What is Debt settlement?

A debt settlement or debt negotiation is an agreement by a debtor to fulfil an outstanding balance of a loan usually for a reduced payoff amount to the creditor. If a consumer can legitimately or financially prove that he or she cannot afford to repay his or her debts through debt management plans offered by consumer credit counselling agencies and who also wants to avoid filing for bankruptcy, the creditor might be willing to settle the total outstanding balance for a reduce sum of payment.

A debt settlement is usually reached when a debtor is unable to fully meet his or her debt obligations due to financial hardships and numerous attempts by the creditor to collect on the debt have failed. The creditor therefore agrees to cancel part of the debt and accept the remaining sum as full repayment. Debt settlement is a go-between credit counselling and bankruptcy. Debt settlement is usually for non-secured loans (credit cards, student loans). If there’s an asset or collateral involved, the creditor might first consider repossessing the asset (e.g. car or home) as opposed to settling for a reduced amount. For example, if you are late on your car payments or mortgage payments, the creditor might first consider repossession of the property.

Debt settlement programs are provided by third parties (e,g. debt arbitrators) who set up payment plans, and then negotiate settlements on behalf of the consumer. Typically, debt settlement programs are able to reduce monthly payments by 50% and get consumers debt free in a short period of time.

Debt Settlement Vs. Debt Consolidation

Debt settlement and debt consolidation both offer ways of reducing your debt. Debt settlement eliminates part of your loans, while debt consolidation reduces interest rates. Even though debt consolidation has the least impact on your credit score, there are cases when debt settlement is a better option. The goal of both debt settlement and debt consolidation is to lower your debt. Debt settlement companies negotiate with your creditors to sometimes reduce the amount of your unsecured debt.

In a debt consolidation program, the credit counselling agency negotiates on a debtors behalf to reduce the interest rate on credit card account. The payments for different debt accounts are consolidated into one payment to the credit counselling agency. The credit counselling agency will then distribute the payment to each creditor based on a scheduled repayment plan over a stipulated period of time.

In a debt settlement program, the debt settlement company negotiates with the creditor to lower the outstanding balance of the debt. The debt settlement company does not negotiate lower interest rates and does not distribute monthly payments to creditors. The debt settlement company, usually through a third party payment processor, arranges for paying off debts once a reduced-balance settlement agreement is reached between the debtor and the creditor. The debt settlement client does make monthly deposits into their settlement fund, usually managed by an independent, third-party payment processor.

Reducing your debts through debt settlement is a method to get out of debt in a short period of time. Debt settlement and debt consolidation usually have an impact on your credit score to an extent. In extreme cases, debt settlement can help to avoid bankruptcy and debt consolidation loans.