How Does Debt Settlement Work?

Debt settlement programs are designed to help consumers pay off what they owe in a structured manner. From the perspective of creditors, settling debts is often better than getting nothing or having to deal with drawn-out bankruptcy and collection processes. The consumer typically gets to avoid paying the whole amount, and they also avoid bankruptcy and save some damage to their credit.

You're likely wondering how this process works. Let's take a look at the basic issues that underpin the debt settlement process.

Putting Together as Many Bills as Possible

One of the first things you'll want to do is to figure out just how much money you owe to how many creditors. The objective of a debt settlement is to take as much debt as practicable off the board at once, and collecting all your bills into a single settlement is the ideal outcome. This won't always play out perfectly, but knowing how much you owe is important regardless of whether you can turn your debts into a single payable lump or you have to negotiate individually.

Do Creditors Have to Offer a Settlement?

No, they don't. Settlement, however, is often to their benefit because it gets them actual cash, closes the balance on the account and allows them to resume dealing with customers. Yes, a company might choose to continue to do business with a customer who settles their debts.

With that in mind, though, a creditor has every right to say no to an offer. They don't even have to humor the idea. What debt settlement programs try to do is to make the offer good enough that it beats continued collection efforts or even seeing much of the debt wiped out by bankruptcy. If a company can settle a debt for 80 cents on the dollar now, for example, that may be better than any of the alternatives. In the credit industry, this is known as "taking a haircut" because a little comes off the top.

Executing an Agreement

If a settlement is accepted, you'll have to agree in writing to the terms of a new set of debt. The settlement, though, is not legally considered to be executed until you make the first payment under the new agreement. The company that brokered the settlement will then assess a fee. The fee is typically a percentage of the difference between the original debt and the new, restructured debt.