It's a little-known fact that when you fall further and further behind on your payments, creditors would much rather agree to settle your debts than have you file bankruptcy and not get paid at all. Not surprisingly, creditors do not like to advertise debt settlement.

Debt settlement is a process to eliminate your outstanding debts for less than the amount actually owed to the creditors. In this process, you stop paying monthly installments to your creditors and instead save the money. When you have saved at least 50% of the total amount, the negotiating starts with your creditors for a settlement. This process is also known as Debt Arbitration or Debt Negotiation and it can be a good alternative to bankruptcy. You may also be a good canidate for debt settlement services if you can't make the minimum payments of a debt management plan (DMP) or haven't made payments on your debts in the past 3 months. This is not a plan for people with on time payments that can afford to continue making the required monthly amounts.

The debt settlement company either takes monthly payments from you and keeps it in their account, or you keep the money in your own account. While you are making these monthly payments to the designated account, they negotiate with your creditors for a lower payoff of around 40-50% of your total amount of debt. Once the negotiated settlement is agreed upon with your creditors, the debt company makes a one time payment to them.

Benefits of debt settlement

• Pay less: When a debt becomes delinquent, late fees, over the limit charges are accumulated with the total debt amount. So you have to pay higher interest towards the debt. Majority of the debt settlement companies negotiate with your creditors and restructure the debts that you owe. In most cases 40% - 60% of the original amount is reduced and it saves you thousands of dollars.
  
• Avoid rude and harassing creditor calls: You can stay away from dealing with abusive creditors and harassing debt collectors and debt buyers. Your settlement company will directly deal with them. They will also make sure that you do not get abusive and harassing calls anymore.
  
• One monthly installment for all your debts: In this process you will have to pay one monthly amount to your debt settlement firm in order to settle all your debts. They save the money in a trust account and starts negotiating with your creditors. The more you save each month the lesser time you take to become debt free.
  
• Get more time to pay: Most debt negotiation plans are worked out for an extended time period. In such cases you have the provision to extend the time span from 2 to 4 years or sometimes even longer. This is helpful for people who cannot afford to pay the whole amount at one go. It is also less likely that you will have to fight with the creditor later to actually delete the negative listing.

Right time to settle your debts

It is very important to take the right decision at the right time to get full benefit from a debt settlement program. We have discussed some specific cases here to explain how a settlement offer is handled when your debt turns older. However, we suggest you to discuss your situation with a settlement company or some experts in the field before taking the final decision.

• Few months delinquent: When you are few months behind with your payment, your creditor might agree to reduce 40% - 60% of the original debt amount.
  
• Charged-off account: If the account is charged-off, it is likely that your creditor would sell the account to a debt buyer. Dealing with these debt buyers is a nightmare. They often charges collection fees and deny accepting any repayment plan. However, a professional debt settlement company can help you settle your account with collection agencies too.
  
• Creditor is going to sue you: Creditor can file lawsuit against consumer. Once a judgment enters your credit report, it stays there for 7 to 10 years. If you have received a summon already, settlement companies are unlikely to work with that debt. However, there are certain law firms and attorneys that can guide you to get an out-of-court settlement.

There are five main objections to debt settlement

• Damages credit
• Increased debt collector calls
• Possibility of lawsuits
• Tax consequences
• Cost of completing the plan

Credit Impact: An understandable downside of the debt settlement program is that it damages credit scores. This is due to not making any payments to the creditors untill a lump sum payment can be made at the discounted amount. However, sometimes the debt  company can ask the creditor to make the credit report show "paid in full" or to delete the account to help off-set the negative impact. Most of the time the credit scores are already damaged from missing payments. A debt settlement plan is meant to get all of debts eliminated so in the future your credit can be restored.

Debt Collectors: The Fair Debt Collection Practices Act is the federal law that dictates how and when a debt collector may contact you. A debt collector may not call you before 8 a.m., after 9 p.m., or at work if the collector knows that your employer doesn't approve of the calls. Collectors may not harass you, make false statements, or use unfair practices when they try to collect a debt. Debt collectors must honor a written request from you to stop further contact.

Lawsuit: While creditors have no obligation to agree to negotiate the amount a consumer owes, they have a legal obligation to provide accurate information to the credit reporting agencies, including your failure to make monthly payments. That can result in a negative entry on your credit report. And in certain situations, creditors may have the right to sue you to recover the money you owe. In some instances, when creditors win a lawsuit, they have the right to garnish your wages or put a lien on your home. Get it in writing that if any creditor sues or trys to garnish wages the debt company's policy is to settle with that creditor. Typically the debt company can offer a "term settlement" with that one creditor to avoid any nasty law suits or wage garnishments.

Tax Liability: Finally, the Internal Revenue Service may consider any amount of forgiven debt to be taxable income. Consult a CPA or accountant to see if insolvency (lack of assets) will protect you from the taxable income as a result of the forgiven debt. For example, if a taxpayer is $10,000 in debt and owns $3,000 in assets, he/she cannot exclude more than $7,000 of forgiven debt from his/her income tax. Any forgiven debt over $7,000 that year must be reported as taxable income. If you have no assets than you may be able exclude of all the 1009c income from your taxable income (insolvency). Keep in mind that not all creditors will file the 1099c forms to hit you with taxable income.

Cost of Services: The fees charged by a debt settlement company are going to cost you about 8-15% of your total debt load. In most cases the fee is rolled in to the monthly savings payment. There may be a one time set-up fee and a monthly maintenence fee. The set up fee should not be more than $100 (may be more if an attorney is required, $199) and the monthly maintenence fee should be less than $85 per month. Read the fine print and guarantee. If they are not wiling to give you a written guarantee to perform and produce you should reconsider doing business with them, regardless of their affiliations or ratings. Get competing offers before making the decision.

A reputable debt settlement company will allow you to make payments into a new account at your bank. They also provide you with detailed statements showing where the money is going. Throughout the process you have your own bank account statements that show any withdrawls and you also have control over your money. 

What debts can be included in a settlement plan?

Typically there are several debts that can be negotiated once they are either reported as late payments or in collections. Not all creditors agree to the standard negotiation percentages listed bellow. Be sure include as many debts as possible because one missed debt could hinder your ability to rebuild your credit later.  It is also recommended to keep a few credit cards, to pay on time, outside of the settlement to get an early start on rebuilding your credit.

• Credit Cards at 40-50%
• Medical Bills in collections at 50%
• Other unsecured debt at 40-60%
• Cell phones in collections at 50%
• Repossessions that are in collections at 50%
• Judgements or litigation at 80% (not always allowed)
• Utility bills in collections at 50%
• Non-Government backed student loans at 50%

What debts cannot be included in debt settlement?

• Small unsecured debts typically will not be negotiated if they are under $500 each
• Home Loans, car loans, boat loans, motocycle loans are all considered secured debt
• Government backed Student Loans are not allowed in debt settlement or bankruptcy
• Payday loans or Check Advances
• Tax Liens

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