Debt Settlement

Debt settlement is a private party agreement

Debt settlement is a private party agreement between us on behalf of the Debtor and the Creditor, for a partial payment of consumer debt, over time. Often confused with “debt consolidation”, debt settlement is the right solution for clients with a small amount of credit card debt, who can make lump sum or short-term repayments to creditors.
The correct way to settle debts outside of a bankruptcy filing is by negotiating directly with the unsecured creditor, obtaining a letter evidencing the settlement agreement before payment, and paying the agreed-upon amount either in a lump sum or over several payments.
There are a few downsides to debt settlement as a form of debt relief.
While debt settlement does not cause a public record notation to be placed on a client’s credit report as bankruptcy does, a settlement that takes a long time to negotiate while payments are not being made does cause significant damage to one’s credit rating. Furthermore, with some rare exceptions, credit card companies do not offer very long repayment terms. The majority of settlements need to be made over a short period, of about one to three months. Very infrequently, the banks may agree to the repayment of a settlement over six to twelve months. A lump-sum payment or short repayment term is great for one’s credit score but may be very difficult for a client who does not have savings or money set aside for settlement and is relying on their monthly income for settlement payments.

Credit Reporting

Once a settlement is completed, there is no way to guarantee whether a creditor will report the settlement to the credit reporting agency as a “payment not in full” or “payment as agreed”. While “payment not in full” is a negative notation, and does cause damage to one’s credit score, “payment as agreed”, is a neutral notation, and does not cause any damage. This uncertainty, is one of the notable downsides to settlement, as a client may summarily pay a very significant sum of money and still experience severe damage to their credit score. One’s general credit standing and credit score may actually be better after a chapter 7 bankruptcy filing, where there are no payments to creditors, thus it is significantly cheaper in the end.

In recent years

In recent years, settlements have become significantly less advantageous, as in the majority of cases, credit card companies are looking for on average, a payment of 50% of the outstanding debt amount or more.

Debt Forgiveness

Unlike bankruptcy, a settlement is a private party agreement that results in debt forgiveness, which is in turn taxable as one’s income. Unless the client qualifies for an insolvency exemption, for which a special form has to be filled out, filed, and approved as part of the yearly tax return, a debt settlement is likely to result in significant tax liability for debt forgiveness.

Debt Relief

Finally, the debt settlement or “debt relief” plans offered by many companies, may sound great as they promise to “save” the client from bankruptcy and allow him/her to pay their debt in small monthly payments over a period of several years. However, this is a clear case of “too good to be true”, as the interest continues to accumulate at the default rate, half of the monthly payment is charged by the settlement company toward their fee, and the settlement funds to be offered to creditors accumulate very slowly. Even more importantly, the settlement funds under such “ settlement plans”, are held in an escrow account of the settlement company, therefore the creditors are not aware of the settlement plan until a settlement is negotiated, which may happen only after several years of payments. In most cases, long before a sufficient settlement amount is accumulated, the creditors’ sue, obtain judgement, restrain bank accounts, place judgment liens on properties and garnish 10% of salaries. For these reasons, among many others, debt settlement through a “settlement company”, is usually not a great debt relief option.

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