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Debt Consolidation Facts

1. If you spend more than 50% of your credit limit every month, this indicates to the Credit Bureau that you do NOT have enough cash on hand to meet your monthly expenses. This will identify you as a high credit risk and will actually reduce your credit score by 60 - 70 points overnight (Fair Isaac).

2. If you miss 1 or 2 payments on your credit card debt, the issuing company will skyrocket your interest rate to a whopping 27% - 30%!

3. Out of a random sample of 3 million American consumers (included in Experian's National Score Index), 51% of them have at least 2 credit cards and 14% of them have 10 or more credit cards.

How debt settlement eliminates debt

As a general rule, only unsecured debt, such as credit cards, is likely to be settled for less than the total balance you owe.  Loans that are secured by collateral assets such as real estate and automobiles are not normally candidates for debt settlement.  This approach usually involves either a lump sum settlement of the debt owed, or a structured payment plan that is less than the monthly payments would have been without a settlement. 

In the case of the lump sum, you would offer the creditor a fixed amount of cash upfront that is less than what you owe, with the agreement that they would permanently cancel the remaining balance.  In most cases, this is the only approach that a credit card company will accept since they want to get the debt off their books without having to wait months or years.  For this to work, you will need to have cash available or assets that can easily be converted into cash in order to offer a lump sum payment.

Can you settle your debt on your own?

You can deal directly with your creditors regarding settling your debts.  While this may seem a bit intimidating to some, there is no reason why you can’t duplicate what a settlement company might do on your behalf.  If you are behind on your payments, the first step is to contact the customer service representative for your creditor.  Ask to speak to someone who has the authority to negotiate on debt settlementbehalf of the creditor.  Explain your situation and what you are willing to offer to settle the debt.  Like any negotiation, your first offer should be less than what you are actually willing to pay to allow yourself room to counteroffer if necessary.  Take detailed notes of the conversation and date and sign them.  If an agreement is reached on a fixed settlement amount, request the creditor to send you a written confirmation.

If your delinquent debt has been turned over to a collection agency, chances are they bought the debt for substantially less than the face value.  Knowing this, you are in a good position to negotiate with the agency since they would most likely accept an amount far below what you owed the original creditor.  You can also request that the collection be deleted from your credit report, and make that a condition of the settlement with the agency.  If that is successful, you will still be stuck with the negative impact to your report from the original creditor.

Doing this yourself will save you money when compared to the cost of hiring a debt settlement professional or attorney.  However, many professionals have an established reputation with large creditors and may be able to cut a good deal very rapidly.  Should you decide to hire someone, do your homework, check their references, and make sure you have a written contract that clearly spells out what they will do and what it will cost.

Video: Credit Counseling or Debt Settlement?

What to expect

As the economic outlook continues to suffer, you are likely to see more and more credit card companies that are willing to settle your debts.  If they refuse to settle, they run the risk of getting nothing from you should you be forced into bankruptcy.  Their bad debt is growing exponentially and they realize that sometimes a bird in the hand is worth two in the bush.  While it is impossible to predict how much you would save by negotiating a settlement, you should target for something in the range of 35% to 65% of the outstanding balance.  Many companies will be tempted to split the difference with you at 50% if your first offer is less than that.

Why use debt settlement

The primary advantage of using this approach is that you eliminate a sizable portion of your unpaid debt and put it behind you.  Once you reach a settlement with a creditor and pay them the amount agreed upon, the remaining debt is canceled.  It avoids the prolonged process of paying down the debt over many years through a debt management plan, when your future ability to pay might be compromised for any number of reasons.

Video: Debt Settlement

Making minimum payments on a large debt will cost you dearly in interest expense in the end.  Settlement also saves the cost of hiring a credit counselor over an extended period of time.  This is probably the quickest and least expensive method available for resolving your debt problems.

While your credit rating will be damaged, you can request that your file be annotated to show the debt was paid or settled in full.  At least this is evidence that you are making a best effort to manage your finances during a time of difficulty.  This is preferable to declaring bankruptcy which will immediately flag you as a high risk and prevent you from getting credit or make it very expensive for the next ten years.  In addition, it avoids the stress, expense, and social stigma associated with filing for bankruptcy protection.  Settlement also avoids placing your assets at risk by pledging them as collateral on a debt consolidation loan.  If your delinquent accounts are unsecured, there is no point in securing them by refinancing your home or initiating a home equity loan.

A disadvantage of this approach is that you have to settle with each creditor individually.  If you can’t do this on your own, hiring someone to do it for you could be expensive if you have many creditors.  There could also be tax consequences since canceled debts are reported to the Internal Revenue Service as income if the amount exceeds $600.  It’s important to take this account when you are negotiating the settlement since the amount forgiven must be large enough to more than offset any additional taxes.  You can also see if you can qualify for the IRS insolvency provisions which would potentially relieve you from any tax liability.