Debt Settlement Company: How Do They Reduce Debt?

Debt settlement companies negotiate with creditors on behalf of debtors to reach settlements that allow debtors to pay creditors less than they owe. Creditors lose money by agreeing to debt settlements, but sometimes agree to such deals if the debt settlement firm makes a convincing argument that a debt settlement represents the creditor's best chance of recouping some of the money that the debtor owes.

Default

You "default" on a loan if you fall more than 30 days behind on your scheduled payments. If you fall behind on loans secured by collateral then your lender can seize the collateral and sell it to recoup your debt. However, if you fall behind on your unsecured debt payments your lenders have very little recourse. A lender can attempt to have a lien placed on your home for the amount of the unpaid debt or a lender can sue you in court, but court judgments typically result in a debtor having to make minimal payments over a number of years.

Bankruptcy

Many people who cannot afford to pay their debts opt to file bankruptcy. If you file bankruptcy your lenders can no longer pursue you for the balance of your unpaid debt. Debt settlement firms often highlight the risk that a delinquent borrower could file bankruptcy as a way of encouraging a creditor to enter into a debt settlement agreement. Creditors' often agree to such deals if the debtor agrees to make a substantial lump sum payment to cover a portion of the balance owed.

Fees

Debt settlement agencies are for-profit companies that sometimes charge substantial fees for arranging debt settlements. Debt settlement companies do not have the ability to do anything that you could not do yourself in terms of agreeing a settlement. However, some people find it easier to leave negotiations to debt settlement firms rather than deal with constant phone calls from collection agencies. However, state laws on debt settlements vary, so before you hand over a lump sum or pay any fees, you should ensure that the creditor has no recourse to pursue you for the remainder of the debt.

Considerations

When you file bankruptcy it has a damaging impact on your credit score and remains on your credit report for 10 years whereas most other credit events only remain on file for seven years. Consequently, some borrowers are reluctant to file bankruptcy and instead enter into debt settlement agreements. However, many debt settlements companies strengthen your case to agree a settlement by instructing you to stop paying your other debts. Doing this lowers your credit score and gives your creditors the impression that you are more of a high risk borrower than you really are. Firms are therefore more likely to agree to a settlement with you rather than risk getting nothing. This enables you to avoid bankruptcy, but has a similarly damaging effect on your credit score.