What is debt settlement?

If you’re finding that your debt has become unmanageable, you may be looking at options for paying it down or resolving it altogether. One approach is to establish a debt settlement plan. This isn’t always the right solution, though, so it’s important to assess your financial situation, understand the risks and rewards of debt settlement before you determine how you will proceed.

Debt settlement allows you to negotiate your debts with each creditor in a way that enables you to settle the outstanding balance for less than you owe. By understanding your debt, learning about the approach each creditor takes to resolving delinquent accounts, and then negotiating settlement amounts that are less than the balance on each account, you can create a debt settlement plan to get out from under the weight of your growing debt.  

To assess if settlement will work for you,  it’s important to consider:

  1. Your balances. Some amounts are too small for settlement.
  2. Your creditors. Each company has its own approach to dealing with delinquent accounts and their policies change periodically.
  3. Your cash flow. Do you have the funds to settle all your debts within 18 months? Even better, can you do it within 12 months as this reduces the risk of creditors suing you?
  4. Can you pay each creditor in the timeline they require and still pay your other bills? There’s no point in settling your credit card debt if you’re risking eviction or repossession of your car.
  5. Are there other sources of funds, e.g., something you can sell, loans from family or friends, that you can access?

Most any type of unsecured debt can be settled. For example:

  • Credit card debt
  • Business and/or commercial debt
  • Slow or late payments
  • Defaults
  • Charge offs
  • Accounts placed with a debt collection agency and/or attorney debt collector
  • Medical bills
  • Deficiency balances
  • Store credit card
  • Pre-judgment and post-judgment settlements

There are some important reasons to leave certain accounts out of your debt settlement plan. These can include accounts with small balances, those with recent balance transfers or recent high-volume purchases.

How debt settlement works

Once you’re at least 90 days late on your credit card or loan payments, your creditors may be willing to negotiate a settlement. Some are more likely to negotiate after you’ve missed five months of payments. You’ll need to understand the policies for each of your creditors. However, because the statistics show that 80% of delinquent accounts never end up getting paid, banks tend to be motivated to work with you, at least to some extent, to resolve your debt.

The window for getting the best settlement deal is usually after you are three months late but before the creditor charges off your debt, which is typically by the 180th day that your account falls into arrears. A charge off is when the bank records your debt as a loss. You can still settle past this day, but a charge off has a bigger impact on your credit score.

To settle your accounts, you or your representative ( such as a financial management service like Resolve) must contact your creditor (or their representative, such as a collection agency or collection lawyer) to negotiate to pay less than your current balance and agree to a one-time payment or payment schedule.

To understand if your settlement plans will work for you, you’ll need to consider:

  • what your settlement(s) will cost
  • how long the settlement plan(s) will take to complete
  • when you should target certain creditors
  • service fees associated with any organization you use to negotiate on your behalf (or you can take a DIY approach as covered later in this article)

Once you commit to your Debt Settlement Agreement with your creditor it cannot be altered. You must adhere to the terms of the agreement or your debt may not be resolved. For example, missing a scheduled payment may nullify the agreement.

What is an acceptable offer?

Creditors will base their agreed settlement amount upon how delinquent your account is, how long you’ve had the account, and how collectable you look on paper (i.e., whether you appear to be managing at least some of your debts well). The terms of the settlement will vary and require negotiation.

In his guide “How to Eliminate Your Debts Quickly and Safely Without Filing Bankruptcy,” ZipDebt founder Charles Phelan says: “The goal is to have the creditor forgive at least 50% of what you owe, and hopefully even more.”

Michael Bovee, co-founder of Resolve, added that an acceptable settlement offer is one the consumer can afford to pay.

“Generally speaking, settlements can be reached at 50% and lower,” Bovee explained. “There are, however, situations that will require 50% and higher settlements. Collections in the courts are certainly part of this higher percentage account pool, but there are a few creditors that will often be settled at just above the 50% range.”

Debt settlement pros & cons (including the impact to your credit)

There certainly are benefits to debt settlement in the right circumstances. For those who have debt that has become unmanageable but who do not qualify for Chapter 7 bankruptcy or do not wish to take that approach, debt settlement may be a good option. While there is a negative impact to your credit, if you’re considering settlement, you’re more than likely already late on payments, so your credit is already impacted. And, if you’ve missed payments with your creditor, and are in collections, settling will eventually help your credit and may help you avoid getting sued.

Settling can improve your financial situation once you are out from under your debts, meaning you’ll be able to move on to accomplish other financial goals as you can apply for credit cards, loans, and mortgages right after your last settlement payment.

However, it’s important to also weigh the risks. In order to negotiate with your creditors, you’ll need to be at least 90 days late on your payments. This does impact your credit. So, if you’re not already late, you may want to consider this impact. And, Bovee cautions, if you have short-term financial goals, such as purchasing a car, co-signing your child’s school loan, etc., debt settlement will not be the right option for you at this time.

Other financial implications can include:

  • Taxes may apply to the amount of debt forgiven in your settlements. You should speak with a tax advisor about this.
  • Your account will be subjected to internal/external collections, which could include being sued.
  • You also must have the money to pay off the debt at the negotiated amount and time because if you miss one payment, your agreement is nullified.

Debt settlement alternatives

As we explained, debt settlement impacts your credit score, can limit your ability to accomplish short-term financial goals, does not protect you against being sued and may have tax implications. You need to consider these risks and review your other options for resolving your debt to ensure this is the step you want to take. Some alternatives to debt settlement include debt management, bankruptcy and debt consolidation.

