Debt settlement is an agreement between a consumer
(or business) and a creditor where the creditor agrees to accept less
than the full balance as satisfaction of the debt. Sometimes this type
of transaction is also referred to as a “settlement in full,” since the
revised agreement fully satisfies the entire balance on the account.
For example, if you owe ABC Bank $10,000 and negotiate a 35%
settlement, that means you would pay the creditor only $3,500. What
happens to the remaining $6,500? It gets canceled (i.e., forgiven) by
the creditor, and of course this represents a loss of that amount to
the bank.
When people first hear about settlements, they immediately
think, “That sounds too good to be true. Why would a bank want to
accept a loss like that? Won’t they just automatically file a lawsuit
against me for the full amount?”
The truth is that it’s the *banks* themselves that want to
settle. The reason they do this is not because they want to show mercy
or kindness! It’s a straightforward financial decision. The big banks
have calculated that the farther behind an account gets, the greater the
risk they will never recover anything at all. The person may have lost
their job and have no income, so there are no wages to go after.
Or
they may have recently lost a property to foreclosure and now the
creditor has trouble locating the person after they’ve moved to another
state. In many cases, people just file
bankruptcy to take care of
their debt problems. Under Chapter 7 bankruptcy, the creditor will
receive nothing on the claim – zero!
Under Chapter 13, they will
receive some amount back, but they have no control over how much since
that is determined by the court (based on the debtor’s ability to make
payments). And most Ch. 13 plans last for five years, so it takes a
very long time for the creditor to get paid that way.
Instead of taking a chance on collecting zero, or
collection a small fraction of the balance over five years, most banks
would rather cut their losses and resolve the account. This is the
rationale behind the banks’ motivation to settle. It helps them reduce
the loss they would otherwise be risking. Every major creditor has
their own individual policy on such settlements. Some are more
difficult than others to achieve settlements with, but it’s common to
see debts settled for 35-40% of the balance, and settlements of 20-30%
are quite common with some creditors.
In my professional opinion, debt settlement is a very good
strategy to consider if you wish to avoid bankruptcy, especially if you
are not eligible for Chapter 7 (where all the debts go away) and have
to file under Chapter 13. Instead of a 5-year path to recovery, while
you are under the financial supervision of the court the whole time,
you can privately negotiate settlements and have a much faster path to
recovery.
Debt settlement is not for everyone who is experiencing a
financial crisis, but it’s certainly a viable and effective strategy in
the right circumstances!
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