Debt resolution, also known as debt settlement or debt negotiation conjures up many negative connotations. In fact, many attorneys who post on various legal advice sites frequently mention scam in the same sentence as debt settlement. And they would not be far from wrong as there are many bad actors that prey upon those who are already in need of help and unbelievably make a bad situation worse. So a debtor who is considering this option needs to do some homework first and thoroughly check out a debt settlement company before forking over thousands of dollars and falling for empty promises.
With debt resolution, the debtor offers to settle a particular debt for less than the balance owed. When the debtor decides to go this route, the debtor starts putting aside funds into a special purpose dedicated account in the debtor’s name. When the debtor accumulates enough funds in the account (say 50% of whatever the balance is on a particular debt), the creditor or collection agency is contacted and hopefully the debt is resolved. The particular percentage will vary, but usually the debtor comes out financially ahead by paying back less than 100% of the debt. The debtor then goes about replenishing the funds in the special account and the next debt is settled when the debtor again accumulates sufficient funds.
There are both pros and cons with this options. First the pros:
(1) The debtor’s participation in debt settlement is not reported to any credit bureaus.
(2) The debtor, if he or she diligently saves funds, can resolve unsecured (credit cards or personal loans) for far less, even including any fees paid to a debt settlement company and any taxes, than if the debtor repaid every penny borrowed, plus interest and late fees.
(3) The debtor can become debt free in a relatively short period of time rather than be a debt slave for a much longer time by paying only the monthly minimums.
(4) Resolving debts takes negative information by turning it into more positive information on a debtor’s credit report. By this I mean that where a credit report showed delinquencies or charge offs, settled debts will be reported as “paid debt settled” or “paid collection” to the credit bureaus. The resolution of the debts from unpaid to paid debts helps create a more positive credit picture to lenders. Of course, only the passage of time and the responsible use of credit going forward can truly heal damaged credit.
Now the cons:
(1) While the debtor is free to decide what debts to settle, the fact is the debtor will find it difficult to obtain any new credit. If a debtor is considering refinancing an existing home or obtaining a home or car loan, then the debtor needs to do that before entering into any type of debt program because debt settlement only works once a debtor becomes delinquent on debts. By allowing a debt to become delinquent, the debtor is causing his/her credit score to drop and will have derogatory information reported.
(2) A debt settlement company should not tell a debtor to stop paying his/her debts. However, as a practical matter, the debtor finds him or herself in a bad position. The debtor has too many debts and not enough income. In a battle or emergency where many people are hurt, all will be treated but priority has to be given to the most seriously wounded and they get treated first. Debt resolution is no different. There is only so much money to go around and things like cars and mortgages and daily living expenses should be accorded priority over credit card debts. However, when the debtor does stop paying his/her credit card bills, the debtor’s credit score is going to take a nosedive.
(3) In order to settle or negotiate a debt, it is a fact of life that creditors will seldom agree to resolve a debt for a fraction of what is owed unless a debtor is behind by ninety (90) days or more. By then, a debtor’s credit is ruined. And a debtor’s credit report will continue to have the adverse information until the debt is resolved or becomes stale.
(4) Cost. Like anything else, services by a debt settlement company cost money. Depending on the policies of the organization, debt settlement companies may charge up-front fees before performing any work on a debtor’s behalf. The Telemarketing Sales Rule (TSR) was designed to eliminate some of the bad behavior by prohibiting debt settlement companies from charging a fee for transactions done on the phone until a debtor makes at least one payment under a settlement. There are exceptions to this rule (such as an exception for lawyers or for companies that meet with a client face-to-face). While a TSR client will accumulate funds on a faster basis, the fees still have to be paid. There is no free lunch.
(5) Tax consequences. Under the tax laws, the IRS requires that forgiven debt which exceeds $600.00 must be reported. Therefore, a credit card company which agrees to settle a debt for a fraction will report the forgiven amount to the IRS and send the debtor a 1099c (cancellation of debt) (for more details see my article entitled Cancellation of debt; http://www.rachelhunterlaw.com/cancellation-debts-1099c-forms/). The debtor will then have to include the forgiven amount of the debt in his/her income. Whether a debtor will have to actually pay tax on that amount is beyond the scope of this article (see my article on cancellation of debts). Suffice it to say that a debtor who receives a 1099c should talk with his/her tax preparer and see if all or some of the forgiven debt can be excluded.
(6) Notwithstanding any promises to the contrary, I am not aware of any debt settlement program out there which prohibits a debtor from being sued. The fact is that while the debtor is building up funds, his/her creditors who are impatient can and will sue. Lawsuits certainly can be managed but promises that a debtor will not be sued are wholly unrealistic.
In sum, these are all the different ways of dealing with a situation in which debts exceed income. You should be leery of companies that promise an easy and painless way out of debt. There is no magic wand or pill. Each of the methods has good and bad points. What is right in each case depends on the debtor’s age, circumstances, assets and debts, so what is right for one person will not work for another. It helps to have the situation reviewed by an attorney who focuses on this area of the law or by a certified credit counselor/debt analyst who will assist you in making the best choice.
Copyright (c) 2012 & 2014 by Rachel Lea Hunter
www.rachelhunterlaw.com
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