Debt settlement, also known as debt arbitration or debt negotiation, is an approach to debt reduction in which the debtor and creditor agree on a reduced balance that will be regarded as payment in full.
How it works?
The debt settlement company negotiates on the borrowers’ behalf with creditors to reduce the overall debts in exchange for an agreement upon regular payments to be made. Only credit card debts and other unsecured loans 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).
In order to work with a debt settlement company, a consumer needs lump sum cash (best scenario), or build up enough funds over pre-determined period of time. Once enough funds are built up the negotiation process can begin with each creditor individually. Accounts can be held by credit card companies or may be sold to collections agency for average of $0.15 on the dollar. 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 a 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.
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.
