Debt settlement involves the process of debt reduction. Typically, debtors negotiate agreements with their creditors that allow debtors to repay a part of their balance; the payments are accepted by the creditor as "paid in full." Some debtors handle the own negotiations with creditors. However, most choose to work with an attorney or debt-settlement firm. The settlement agreement may call for the debtor to make a large one-time payment or a series of affordable payments over time.
Settlement methods
Debt settlement begins with an analysis of your personal finances to determine the amount of your debt load and to create a debt management plan you can afford. People who negotiate their own settlements tend to offer creditors a single payment or a series of lump-sum payments. In exchange, the creditors agree to accept a portion of the outstanding balance as "paid in full" as long as the terms of the new agreements are met. Debtors who do not have money to offer such a settlement can work with debt-settlement companies to pay off the debt over an extended period---sometimes as long as five years. Typically, the debtor is required to deposit a monthly payment into a savings account. The settlement company then divides the payments between the creditors. Most settlement companies charge an upfront or monthly fee for this service; others receive payment in the form of 20 percent of the amount save by the negotiated settlement.
Debt management plan
A debt management plan is intended to help consumers get out from under an overwhelming amount of debt. It is commonly put together by debtors who are working with debt settlement or credit counseling firms. An effective debt management plan is based on a person's current finances; it is an affordable strategy for repaying unsecured debts in five years or less. The consumer who takes this path realizes a few immediate effects of debt settlement, including lower interest rates, reduced payments, elimination of fees and penalties and fewer collection-agency calls.
Reduce payments
Some states have financial hardship laws that permit consumers to lower the amount of money they owe if they can prove that they cannot afford to pay the full amount of their debt. Some people are able to negotiate with creditors to get the outstanding balance reduced from 25 to 65 percent. Other people use the tactic of bargaining for a reduction in the interest rate.
Penalties and fees
If you are having difficulty making your payments on time or exceed your credit limit, most creditors will automatically charge late fees and other fines. These fees can add a substantial amount to your outstanding balance over time. Consumers who stop paying on their accounts face penalties, fees and interest that continue to inflate the account balance. Negotiating a debt settlement with your creditors can significantly reduce, and in some cases eliminate, the additional charges.
Improve credit
Each month, your pattern of paying creditors is usually reported to the three major consumer credit reporting agencies. A history of late payments, defaults and charged-offs will drastically lower your credit score. Even if you are able to secure credit in the future, it is usually at a much higher interest rate. One of the effects of debt settlement is that you can immediately move toward paying off the accounts and improving your credit score. Usually the creditor will add a comment to your credit report indicating that you are making payments by a debt settlement organization. This information generally remains on the report until the debt is paid.
Tips
One of the emotional effects of debt settlement is the peace of mind it brings once you have your financial life back under control. In debt settlement, you should know what your rights are and get every agreement in writing, no matter if you're negotiating the debt settlement agreement yourself or having a third party do it for you. For example, if the creditor agrees to accept a single lump-sum payment as fulfillment of your debt, send a follow-up letter to the company detailing the agreement. In addition, you should write on the check "Cashing this check acknowledges payment in full." If you are working with a debt settlement company, monitor what they do. If they agreed to pay your bills, make sure the payments are paid according to the agreement.
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