Debt Settlement

Debt settlement, also known as debt arbitration or debt negotiation, is an approach to debt reduction in which the debtor and creditor agree on a reduced balance that will be regarded as payment in full.

As long as consumers continue to make minimum monthly payments, creditors will not negotiate a reduced balance. However, when payments stop, balances continue to grow because of late fees and ongoing interest.

Consumers can arrange their own settlements by using advice found on web sites, hire a lawyer to act for them, or use debt settlement companies. Some settlement companies may charge a large fee up front; or take a monthly fee from customer bank accounts for their service, possibly reducing the incentive to settle with creditors quickly. One expert advises consumers to look for companies that charge only after a settlement is made, and charge about 20 percent of the amount by which the outstanding balance is reduced.

As a concept, lenders have been practicing debt settlement for thousands of years. However, the business of debt settlement became prominent in America during the late 1980s and early 1990s when bank deregulation, which loosened consumer lending practices, followed by an economic recession placed consumers in financial hardships.

With charge-offs (debts written-off by banks) increasing, banks established debt settlement departments staffed with personnel who were authorized to negotiate with defaulted cardholders to reduce the outstanding balances in hopes to recover funds that would otherwise be lost if the cardholder filed for Chapter 7 bankruptcy. Typical settlements ranged between 25% and 65% of the outstanding balance.

Alongside the unprecedented spike in personal debt loads, there has been another rather significant (even if criminally under reported) change – the 2005 passage of legislation that dramatically worsened the chances for average Americans to claim Chapter 7 bankruptcy protection. As things stand, should anyone filing for bankruptcy fail to meet the Internal Revenue Service regulated ‘means test’, they would instead be shelved into the Chapter 13 debt restructuring plan. Essentially, Chapter 13 bankruptcies simply tell borrowers that they must pay back some or all of their debts to all unsecured lenders. Repayments under Chapter 13 can range from 1% to 100% of the amounts owed to unsecured creditors, based on the ability of the debtor to pay. Repayment periods are 3 years (for those who earn below the median income) or 5 years (for those above), under court mandated budgets that follow IRS guidelines, and the penalties for failure are more severe.

Essentially, the debt settlement company negotiates on the borrowers’ behalf with creditors to reduce the overall debts in exchange for an agreement upon regular payments to be made. Only unsecured debts, such as medical bills and credit card debts can be handled, not student loans, auto financing or mortgages. For the debtor, this makes obvious sense – they avoid the stigma and intrusive court-mandated controls of bankruptcy while still lowering, sometimes by more than 50%, their debt balances. Whereas, for the creditor, they regain trust that the borrower intends to pay back what he can of the loans and not file bankruptcy (in which case, the creditor risks losing all monies owed).

The debt collection business has become very grand during this recent “Great Recession.” Bad debt is also bought and sold in the open market. This only leads further complexities when you are trying to settle debt on your own. The overall confusion makes it necessary to hire a legal help when settling debt.

Negotiating with your creditors alone is a very grueling process. Debt collectors tend to be ruthless when they pursue a collection matter. They will use aggressive and often demeaning tactics to persuade a debtor to pay a bill. They know that the client does not have an understanding of credit and collection laws. This gives them a clear cut upper hand when negotiating a debt settlement deal with the debtor. However, the picture changes greatly when an attorney represents the debtor. The collector can no longer use intimidation to ascertain results. They need to abide by the rules. All collection agencies hate negotiating with law firms. Hiring a law firm to handle a debt settlement matter is the ultimate “trump card” for the debtor.