Debt SettlementDebt Settlement (also known as Debt Arbitration) is one of the most aggressive means of reducing a person’s debt. It is usually used by large-scale debtors who are considering bankruptcy. If such thing happens, the management of the debt is passed to a debt arbitration agency, which tries to persuade the creditors to accept an amount lower than the owed one, thus saving their money for a lump-sum settlement payment. If the debt is settled successfully, the creditor forwards a letter to the debtor confirming that the debt obligation was fulfilled and informs credit bureaus about the debt being “Settled for less than full amount”, “Paid”, or “Settled”.
The reason why some creditors agree to accept a sum lower than the owed one is that, in case of bankruptcy of the debtor, they will get nothing at all. Thus, if they know that the debtor is experiencing serious financial problems, there’s a high possibility that debt settlement will work out. However, if the debtor appears to be in the sate of good financial well-being, the creditors may decide to take legal action.
Contents of the article: 1 Premise
2 Brief history of debt settlement
3 The process of debt settlement
4 Comparison of debt settlement opportunities and debt management plans by Customer Credit Counselors
5 Types of debts that debt settlement agencies usually deal with
6 Debtor’s reasons for enrolling into debt settlement process
7 Creditor’s reasons for accepting a debt settlement offer
8 Main disadvantages of debt settlement
8.1 Damages credit
8.2 Increased collection calls
8.3 Possibility of lawsuits
8.4 Tax consequences
8.5 The necessity to settle with all creditors
9 Debt Settlement Trade Associations
Premise A debtor may resort to the help of a debt arbitration agency if he/she is not able to meet his/her financial obligations to their full extent, and if the attempts to collect on the debt performed by the creditor have failed. In this case, the creditor may agree to settle on the debt by accepting a part of the debt as full repayment.
Basically, debt settlement is a process that falls right in between the processes of consumer credit counseling and bankruptcy. Why say so? The reason is pretty simple – most consumer credit counseling agencies aim at avoiding filing bankruptcy, while the debt management plans that they offer often prove to be unacceptable for consumers experiencing legitimate financial hardships. That’s why a large number of debtors prefer to resort to the help of debt settlement offices rather than sticking to the services of consumer credit counseling agencies.
Some creditors turn out to be willing to keep on working with their debtors even when their accounts are past due so it might be useful to contact your creditor and try to re-arrange payment plans. However, in most cases a reputable debt settlement professional proves to be more efficient in such situations anyway.
In a general way, what a debt arbitration agent actually does is setting up a payment plan that a given customer will be able to handle and then negotiating it with the creditor on the debtor’s behalf. Usually debt settlement programs prove to be capable of reducing the regular monthly credit card payment by up to 50%, thus getting a given consumer out of his/her debt in a pretty short time.
Brief history of debt settlement Basically, the history of debt settlement is about as long as the history of the debt itself because it has been practiced by all lenders since the ancient times. However, it turned into a sort of business only in 1980’s-1990’s in the USA, following the well-known bank deregulation and economic recession, which triggered severe financial hardships among the customers.
The rapid growth of charge-offs (debts written off by the banks due to customers’ bankruptcy) made bank professionals seek for a way to prevent the debtors from filing for Chapter 7 bankruptcy, which made the banks lose their funds without any chance to regain them. That’s how debt settlement departments were established. The personnel that such departments were staffed with were authorized to negotiate with the debtors on the verge of bankruptcy to reduce the outstanding balance, which would help to recover at least some part of the funds. At that time the creditors accepted debt payment settlements ranging between 25-65% of the original debt…
During the late 1980’s and the beginning of 1990’s there were only two major companies specializing in third-party debt arbitration - Berglas Hill & Ryan and Arbitronix Inc. However, at that time the emphasis was focused more on the consolidation of commercial debt rather than the settlement of debts of regular customers. Still, it was real breakthrough for debtors who finally got a fully legal chance to oppose numerous Collection Agencies and Debt Collection law firms. Soon the concept of debt settlement moved on to the Internet, causing the appearance of a large number of independent and cooperative debt arbitration companies. For a short period of time all such enterprises were the members of a trade association for commercial debt settlement companies – but this association didn’t last and soon was replaced by what now exists in the consumer debt field as set forth below.
During the late 1990’s and the beginning of the new millennium the amount of debt owed by regular customers reached an all time high. Consumer Credit Counselors and similar non-profit and for profit organizations had been handling the situation for some time but they didn’t last for too long. The banks’ interest to debt counseling was suddenly dropped and replaced by another form of debt settlement coming from the world of commerce. There had been registered a booming growth in the number of companies offering third-party debt settlement – but none of them had enough experience in negotiation with bank representatives, so a large number of such companies soon disappeared (a large number of them was just closed by the FTC). From that time and on, consumer debt settlement was under strict control of FTD. The only ones to stay in the market of third-party consumer debt arbitration were the most ethical entrepreneurs from the commercial world and consumer debt departments of the most respectable companies who had previously been dealing with commercial debts only. They were no longer supported by banks, so most of them quickly turned into for-profit organizations charging fees for their services. Usually they ask for a lump-sum payoff or short-term installment payoff in exchange for their attempts to reduce the outstanding balance of a debt.