Bovee advises that the first alternative to consider is Chapter 7 bankruptcy because it is the lowest cost and fastest option and, he adds, it’s not the credit-killer it’s often made out to be. If you don’t qualify or you don’t feel it’s the right solution for you, you can also look at debt management as this won’t have the same negative impact on your credit score, you won’t have to deal with collectors, and you won’t be sued. However, debt management is a rigid plan that doesn’t allow for any deviation from the agreement so can be challenging to complete unless you have consistent income for the three to five years the plan will last.

Bovee explains that for some a viable option is to do nothing. If your current finances don’t allow you to both cover your household needs and pay down debt, you may need to ignore the debt. He says, “If you really are broke, then you don’t even have to worry about them collecting something from you after a judgement.”

DIY settlement: How to negotiate your debt for pennies on the dollar

It is possible to negotiate directly with your creditors and pay off your debt for pennies on the dollar. But there is a basic formula to follow in order to maximize savings and limit risks, according to Bovee. He explains that the more creditors you have, the more important it becomes to strategically plan for which accounts to negotiate with first, and which would be better settled with outside debt collection agencies (after charge off). How you develop your plan should be based on how much money you have available to settle for the best rate of savings given your particular lenders’ policies at the time you are negotiating with them considered alongside any credit cards you have with a lender that is more aggressive in collecting.

You’ll need to be able to handle seeing your credit score impacted by your past-due accounts and manage an onslaught of collections calls. But there are steps you can take to set yourself up for success. You’ll need to:

  • Learn about the current policies of each of your creditors for negotiating delinquent accounts
  • Review your timeline for each account to understand how many days past due you are and when you’ll be in the ideal timeframe for negotiation
  • Have a realistic understanding of your finances to ensure that you’ll have the funds needed to pay on each agreement at the agreed-upon time
  • Set up a separate bank account for payment of your agreements
  • Ignore collector’s phone calls until you are past due for at least 90 days. Then, at the time you deemed to be “right” per what you learned about negotiating with this particular creditor, contact them ready to offer a specific settlement amount. (You calling them can give you a sense of control, which is often lost in the barrage of collections calls.)

Negotiating a settlement might take one call or many. Once you reach an agreement proper documentation is critical. Before you send any money, you must get that agreement in writing.

In some cases, Bovee explains, certain banks require you provide your ACH payment information prior to sending you the agreement. If this happens, it’s wise to record the segment of the call covering the settlement deal. Inform your creditor that you’re recording the conversation because they refuse to send the agreement letter prior to your submitting payment. Hold onto that recording until you receive the written agreement.

He also suggests scheduling the payment 10 days out to allow time to receive the agreement. Then follow up in 72 hours to request it via fax if you’ve not gotten it in the mail. And, if they won’t send it, cancel the scheduled payment and be willing to walk away from the agreement.

Debt settlement agreements

The debt settlement agreement is the settlement contract between you and your creditor that includes all of the critical details you have both agreed upon – settlement amount, payment plan and date(s), involved parties, etc. If you negotiate your settlement plans yourself, you can use a debt settlement agreement template to create this binding document, but you’ll want to be careful about the template you choose. You’ll need a separate agreement for each creditor.

In addition to disclosures and text that covers the creditor be sure the following information is included to protect your interests:

  • The creditor and/or debt collectors name
  • The date the letter was drafted
  • Your name
  • Your account number
  • Outstanding balance owed on the account (this is sometimes missing and is not a deal breaker according to Bovee)
  • Amount that is being agreed upon as a settlement and satisfaction of the debt, which is less than the full amount owed
  • Terms and amounts of payments to be made if you’re settling the account over a period of time instead of with one lump sum
  • Date your payment(s) must be received by in order to fulfill the settlement agreement
  • The settlement agreement must reference that the account is being satisfied in full. This may also be noted as “settled,” “settlement of this account,” “accepted as settlement in full” or “paid in full.”

The challenges of debt settlement companies & plans:

There are a lot of traditional debt settlement companies and not all have your best interest in mind. Most charge high fees for their programs, such as 20-25% of your total debt balance, and many negotiate your accounts in an order that gets them paid faster rather than saving you the most money. There are also many that prey upon people who are in desperate financial situations and offer deals that are truly too good to be true.

While the many debt settlement companies out there would have you believe they have some special inside connections that enable them to get a better deal for you, but that’s most often not the case.

Why Resolve is different

While people can negotiate on their own, there’s often a level of knowledge and understanding needed to get the best settlements. Bovee explains that because each creditor has different policies and their approaches to dealing with delinquent accounts change – sometimes often – it’s challenging for a consumer to know the best way and best time to negotiate with each creditor.

Most traditional debt settlement companies often don’t have the consumer’s best interest in mind with regards to their fee structure and their approach to negotiating their clients’ debts. That’s one of the reasons he co-founded Resolve, a free financial management platform the helps people identify their best options for resolving their debt. The platform offers an easy way for people to review specific solutions based on their situation and access free expert guidance while deciding the best route to handling their debt.

And because there are times when professional assistance is needed in order to execute the best possible outcome, Resolve has set up a system of network partners to help in specific areas. When using the  platform clients can see any fees that would be associated with the solution options. And, Network Partners charge rates that are fair and substantially less than the traditional debt settlement companies. For example, whereas a typical company charges 20-25% of your debt balances, Resolve partners charge 15% of what you save. This structure sets you up for the best settlement offers and paying your debts in the order that saves you the most money.  

Resolve Network Partner Savings Structure

Typical Debt Settlement CompanyResolve Network Partner
Your debt is $30,000Your debt is $30,000
Fee is 20-25% of your debt totalFee is 15% of of your total savings
You’d pay them between $6,000 and $7,500Assume all of your accounts settle for a total of $14,000 on that $30,000 debt. You saved $16,000, so you’d pay 15% of that amount in fees, which is $2,400.
It does not matter how much they save you – you pay them the same amount.You pay based on how much the Resolve Network Partner saves you.
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