When a debtor is in a financial condition that makes it nearly impossible to send payments toward the creditor, both sides may decide to come to an agreement to pay back what’s owed at a lower amount. This is referred to as debt settlement, because the creditor is settling for a smaller amount than what is actually owed in total. It can also be called debt negotiation, because the debtor needs to haggle with the creditor to reach a settlement agreement.
Both the creditor and debtor have their own reasons for wanting to settle the debt at a reduced cost.
The Debtor: is trying their hardest to solve their financial problem without having to declare bankruptcy. When they are unable to use debt consolidation because they cannot afford paying for the whole debt balance, debt settlement becomes the better alternative compared to bankruptcy. The thing that makes bankruptcy scary is the negative effect that it will have on your credit score. Although debt settlement will damage your score, it will not be as grave as being bankrupt. Because the debt is to be paid off (albeit with a lower amount than what is owed), it ends the harassment from collectors and the stress that comes from having bills that are long overdue.
The Creditor: will accept a debt settlement proposition because it means they will get more than what bankruptcy can give them. If the debtor is really unable to afford debt consolidation, the creditor is forced to accept a settlement agreement. In bankruptcy, they will have to pay for the professional fee of a lawyer. Not only that, if the debtor is qualified for a Chapter 7 bankruptcy, creditors might be left with nothing to collect for the debt at all. In most cases, debt settlement means they will get much more than they would were the debtor forced to go bankrupt. They will get their payment faster, and it will be under terms that they can accept – not ordered by the bankruptcy courts. This reduces the risk from the bad debt brought about by the financial hardship of the borrower.
A lot of debt management services use a combination of both debt settlement and consolidation efforts whenever possible, reducing individual debts in advance of consolidating them into one debt at a lesser interest rate.
Kinds Of Debts That Can Be Settled:
The majority of unsecured debts can be settled in the right situations. An unsecured debt would mean there was no collateral needed to get the loan, such as credit cards or service bills. Some examples of secured debts would include things like a mortgage or car loans, which would be used as collateral/security.
Some examples of potentially negotiable debts would include:
- Old service bills (like utilities)
- Department store credit cards
- High-interest credit cards
- Legal and medical bills
- Collection agency debt
- Personal loans (unsecured)
Debt settlement terms can change based on the debtor’s individual situation, and creditors are not required to entertain settlement propositions at all. It’s more likely for creditors to consider a proposal when they are concerned about the debtor going bankrupt. When that is the case, receiving anything directly from the borrower is often preferable to what will be received from a bankruptcy settlement.