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From Wikipedia, the
free encyclopedia Debt
settlement, also known as debt arbitration or debt negotiation,
is an approach to debt reduction in which the debtor and creditor agree on a
reduced balance that will be regarded as payment in full.
As long as consumers continue to make
minimum monthly payments, creditors will not negotiate a reduced balance.
However, when payments stop, balances continue to grow because of late fees
and ongoing interest.
Consumers can arrange their own settlements
by using advice found on web sites, hire a lawyer to act for them, or use
debt settlement companies. Some settlement companies may charge a large fee
up front; or take a monthly fee from customer bank accounts for their
service, possibly reducing the incentive to settle with creditors quickly.
One expert advises consumers to look for companies that charge only after a
settlement is made, and charge about 20 percent of the amount by which the
outstanding balance is reduced.
History
As a concept, lenders have been practicing
debt settlement thousands of years.However, the business of debt settlement
became prominent in America during the late 1980s and early 1990s when bank
deregulation, which loosened consumer lending practices, followed by an
economic recession placed consumers in financial hardships.
With charge-offs (debts written-off by
banks) increasing, banks established debt settlement departments staffed
with personnel who were authorized to negotiate with defaulted cardholders
to reduce the outstanding balances in hopes to recover funds that would
otherwise be lost if the cardholder filed for Chapter 7 bankruptcy. Typical
settlements ranged between 25% and 65% of the outstanding balance.
Alongside the unprecedented spike in
personal debt loads, there has been another rather significant (even if
criminally under reported) change – the 2005 passage of legislation that
dramatically worsened the chances for average Americans to claim Chapter 7
bankruptcy protection. As things stand, should anyone filing for bankruptcy
fail to meet the Internal Revenue Service regulated ‘means test’, they would
instead be shelved into the Chapter 13 debt restructuring plan. Essentially,
Chapter 13 bankruptcies simply tell borrowers that they must pay back some
or all of their debts to all unsecured lenders. Repayments under Chapter 13
can range from 1% to 100% of the amounts owed to unsecured creditors, based
on the ability of the debtor to pay. Repayment periods are 3 years (for
those who earn below the median income) or 5 years (for those above), under
court mandated budgets that follow IRS guidelines, and the penalties for
failure are more severe.
How it works
Essentially, the debt settlement company
negotiates on the borrowers’ behalf with creditors to reduce the overall
debts in exchange for an agreement upon regular payments to be made. Only
credit card debts can be handled, not student loans, auto financing or
mortgages. For the debtor, this makes obvious sense – they avoid the stigma
and intrusive court-mandated controls of bankruptcy while still lowering,
sometimes by more than 50%, their debt balances. Whereas, for the creditor,
they regain trust that the borrower intends to pay back what he can of the
loans and not file bankruptcy (in which case, the creditor risks losing all
monies owed).
There are obvious drawbacks – credit
reports will show evidence of debt settlements and the associated FICO
scores will be lowered as a result. There’s always the possibility of
lawsuit whenever debts lay unpaid. Since few creditors wish to push
borrowers toward bankruptcy – and the potential of governmental protection
against all debts. In addition, the specific debts of the borrowers
themselves affect the success of negotiations. Because Tax liens and
domestic judgments cannot be discharged through bankrupcy, they remain
unaffected by attempts at settlement. Student loans, even those not
federally subsidized, have been granted special powers by recent legislation
to attach bank accounts without possibility of Chapter 7 bankruptcy
protection. Also, some individual creditors, including Discover Card, for
example, tend to have an aggressive resistance against negotiations.
Debt
Settlement Companies
In order to work with a debt settlement
company, a consumer needs lump sum cash (best scenario), or build up enough
funds over pre-determined period of time. Once enough funds are built up the
negotiation process can begin with each creditor individually. Accounts can
be held by credit card companies or may be sold to collections agency for
average of $0.15 on the dollar. In which case debt can still be negotiated.
The debt settlement company negotiates with the credit card companies for
35% - 50% of the existing balances. The debt settlement companies typically
have built up a relationship during their normal business practices with the
credit card companies and can come to a settlement agreement quickly. Once
the consumer pays the agreed upon amount, the debt settlement companies take
a percentage of the savings of the forgiven debt as the fee. With the
current economic crisis, more and more credit card companies may be willing
to settle existing credit card debts rather add to their already large
written off bad debt.
Because many debt settlement companies are
for-profit and their employees are paid based on commissions, many
frequently don't even contact the debtor until the account has charged-off.
In many states this practice is conisidered unethical, and debt settlement
companies are not allowed to practice in Arizona, Georgia, Hawaii,
Louisiana, Maine, Mississippi, New Jersey, New Mexico, New York, North
Dakota, West Virginia nor Wyoming.
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