Debt settlement is often a better debt solution than filing bankruptcy or enduring a multi-year consumer credit repayment program, especially when liquid funds are available to fund the settlement. Although the vast majority of people I meet with debt problems are not good candidates for debt settlement, those who can tap into a lump-sum of cash by selling assets or liquidating investments may look at debt settlement options.
Should you consider debt settlement?
My general rule that you should not consider debt settlement unless you have have at least one-third of the account balances owed on hand in cash within 6 months of stopping payments to creditors. So, if you owe $30,000 of credit card debt, do not consider debt settlement unless you can have at least $10,000 of than saved in cash within 6 months of stopping payments on the credit cards, and you will need to add more to the pot each month until you have 40% to 50% of the account balances saved in cash. If you cannot do that do not try debt settlement. Most credit card companies will settle the account for roughly 40% of the account balance, but they want that settlement in cash in a lump-sum payment.
#1: Stop paying the accounts.
If debt settlement is your best option, the first step is to stop paying the accounts. Credit card companies do not negotiate settlements unless the account is in default. Once an account has become 4 to 6 months delinquent, the creditor is generally willing to cut their losses and settle the account.
#2: Call the creditors.
Once you stop paying the account, the next step is to reach out to the creditor and request a settlement. Debt settlement companies say they know secrets and tricks that credit card companies don’t want to tell you about settling debts. That is hogwash! There are no secrets. Just pick up the phone and call.
#3: How much should you offer?
Chances are, when you call the creditor you will be speaking to a poorly paid customer service representative who is just reading a script off their computer screen. There is no real negotiating going on here. Credit card companies have settlement standards and the employee on the phone can only accept what they are authorized to accept. They are not going to look at your individual circumstances–they just don’t have the authority. You are talking to a machine. By all means, offer them a low settlement, perhaps 25% of the balance, but most likely they will counter at 40% to 50% of the account balance. If you don’t like the offer just say goodbye and call back the next month.
#4: Account balances grow larger each month.
Each month the account becomes older the balance becomes larger, especially as the late payment fees and default interest rates kick in. So, although you may settle the account for 40 cents on the dollar at some point, the savings is diminished since you are settling a larger account balance.
#5: Never pay a settlement without a settlement letter in hand.
Never pay a creditor a dime until they send you a settlement letter stating that they will accept X amount of dollars in full satisfaction for the account balance. No letter, no settlement.
#6: Settlement deadlines are false.
Debt collectors will constantly tell you that the settlement offer will expire by a certain date. Don’t believe them. That same offer you have today will be there next month. The truth is that debt collectors are paid on commission and they must submit monthly performance reports to their employers. They more they collect the more they get paid. They will try to trick you into believing that you will not get the same offer next month and that you will have to pay more to settle if you do not accept their offer by their deadline.
#7: Never pay a settlement with a Check by Phone.
I never pay credit card collectors over the phone. Never give anyone access to your bank account. Instead, get a Cashier’s Check from your bank and send it to the collector by Certified Mail or by some other tracking service such as FedEx or UPS.
#8: Time is Limited.
Once an account is six months delinquent, credit card companies start selling the accounts to aggressive junk debt buyers who are quick to file collection lawsuits. In some cases credit card companies will actually file a collection lawsuit once the account becomes more than six months delinquent. Once litigation commences the rules of the game change. Now there is a litigation attorney in charge of your account, and that person may see that you have equity in your home or know where to garnish your paycheck. It is best to settle all the accounts before litigation begins.
#9: There may be tax consequences to settling debt.
When you settle a debt for less than what is owed, the creditor may send you and the IRS tax form 1099-C for the amount of debt you did not pay. For some people this will become taxable income and for others it will not. Read this article for more information on that topic.
#10: Know when to hire a Pro.
The fact is, we can settle debts better than you. We can settle them faster and for less money that you can. Creditors know that when they reject our settlement offers we may hit them with a bankruptcy case and then they get nothing. We know how to drag out the process and wear down collectors. We deal with their attorneys every day and know how to cut through the red tape to get settlements done quickly. If an account has gone to litigation, it’s time to call the a debt settlement professional.
Image courtesy of Flickr and Carl Wycoff.