(If you missed Part 1 – you can find it here)
If you believe the hype spun by many debt settlement firms, debt settlement sounds like an incredible solution for those consumers with too much consumer debt. Many advertise the ability to stop collection calls, avoid bankruptcy, and settle your debts for pennies on the dollar. Sounds good, right?
Well, although there are very few if any sources of independent data tracking the success rate of debt settlement efforts – it’s widely believed that most consumers fail in their efforts. If you believe the media and the FTC - it’s because all debt settlement companies are scam artists out to steal money.
While there are many in the debt settlement industry that do more harm than good – there are some that add quite a bit of value to the process.
I believe there are 2 main reasons most consumers fail with debt settlement, whether trying it on their own or with the help of a debt settlement company.
- Not a candidate for debt settlement. The solution attracts just about everyone looking to eliminate debt and avoid bankruptcy. Problem is, many aren’t good candidates for this solution. Good debt settlement companies will disqualify a large percentage of the people that contact them. Some consumers are better served by consumer credit counseling or bankruptcy.
- Wrong Expectations. Many debt settlement companies sugar-coat the process. Unfortunately, that leaves consumers unprepared for some of the potential hiccups along the road. They wind up giving-up due to pressures from debt collectors, creditors, self-doubt, etc.
The goal of this part of the 3 part series (which may wind up being expanded to 4 parts) is to address the “expectation” problem. It is important for you, and your clients, to understand some of the pitfalls and obstacles associated with debt settlement.
Credit Damage
Walking away after having successfully completed debt settlement without damaging your credit is virtually impossible. In almost all cases, in order to negotiate your debts with your creditors, you will have to stop making the required minimum monthly payment. During the process you will accrue late payments for that particular tradeline and when the account is settled for less that what is owed – it will be notated as such on your credit report.
Given that the alternative for most is bankruptcy, which will have a greater negative impact, this typically isn’t much of a concern.
Tax Consequences
If you have more than $600 in cancelled debts, you will need to report the amount to the IRS as income. Fortunately, the IRS allows you to write-off this income up to the amount you by which you were insolvent at the time. In most cases, someone who is looking to settle their debts owes more than they have and is considered insolvent.
In the off chance a consumer does wind up paying taxes on the cancelled debt, they still wind up paying less than if they had paid the debt off in full.
Collection Calls
Due to the fact that payments are no longer being made to creditors, creditor and collection calls are inevitable. Debt Settlement is not intended to be a “stop collection calls” solution and those companies that make such claims are relying on antiquated strategies that do more harm than good (e.g. cease and desist letters). There are strategies consumers can utilize to help protect their privacy and peace of mind.
Lawsuits
Any time a creditor stops receiving payments there is always the risk of them leveraging legal options to collect on a debt. Although statistically unlikely, the risk of a lawsuit increases the longer it takes to resolve the problem. Some debt settlement companies advertise options to settle your debts over a 3-5 year time frame. If you cut-off communication to your creditors and stop making payments for 3-5 years, there is a strong likelihood that you will be sued. Your goal should be to settle your debts as quickly as possible – as a rule of thumb – in less than 2 years.
Access to Credit
Once you’ve missed several payments and your account has been charged-off – you will no longer have access to any available credit associated with that credit line. You may find that accounts you have in good standing get closed by the credit grantor since they monitor your payment history with other accounts. You should enter debt settlement with an understanding that you will have little or no access to credit during the process.
So, why the heck would someone choose debt settlement?
Despite some of the drawbacks, there are plenty of benefits to debt settlement – especially compared to the alternatives. Those will be covered in Part 3….
As always, I’m happy to answer any questions about debt settlement for you or your clients as best I can…
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{ 14 comments… read them below or add one }
“There are strategies consumers can utilize to help protect their privacy and peace of mind.”
Can you expound a bit on this? What can consumers do to restrain or stop collections calls other than filing bankruptcy? Can they be required only to contact you at one phone number, for example. Perhaps you can restrain them to contact you on your cell only instead of home, work, etc.
This is good information, Chris.
great post. I cant wait to see part 2 and 3 I am very interested ing seeing alternatives.
Thanks Wade. I could probably write a separate post on the topic — but some quick/random info:
1) Don’t ignore collectors. Try and proactively speak with them at least once per month. It’s when they begin having difficulty getting a hold of you that they begin calling friends, family, work, etc.
2) Have a written script prepared for when you speak with them. Often times consumers aren’t properly prepared with what they are going to say and find themselves losing control of the call. Basic script should cover the fact that you’re experiencing a financial crisis, you would like to settle your debt and avoid bankruptcy, and low-ball a settlement offer. If they come back with an amount that cannot be afforded – thank them for their time, explain you cannot get that much money together right now, and you will continue to try to work through your situation as best you can.
3) Keep the calls short and stick to your script. Become a broken record and keep repeating the same script. Do not get lured into responding to threats, probing questions, etc.
4) Understand your rights under the FDCPA
5) Screen your calls and take control over when you answer them or return them. Turn the ringer off and have friends and family call you on a different line (cell phone, etc).
6) Hang up on rude or abusive callers
7) Never provide more info than they already have
A good debt settlement company can counsel you on where your debt is in the collection process, what to say, how often to speak with a collector, how to respond to threats, what to do when your rights have been violated, etc. The strategy can change if you are dealing with the creditor, a collection agency that has been assigned the debt, or a debt collector who has purchased the debt.
I’ve heard of specific strategies, like the Debt Snowball method. Can things like this be done without the help of a debt settlement agency? I read a little bit about it, but the calculations are a bit complicated.
Ling – Yes, certainly, consumers can negotiate their debts or implement the snowball method on their own.
The snowball method is simply taking what you can pay above the minimum payments and applying that amount towards your smallest debt. Once that’s paid, you take that additional + what you were paying as the minimum payment on the smallest debt and apply both to the next smallest debt. And so on… Very simple strategy – the opposite of paying off higher interest rate debt first. Some consumers find it more motivating to pay off a smaller debt quickly than only part of a higher interest rate debt.
I’ll cover what I think are some of the benefits of working with a debt settlement company, as opposed to doing it alone, in a future post.
I think that many people who go into this do it for the wrong reasons and thinking it would be easy.
I agree, alltough always slightly complicated informing onself of options available and how to prepare for them is definately helpful. Perhaps more information on how Do-It-Your-Self is required on the net..
I find it hard to believe that these “big banks” get government bail outs and then turn around threaten consumers for being late on thier 29.9% interest rates. What a country!
Thanks for the post, Chris. Perhaps the most thorough article on this topic I’ve read. I did not know that people could/would potentially be locked out from other credit sources during the process.
If you go for debt Settlement, does your credit improves? If so then how much will it improves? Please let me know, if you have the answer. Waiting for your reply
I’m so worried about getting screwed by an incompetent company. Also, I checked with Debtmerica and they’re trying to charge me a 15% fee to do the debt negotiation. I’ve checked with a few other places too and somebody recommended going with an attorney-based debt settlement company to get better results. Any help would be appreciated.
Bankruptcy credit counseling is a requirement of the new bankruptcy law effective October 17, 2005. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 requires court approved bankruptcy credit counseling to be completed by debtors prior to filing for bankruptcy within the 180 days immediately preceding the filing of a bankruptcy petition.
I've heard of specific strategies, like the Debt Snowball method. Can things like this be done without the help of a debt settlement agency? I read a little bit about it, but the calculations are a bit complicated.
Hello,
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