Debt negotiation, also called debt settlement or debt arbitration, is a process by which you agree to pay an amount less than what you owe. Debt negotiation is typically used when a consumer has acquired an overwhelming amount of unsecured credit card debt. Although you might believe that offering to pay a portion of your debt will foster goodwill with creditors, this method of getting rid of debt has a negative affect on your credit report.
About Debt Negotiation
Consumers often find out about debt negotiation through advertisements that present these services as an alternative to bankruptcy, says the Federal Trade Commission. Many of debt settlement companies claim to have nonprofit status and, for a fee, will contact your creditors and arrange to have 10 to 50 percent of your debt reduced. If you seek professional debt settlement services, you make payments to the company rather than your creditors. The debt negotiation company then uses your money to pay off debt. You may also be advised to refrain from paying your credit card bills while your accounts are being "negotiated."
Debt Negotiation: The Fall-Out
The problems associated with using debt negotiation companies are rife. One is predicting the total cost of fees that you'll pay the company. An August 2007 MSN Money report indicated that companies had arbitrary fee structures. Some companies charge consumers a percentage of their total debt (usually 15 to 18 percent) while others charge consumers a percentage of the debt that was negotiated, which is typically 25 percent. There are also sign-up fees, monthly service charges and other fees.
Some debt negotiation companies "top load" their fee structure, which means that consumers pay the total amount of the professional fees before their deposits begin to go toward paying off the debt. During this time, creditors can take action against you in court. Late fees and interest continue to accumulate. A record of a settled debt also influences your credit score, says the National Foundation for Credit Counseling. A record of a settled debt stays on your credit report for seven years and can prevent you from obtaining new credit cards or loans.
When Debt Negotiation Makes Sense
Debt settlement is most appropriate for consumers with heavy amounts of debt whose credit reports are already tarnished by late payments says Credit.com. Debt settlement may also be the better choice for those with high incomes who are precluded from filing Chapter 7 bankruptcy but who don't want to file Chapter 13 bankruptcy, which requires debt to be restructured and paid back within five years, says MSN Money. However, even debt negotiation can still come at an unexpected price. The amount of negotiated income is considered taxable income by the Internal Revenue Service. MSN Money notes that if you fall in a 25 percent tax bracket, you'll owe $2,500 for every $10,000 of debt written off by your creditors.
Your Can Do It Yourself
Consumers who wish to settle debt with creditors can act as their own arbitrators. MSN Money says that usually, creditors won't work with you unless an account is delinquent by between three and six months. And, when you work one-on-one with your creditors, you'll be asked to pay off the amount of negotiated debt in full in a one-time payment. While your accounts grow delinquent, you'll have to make a concerted effort to save. Finally, MSN Money says if you have several accounts you wish to settle, it may be very difficult to know which creditor is amenable to an early settlement.
Professional Advice
Particularly problematic are the unscrupulous debt negotiation companies that take advantage of consumers' lack of financial savvy. A May 2009 National Foundation for Credit Counseling press release warned that debt settlement services often result in consumers being in deeper debt than they were before they sought help--and their credit reports were sullied as well. The National Foundation for Credit Counseling advises consumers struggling with debt to contact a reputable credit counseling organization for free and low-cost advice on how to manage their debt loads.
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