How Debt Settlement works

Essentially, the debt settlement company negotiates upon the borrowers’ behalf with creditors to reduce the overall debts in exchange for an agreement upon regular payments to be made. Only unsecured 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).

There are obvious drawbacks – credit reports will show evidence of debt settlements and the associated FICO scores will be lowered as a result. There’s always the possibility of lawsuit whenever debts lay unpaid. Since few creditors wish to push borrowers toward bankruptcy – and the potential of governmental protection against all debts. In addition, the specific debts of the borrowers themselves affect the success of negotiations. Tax liens or domestic judgments, for reasons that should be clear, remain unaffected by attempts at settlement. Student loans, even those not federally subsidized, have been granted special powers by recent legislation to attach bank accounts without possibility of Chapter 7 bankruptcy protection. Also, some individual creditors, including Discover Card, for example, tend to have an aggressive resistance against negotiations.

Debt Settlement Companies

In order to work with a debt settlement company, a consumer needs lump sum cash, and the accounts need to still be held by the credit card companies. The debt settlement company negotiates with the credit card companies for 35% - 50% of the existing balances. The debt settlement companies typically have built up a relationship during their normal business practices with the credit card companies and can come to an settlement agreement quickly. Once the consumer pays the agreed upon amount, the debt settlement companies take a percentage of the savings of the forgiven debt as the fee. With the current economic crisis, more and more credit card companies may be willing to settle existing credit card debts rather add to their already large written off bad debt.

Debt Negotiation Companies

Also a type of debt settlement firm, they offer a consumer a different way to get out of debt. These companies work with consumers who have no cash to make settlement offers with the credit card companies. Debt Negotiation companies set up "trust" for you - though they are not a licensed bank entity under the Federal Reserve. They collect a monthly fee to maintain the account, with the idea being that you are saving enough money to settle the accounts at a future date. A portion of the monthly payment towards the "savings account", a part of the payment is taken as a fee for the debt negotiation company. Unlike consumer credit counseling services, they do not pay your creditors each month, they put money into your "trust". Your creditors are not told of your "arrangements" with the debt negotiation company.

The drop out rate of consumers from debt negotiation companies is high.  The debt negotiation companies do not handle calls from the credit card companies, nor the collection agencies. Credit card accounts typically go into collection after they are charged off, typically 180 days after the last payment on the account. The length of the program is often 3-5 years, and many consumers cannot keep up the payments for this period of time. Often, consumers wind up being sued or even more deeply in debt with added interest and fees piling up.