Debt Settlement
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Debt Settlement
Also known as Debt Arbitration or Debt Negotiation, is an aggressive approach to debt reduction.
Brief history of debt settlement

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. The settlements ranged between 25% and 65% of the outstanding balance.

Creditor’s incentives
The creditor’s primary incentive is to recover funds that would otherwise be lost if the debtor filed for bankruptcy. The other key incentive is that the creditor can often recover more funds than through other collection methods. Collection agencies and collection attorneys charge commissions as high as 40% on recovered funds. Bad debt purchasers buy portfolios of delinquent debts from creditors who give up on internal collection efforts and these bad debt purchasers only pay between 1 and 7 cents on the dollar. Collection calls and lawsuits often push debtors into bankruptcy, in which case the creditor often recovers no funds.

Common objections to debt settlement

There are five main objections to consumer debt settlement: damages credit, increased collection calls, possibility of lawsuits, tax consequences and the need to settle with all creditors.

 

Tax consequences

Another common objection to debt settlement is that debtors whose debts are partially canceled outside the bankruptcy system will need to report the canceled portion of the debt as taxable income. (IRS Form 980)

 

The Internal Revenue Service considers $600 or more of forgiven debt as taxable income. The forgiving creditor must provide the taxpayer with a 1099-C tax form. This form will list the amount of forgiven debt and interest in Box 2. Taxpayers with portions of personal loans forgiven may not subtract the interest reported in Box 3 from the amount of reportable income on this form.

 

However, the IRS does not require taxpayers to report forgiven debt if the tax payer was insolvent at the time the creditor forgave the debt. Being insolvent means that the amount of a debtor’s debts are greater than his/her assets (how much money and property the debtor owns). However, the IRS adds that “you cannot exclude any amount of canceled debt that is more than the amount by which you are insolvent.”

 

For example, if a taxpayer is $10,000 in debt and owns $3,000 in assets, he/she cannot exclude more than $7,000 of forgiven debt from his/her income tax. Any forgiven debt over $7,000 that year must be reported as taxable income.

Debt Settlement Trade Associations

Due to the rise of debt settlement as a debt relief alternative to bankruptcy, groups working in the industry have established trade associations to help secure industry standards that will protect consumers against unethical business practices. These trade associations were also established to lobby state governments because many state legislatures are passing laws that restrict out-of-state companies from providing debt negotiation services to in-state residents. The two major trade associations are the United States Organization for Bankruptcy Alternatives (USOBA) and The Association of Settlement Companies (TASC). Both of these organizations publish on their websites information about debt settlement and the debt settlement industry.

 

Individual Debt Settlement consultants can obtain thorough industry training and Certification through The International Association of Professional Debt Arbitrators. (IAPDA).

 

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Our Featured Question & Answer of the Day For Wednesday

 

Q. How does Debt Settlement hurt my credit?

 

A: How Debt Settlement affects your credit depends on many factors. The primary factor has to do with how your credit rating is now.

 

 If you have perfect credit, or even slow credit, Debt Settlement will derogatorily affect your credit. If however, you already have accounts that are over 4, 5 or 6 months past due, it may not affect your credit any worse than it already is. 

 

When a revolving account becomes past due, typically over 180 days, the account is “written to profit and loss” by the creditor. This is lender lingo for what is also known as a “charged-off account” or “charge-off”. This profit and loss status or charge off status is reported to the 3 credit bureaus. 

 

It doesn’t matter if the “charge off” occurred prior to enrolling into a settlement program or occurs after enrolling into the program, a charge off is a charge off no matter how you cut it.  

 

The delinquent status and subsequent charge status will be reported on your credit file, in either case.  

 

Creditors report monthly payment history using number – it is a little confusing because one credit bureau uses 1 as current and paid as agreed, while another uses 0 as paid as agree.  

 

Depending on the bureau, the numbers used to report account payment history is commonly 1, 2, 3, 4, 5, and 9. A Charge off is reported on your credit file as a “9” on your credit file.  

 

Over 60, 90, 120, 150 and 180days, charge-offs and written to profit and loss, are all considered derogatory credit remarks and will remain on your credit file for up to 7 years.

 

 If all these next statements are true, then debt settlement may not be the right course for you: 

 

1) Good credit is important to you

 

2) You have the means to pay off your debt in full by making required monthly minimum payments

 

3) You can afford the high interest charges associated with paying off unsecured debt. 

 

While debt settlement will adversely affect your credit score, there are many factors that influence your overall credit. In addition to your credit fico score (a number between 350 and 900) another major factor in determining your credit worthiness is your debt to income ratio. If you are maxed out on your credit lines and your debt to income ratio is out of sight, you are most likely not bankable – therefore, in many cases, even having a great credit score is not as valuable as it may seem. Therefore, you must liquidate your debt in order to get your debt to income ratios in line. Either way, you may have credit problems. So the question might be, how do you want to resolve the problem?