Debt settlement usually finds favor with the consumers since it brings about a considerable reduction in the debt amount. Find out how it works and why the creditors agree to receive less than what is owed to them.
How does a debt settlement program work?
When you enroll in the program, your monthly payments to the debt settlement company get accrued in a trust account for a certain number of months. You’ll not be required to make any payments to the creditors .You can access the trust account through your secure login area. Once enough money has been deposited into the account, the debt settlement company initiates the negotiation procedure with the creditors.
The debt settlement company negotiates with the creditor or the collection agency to settle on such an amount that is acceptable to both the creditor and the debtor. Once the debt settlement company settles down on something with the creditor, you can pay off the amount either in lump sum or in installments.
Usually, a debt settlement negotiation reduces a significant portion of your total outstanding debt balance. However, how much reduction you will get, chiefly depends upon the efficiency of the debt settlement company.
Why would your creditor accept a settlement offer?
When a creditor accepts a settlement offer, he forgives a part of your debt. Quite clearly, he loses money. You may wonder why a creditor agrees to work out a settlement agreement with the consumer when he loses money.
Creditors are intelligent people. They understand that a consumer can go bankrupt if his financial state is very poor. In this case, they can hardly recover any money from the consumer. Debt settlement is a better deal for a creditor since he gets back a significant part of the original debt. This is why creditors often agree to settle a debt.
Are you eligible for the settlement program?
Though debt settlement solutions are quite beneficial for the consumers, but not everyone is qualified for this program. Your creditor will agree to settle your debt if:
- You have defaulted on the loan.
- You’re missing payments continuously.
- You have some source of income.
- Your debt amount is quite high.
- You’re facing financial hardship.
What is the duration of a settlement program?
The duration of a debt settlement program usually depends upon the total number of debts, the kinds of debts, the total debt amount which a consumer intends to settle, and the amount he can afford to settle for. In general, a settlement case gets completed within 2-3 years. The more you, the consumer, can pay, the earlier your debt gets settled.
What are the debt settlement pros and cons?
Like every debt relief program, debt settlement too has its share of benefits and drawbacks. Check out the debt settlement pros and cons before reaching upon a decision:
Here are the 5 settlement pros you must be aware of:
- Get a reduction in the debt amount: A considerable percentage of the outstanding balance can be reduced through debt settlement. If the professional debt arbitrator has excellent negotiation skills, then the creditor may agree to forgive a large percentage of the debt amount.
- Will not have to pay extra fees: The debt settlement firm or the attorney will negotiate with your creditors, and get all the late fees eliminated. Extra fees and penalties will be eliminated too.
- Get respite from the collectors: The debt settlement company or firm will handle all your collection calls after enrolling into the program. It will be their responsibility to tackle the creditor calls on your behalf. However, the creditors/collectors can call you in certain situations. Make sure you respond to those calls.
- Avoid legal hassles: The creditors/collectors are less likely to file a lawsuit against you after enrolling into the settlement program. The reason is, creditors/collectors realize that they will get back their money eventually. Even if the creditors decide to register a case in the court, the debt settlement attorney/firm may give you legal assistance. They may guide you how to deal with the lawsuit.
- Avoid the hazards of bankruptcy: As you repay your bills through debt settlement, you won’t have to think about filing bankruptcy anymore. You won’t have to submit bankruptcy petition or go through the means test for discharging your debts.
Check out the 2 settlement cons before getting help from an attorney or a company:
- Tax implications: If you settle your debt for less than what you actually owe, or if the creditor writes off a debt you owe, the Internal Revenue Service (IRS) treats the forgiven amount as income, on which you may have to pay income taxes.
Any creditor, who forgives or writes off $600 or more from the primary debt balance, must send you and the IRS a Form 1099-C at the end of the tax year, and keep a copy with him. These forms are intended for reporting income to the IRS that you are receiving due to a settled or forgiven debt.
Again, the creditor may send Form 1099-C to the IRS and not to you. In that case, if you don’t list this income while your tax return, you can get a tax bill or even an audit notice.
This can compel you to pay more for IRS interest and penalties.
- Credit score may drop: A settlement program does not help your credit score. This is because you do not pay back the full amount to the creditors when you settle your debt. Creditors would report the account as "Paid as Settled" or “Paid as Agreed” to the credit bureaus. This negative remark will stay on your credit report for 7 years.
However, most people who settle their debt already have blemished credit. Creditors will agree to settle your debt only if you’re missing payments consistently (which drops your credits score). Therefore, credit score should not be an issue with you, the consumer, who are contemplating to settle debt.