Overview of Debt Settlement Programs
The third blog in our debt consolidation solutions series focuses on debt settlement programs. It functions by halting all payments you are making to creditors and requires you to close your accounts. Instead, you will make monthly payments (usually lower than your current payments) to a trust account. When that account has built up enough to pay off your debt in full, the debt settlement program company will begin negotiations with your creditors. They will also attempt to negotiate a lower debt amount by offering to make a lump sum payment.
This option negatively affects your credit score because:
- You have to close your accounts
- Work with a debt settlement company
- You don’t pay your debts in full
Furthermore, creditors do not have to comply with your debt settlement program; creditor participation is voluntary. A debt settlement program stops creditor harassment but cannot stop collection actions. Creditors still have the right to file a lawsuit against you or garnish your wages, for example.
How it Works
A debt settlement program works differently than a loan or debt management program. In a debt settlement program you will sign an agreement with a debt consolidation company to stop making monthly payments on your unsecured credit and close your accounts. This is not good for your credit score – every month you don’t make monthly payments on your debt, your credit score suffers.
Instead of making monthly payments to creditors you will make monthly payments into a trust account managed by the debt settlement company. In order for this to be a viable debt solution, this monthly payment needs to be less than the payments you are currently making.
Negotiations & Tenure
Once this account is large enough the debt consolidation company will begin negotiating with your creditors; one common settlement offer is to make a one-time lump sum payment that will eliminate your debt. The consolidation company will request a lower amount, which benefits you, in exchange for a one-time payment, which benefits the creditor.
This benefit for creditors is that you (the debtor) and your lack of responsibility to pay off your debt will go away. Creditors may agree to this offer because they will get paid some of your debt; if you end up filing bankruptcy they run the risk of not getting paid at all. Their logic behind accepting a settlement is that some is better than none.
These negotiations between your settlement company and your creditors don’t start until your account has built up enough money to make a full payment. Typically, people in debt aren’t able to make large monthly payments so this account buildup could take a long time.
There is no determined tenure of a debt settlement program because it is dependent on your ability and the speed of which you can build up your trust account. The longer it takes the longer your credit score suffers. And the longer it takes you to build up your account and pay off all your creditors, the better it is for the debt consolidation company because they take a percentage of your monthly payment as fees for their service.
Creditor Compliance
Just because you enter into a settlement program doesn’t mean your creditors can’t make attempts to collect on your debt. You are still subject to collection activities and legal action, especially if a creditor chooses to deny your consolidation company’s settlement offer. This can cause additional headaches because now you are making monthly payments to your consolidation company (from which they are taking a percentage for payment) and your creditors won’t comply which may result in additional harassment or legal consequences.
Learn how the other debt solutions compare to debt settlement programs by downloading our free eBook, The Truth About Debt Consolidation.
Check out the other blogs in our Debt Consolidation Solutions Series:
- Debt Consolidation Solutions Blog Series: Unsecured Loans
- Debt Consolidation Solutions Blog Series: Home Equity Loan
- Debt Consolidation Solutions Blog Series: Debt Management Program
- Chapter 13 Bankruptcy
