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Debt Settlement: Just What Is It, Anyway?

By: Michael Millington

There’s an old saying: when you owe the bank $10,000 and can’t repay, you’re in trouble. When you owe the bank $10 million and can’t repay, the bank’s in trouble. No matter what the size or the circumstances, debt is a problem for people, for businesses and for governments all over the world. Sometimes it becomes possible to settle a debt for less than the debt actually calls for, and in a case like that, a debt settlement company can be a great place to start looking.


Debt settlement is a practice by which usually a third-party negotiator—often a company—steps in between a debtor and a creditor to negotiate a settlement. This settlement represents a certain minimum amount that a creditor is willing to accept, generally not the full amount. However, as a condition of this, the debt settlement required is often a lump sum payment. That doesn’t necessarily mean the debtor has to come up with that payment, however; instead, the debtor agrees to deposit a certain amount of money every month into an account that works a lot like an escrow account. The amount of the account builds up until the settlement target is reached, and then the resultant cash is given to the creditor in settlement of the debt.


That poses a risk in and of itself, however. First, it requires the debtor to make these payments for the life of the settlement agreement, sometimes three years or even longer. That means it’s necessary to consider current obligations and income to make sure that the payment can be met. This doesn’t even factor in the potential of sudden and protracted job loss. Plus, the creditors are under no obligation to negotiate a settlement at all; they may demand the full amount despite any efforts by negotiators. Since settlement programs generally require the stoppage of payment to the creditor, that can be a hit on credit ratings or even potentially a means to drive late fees and other penalties. Calls from debt collectors and even lawsuits are a possibility under debt settlement.


Perhaps worst of all is that there are even debt settlement scams in operation that will offer impressive promises—guaranteed settlements, for example, and at pennies on the dollar—and in exchange will demand fees up front. That’s a practice forbidden by the Federal Trade Commission (FTC), so when someone wants fees before a settlement, it’s not only a good sign of a scam afoot, it’s also straight up illegal.


So why would a creditor even entertain the thought of a settlement to begin with? It’s a simple risk-reward analysis for many. Put yourself in the creditor’s shoes for a moment, and ask yourself, if someone owed me several thousand dollars, but could only pay half or three-quarters of that, wouldn’t it be a good idea to take what I can get? Sure, I could hold out, you might think, and even use the courts to force this guy’s hand, but what happens if this guy declares bankruptcy? I’m not a secured creditor, or a student loan operation; I’d lose the whole amount. Better to get some instead of none.


Some instead of none. That’s the bottom line when it comes to debt settlement, because for creditors, there’s the possibility of running afoul of bankruptcy law and the potential loss of the whole debt. No one wants to run that risk, so there’s often a possibility of making that settlement and making it stick. That chance represents an entire industry, and makes debt settlement look like a potential help for a lot of debtors in trouble.


Written by Steve Anderson