In 2004, the United States Organization for Bankruptcy Alternatives (USOBA) was established by debt arbitration practitioners. The main aim of USOBA is supporting the debt settlement industry and developing standards and best practices. The enterprise responsible for training and certifying debt arbitration practitioners is the International Association of Professional Debt Arbitrators (established in 2000). Another famous association related to the industry of debt settlement is The Association of Settlement Companies (TASK), which was initially aiming at fighting “unfair and ambiguous debt management legislation” in Texas and later broadened its influence onto all fifty states after conducting a successful campaign in Texas. The activity of debt settlement companies is regulated by The Uniform Debt-Management Services Act (UDMSA), adopted in all 50 states.
The process of debt settlement Basically, the process of debt settlement is the same both for a debtor acting independently and for a third-party debt arbitration agency acting on behalf of the debtor (a limited power of attorney has to be signed by the debtor in order to make this representation legal). The next step that the debtor will have to do is saving money and building up a settlement fund. As soon as this fund gets big enough to make a reasonable offer accrue to the creditor, the negotiation will be held. Usual payoff amount for such cases equals to 25-50% of the original debt.
If the creditor agrees to accept the offered amount as a full payment, the payment gets arranged and the debtor’s account gets the status of “settled-in-full” (as opposed to “paid-in-full”). Meanwhile, the debtor keeps on saving up funds for negotiating a settlement for the next creditor willing to accept the offer. It will continue this way until all debts are settled.
Comparison of debt settlement opportunities and debt management plans by Customer Credit Counselors Debt settlement is often confused with debt management plans available through non-profit organizations specializing in customer credit counseling. However, these two are not similar in any ways.
Debt management plans offered by CCC agencies are aimed at lowering the interest rate on the credit card, which may result in the lowering of the regular monthly payment and directing the larger part of the funds towards paying off the principal instead of the interest charges. This results in a faster (within 60 months) payoff of enrolled debts. The debtor makes one payment to the credit counseling agency, which then distributes it among the creditors according to the regulations of a scheduled repayment plan. Some credit counseling agencies may charge a set-up general fee and a small regular fee collected in the end of each month, even though most of them are non-profit ones.
The activities carried out by a debt settlement agency are pretty different from the ones stated above. First of all, the thing such company is aiming at is lowering the outstanding balance of the debt. The debtor must sign the power of attorney to entrust the debt arbitration company with the right to negotiate with the creditors. Debt settlement agency is not aimed at negotiating lower interest and it doesn’t charge its clients with monthly fees. What it does is negotiating a reduced-balance settlement between the creditor and the debtor and carrying out the payment on this settlement (usually through some third-party processor). All that the client has to do is making monthly deposits into the debt settlement fund.
Creditors dealing with debtors on the verge of bankruptcy usually prove to be willing to negotiate with a third party, since in some cases it is the only way for them to get at least some part of their money back. Plus, you should remember that some banks often offer special programs to their customers suffering from financial hardships – you might want to use this opportunity instead of resorting to the help of debt arbitration or debt management agencies.
Types of debts that debt settlement agencies usually deal with The list of debts that can be negotiated for settlement includes only unsecured debts (credit card debts, medical debts, etc). The reason why secured debts (home loans car loans etc) cannot be negotiated is that the creditor usually has the right to repossess the property purchased for the borrowed money. The minimum amount of the enrolled debt that a debt settlement company will usually agree to work with should be equal to at least $7,500-$10,000. However, there are some debt arbitration agencies that do accept smaller debt loads.
Debtor’s reasons for enrolling into debt settlement process The main reason why a debtor might want to enroll in the debt settlement negotiations with creditors is the willingness to payoff his/her debts according to his/her financial ability (which is most likely to be strained due to certain financial hardships caused by unemployment, loss of income, high fees for healthcare, or other burdens). The other reason is the willingness to avoid bankruptcy, which can be kept on the debtor’s credit file for as long as the next10 years.
Creditor’s reasons for accepting a debt settlement offer The main reason why a creditor might want to enroll into debt arbitration process is the need to recover the funds that can be lost completely in case a debtor files for bankruptcy. Plus, this method is always likely to recover more funds than other debt collection methods are capable of recovering – simply because of the high fees that most debt collection companies and collection attorneys usually charge for their services (the amount can be as high as 40% of the recovered amount). Creditors may also try to sell the debts that they can’t return to bad debt purchasers – but in this case they will get only 1-7% of the initial debt amount. Only a few creditors resort to the help of collection calls and lawsuits, since these means usually push a debtor into bankruptcy and the creditor doesn’t get any money at all.
