrollees had 75 percent or more of their debt settled within three years.
Creditors Can’t Be Forced To Settle
As I already said, there’s no court or judge involved in debt settlement. It all comes down to negotiation between you and the creditor.
They don’t have to accept a settlement from you. And if they propose one, it need not be one you like.
You can argue that it makes sense for a creditor to settle a debt you’re not paying, and you may be right. But just because it makes sense from your point of view to settle doesn’t mean that’s true for the creditor’s side of the table.
Creditors That Don’t Settle Can Still Sue You
You can try to settle before a lawsuit is filed against you, but if negotiations break down then the creditor can still look to the court system.
If Everyone Doesn’t Settle, You’ve Got Trouble
Remember when I said that it’s more difficult to settle when you have many accounts?
And when I just told you that a creditor can decide to sue you if negotiations fall through?
Think about it – you could conceivably have 8 outstanding accounts and successfully settle 6 of them. The last two don’t settle but choose to sue you.
Now you’ve got a few choices. You can pay the judgment voluntarily, risk your bank account being frozen and your income seized in a wage garnishment, or file for bankruptcy.
All that, after working so hard to settle the debts.
How To Avoid The Pitfalls
If you’re thinking about debt settlement, beware of the risks.
Recognize the chances of success get smaller as your debt situation becomes more complicated.
Look into your options, then move ahead with your eyes open.