Shrink Your Debt
A strategy guide for negotiating with creditors.
Department of Justice
Federal Trade Commission
Internal Revenue Service
Association of Independent Consumer Credit Counseling Agencies
In general, the best choices for debt negotiation and settlement are unsecured loans and credit cards. Since there is no collateral that can be attached to satisfy the debt, creditors are more likely to negotiate to avoid writing off the entire debt. The two most common approaches for debt negotiation are to pay a lump sum that is less than the total amount owed, or to restructure the payment schedule with lower monthly payments.
With the first option, you negotiate a reduced, upfront payment that permanently cancels the entire debt. Many creditors will only accept this approach because their goal is to erase the debt from their books without having to wait an extended period. If you are already struggling with your current debts, it may be difficult to raise the cash necessary to accomplish this. In which case, you might consider the second option to reduce the principal and possibly stretch out the payments.
Many companies specialize in debt negotiation and settlement assistance. While some of them are very reputable and do achieve results, with some advance planning and strategic thinking, you can do the negotiating for yourself.
The first step is to contact the creditor and ask to speak with a manager authorized to negotiate. Briefly explain your circumstances, and make an appointment for a personal meeting if geographically feasible. A face-to-face meeting demonstrates that you are serious about resolving your problem, and allows you the undivided attention of the person you are dealing with. It's also a good idea to take notes of all conversations, regardless of how they are conducted. Sign and date all your notes.
Do not threaten to close your accounts if you are having trouble paying your bills. You will be perceived as someone that has shirked their responsibilities and opted for the easy way out. The best approach is to deal directly and openly with your creditors in order to find a mutually acceptable solution.
Your first offer should be less than you are willing and able to pay, to allow room to maneuver and counteroffer if necessary. With the prospect of rising defaults due to a faltering economy, creditors are more likely to deal and this leverage should be used to your advantage. The old saying "a bird in the hand is worth two in the bush" definitely applies to debt settlement.
Many creditors sell delinquent accounts to collection agencies, usually for a fraction of the account value. Knowing this puts you in a position to make a lowball offer and judge the reaction of the agency. All the agency needs to do to turn a profit is to settle for something slightly above the amount they paid for your account. Keep this in mind as you try to reach a settlement. Be patient and firm, and resist the temptation to raise your offer during the negotiation process. You can ask that the collection be removed from your credit file as a condition of settlement, but that will not erase the detrimental impact of the original creditor.
Unsecured creditors face the risk of getting nothing if you decide to declare bankruptcy. While there is no way to predict what each creditor will accept in lieu of full payment, your target should be to pay one-third to two-thirds of the outstanding balance, depending on your particular circumstances. Many creditors will be very tempted to accept a 50-50 split as the final settlement, even if it takes a few counteroffers to arrive at that conclusion.
Advantages of Settlement
Settlement is a quick and efficient means of reducing your debt load by effectively eliminating a portion of your remaining principal. If you are making the minimum payments on a credit card, settlement also saves you the significant interest charges racked up every month and achieves finality without destroying your ability to secure new credit. Delinquencies on your accounts will damage your credit score, but they also increase your leverage to negotiate the best deal. The further behind you are in your payments, the greater the risk assumed by the creditor.
You can request your credit file be updated to reflect that the debt was settled in full once a settlement is achieved. This demonstrates you're making the effort to resolve your financial difficulties. A well-structured settlement also avoids the need for a debt consolidation loan that may require collateral assets. It's unwise to risk other assets for a new loan if you're eliminating unsecured debt.
Unlike a bankruptcy that stays on your file for 10 years, a settlement is viewed as a temporary condition designed to get you back on track with your finances. A bankruptcy makes it extremely difficult to get any new credit and the stress and social stigma can be lasting.
One particularly detrimental disadvantage to settlement is the possibility of the canceled portion of your debt being reportable income for tax purposes. It's not worth negotiating a settlement unless the amount forgiven is more than enough to cover the additional tax. Consult your tax advisor regarding tax implications, and to determine if you qualify for the IRS insolvency rules.
Closing the Deal
Whether you negotiate by phone or in person, be sure to request a written summary of your agreement is issued with a commitment to provide the formal discharge papers as soon as possible. In most instances, the terms "cancellation," "discharge" and "forgiveness" are synonymously applied to the termination of a loan or credit arrangement. As with any contract, make sure the terms and conditions of the discharge papers match the agreement documented in your notes. The discharge papers may vary depending on the type of credit extended.
One key issue is who retains title to any items that were purchased with the credit if part or all of the remaining balance is forgiven. This should be spelled out clearly during the negotiation process. If you have any questions or issues that you can't answer or don't understand, consult a financial expert or attorney before signing any agreements.
Geoffrey Michael is a freelance writer specializing in business, finance, law, negotiating and political analysis. He graduated from the Air Force Academy with a degree in business and finance. He is also licensed to practice law in California and New Hampshire.
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