Main disadvantages of debt settlement Basically, there are 5 main features of consumer debt arbitration that can be considered its disadvantages. These are: damages credit, increased collection calls, possibility of lawsuits, tax consequences and the necessity to settle with all creditors.
Damages credit As stated above, the main step of debt arbitration process that the debtor must make is saving up and setting money aside into a settlement fund from which the settlements are paid. However, due to certain financial hardships that the debtor is suffering from, there’s a high probability that he/she would not be able to make minimum payments towards credit card debts while trying to build up the settlement fund. This may result in the credit card company reporting non-payment to credit bureaus (the list of credit reporting agencies includes: Equifax, Experian and TransUnion).
This may affect the debtor’s FICO credit score calculation dramatically, since 35% of it depends on the payment history of a given debtor. Any reported non-payment will certainly lower the debtor’s credit score and affect his/her credit report negatively. However, you should also remember that 30% of a given debtor’s FICO score is calculated by the amounts owed. Thus, even if debt settlement damages your payment history, once the debt is eliminated, the FICO will be improved again (the amounts-owed portion of FICO to be precise). This process will also improve your debt-to-income ratio – the ratio used by future lenders.
Debt arbitration agencies are currently arguing with the existing system of calculating the FICO score. The main reason for such argument is that the good credit and loose lending opportunities offered by credit card industry allow the consumers to accumulate enormous debt amounts, which later results in the fact that a single financial hardship can interrupt the consumer’s ability to pay his/her debts according to the schedule once and for all. Plus, the credit card score doesn’t always reflect the state of a given customer’s financial well-being at a given period of time.
Increased collection calls Another peculiarity of debt arbitration process that can be considered its disadvantage is the increase in debt collection activities that always follows the debtor’s failure to continue the debt payoff according to the primary schedule. This may be incredibly stressful for a given debtor.
Debt settlement agencies counter this statement pretty easily – they say that in most cases it is the increased collection activity itself that makes debtors seek for debt arbitration. Most debt arbitration agencies offer their customers an opportunity to pass the responsibility for alleviating collector calls into their hands. Plus, a customer of a debt settlement company will always be informed about all his rights stated in the Fair Debt Collection Practices Act (FDCPA). A debtor may even be offered to change his/her phone number in order to get the debt collection calls transferred directly to the representatives of the debt arbitration agency.
The power of FDCPA currently varies from state to state. Initially, this law document applied to third-party debt collectors only, not the creditors themselves. However, pretty recently several states passed legislation to supplement the FDCPA by including both creditors and their representatives in their state consumer protection laws concerning debt collection.
Possibility of lawsuits The debtors enrolling in debt arbitration are often afraid of the lawsuits that their creditors might want to start against them. However, this possibility if usually countered by the argument that the treats of lawsuits filed against debtors holding delinquent debts are usually more common than the lawsuits themselves. In most cases, the creditors are not that eager to start such lawsuits since the costs of the legal action often exceed the amount of money received as the result of the lawsuit. Legal threats make most debtors pay higher attention to settling the problems with a given creditor and that’s the basic reason why they are made.
Tax consequences One more disadvantage of debt settlement is that the debtors who don’t file themselves for bankruptcy and have their debts partially cancelled, have to report the canceled portion of the debt as taxable income.
Minimum taxable amount of the forgiven debt is $600. The creditor forgiving an amount of debt equal or exceeding this sum must supply his debtor with a 1099-C tax form stating the amount of the forgiven debt and interest in Box 2. The interest reported in Box 3 may not be subtracted from the total amount of reportable income stated in this form.
However, the IRS allows insolvent taxpayers (the debtors with the amount of debts greater that his/her assets) to skip reporting the forgiven debt as taxable income. On the other hand, you should know that IRS doesn’t allow excluding any amount of canceled debt in case it exceeds the amount by which you are insolvent. For instance, if a taxpayer owes $100,000 to his creditor and possesses $30,000 in assets, he/she cannot exclude more than 70% of forgiven debt ($70,000) from his/her income tax. Any forgiven debt that is over $70,000 that year must be reported as taxable income.
The necessity to settle with all creditors There’s a high probability that some of the debtor’s creditors will refuse to settle for the offered amount. The more creditors a debtor has, the higher is this probability. In case a given debtor doesn’t succeed in settling with all his creditors, he/she will still be left in the danger of bankruptcy, lawsuits and subject to debt collection activity.
Debt Settlement Trade Associations There’s currently a number of debt settlement trade associations established by practitioners in this industry. The main aim of such associations is securing high industry standards and fighting unethical and sometimes unlawful actions taken against the customers. There are currently two most prominent debt settlement associations, namely the United States Organization for Bankruptcy Alternatives (USOBA) and The Association of Settlement Companies (TASC). You can visit their official websites to learn more about debt arbitration industry itself and the policies of these associations.
Individual practitioners working in the debt arbitration industry are subject to passing the training and certification at International Association of Professional Debt Arbitrators (IAPDA). Always make sure that the specialists in the debt settlement company that you resort to are IAPDA-certified.
|
