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9 Things a Solid Debt Settlement Agreement Should Have

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In a Nutshell

If you’re struggling to pay a debt and your account is in default, you can try to negotiate a debt settlement agreement with your creditor. If a creditor does agree to negotiate a debt settlement agreement, it's important to get the details right before signing a binding contract. This article will explore when to consider a debt settlement agreement, how long the process takes, how it affects your credit score, and what an agreement should contain.

Written by Mark P. Cussen, CFP® , CMFC.  
Updated September 13, 2021


Handling debt is an important part of personal finance. If you’re struggling to pay a debt and your account is in default, you can try to negotiate a debt settlement agreement with your creditor. These agreements can be difficult to get though. Many creditors, such as some credit card companies, don’t allow their borrowers to negotiate their debts, and the odds of convincing them otherwise are low. 

But it can still be done. In fact, a report published by the Consumer Financial Protection Bureau shows that the number of approved debt settlement agreements has steadily risen since 2016. This should be encouraging if you have one or more debts that you would like to try to negotiate with your creditors. This article will explore when to consider a debt settlement agreement, how long the process takes, how it affects your credit score, and what an agreement should contain.

When Should You Consider a Debt Settlement Agreement?

A debt settlement agreement is when you, or a debt settlement company working on your behalf, negotiate with a creditor to reach an agreement on a payoff amount for your debt. A debt settlement agreement is a binding contract that either you or the creditor drafts. This contract states that you, the debtor, will pay your creditor a lesser amount than what you owe on a debt. The payoff may be an upfront lump-sum payment or a series of payments. 

Most debt settlement agreements allow borrowers to pay 40%-60% of what they originally owed. Once the creditor agrees to a debt settlement amount, they’ll forgive the remainder of the debt. If you can come up with a lump-sum payment, you may have better odds of settling with your creditor than if you need a monthly payment plan.

Debt settlement agreements can only be created for unsecured debt, such as credit card debt, personal loans, department store charge cards, or medical bills. They cannot be used with secured loans such as mortgages, car loans, or federally subsidized student loans. Some creditors won’t be open to any settlement offers, but others would rather get something than nothing. Also, while you can hire a debt settlement company to negotiate on your behalf, some lenders will not negotiate with a third party.  

How Long Debt Settlement Takes

If you directly negotiate a lump-sum payment with your lender, then your settlement will happen fairly quickly. If you are making payments, then your settlement will take longer. But if you hire a debt settlement company to negotiate on your behalf, then it may take as long as two to four years before the settlement happens. 

Most debt settlement companies require you to make monthly payments into a savings account they manage so they can eventually negotiate a lump-sum settlement with your creditors. It takes a while for your monthly payments to add up to enough to make these lump-sum payments. In the meantime, the company may ask or require you to stop making payments to the creditor, which has serious negative consequences on your credit score.

If you have old unsecured debts that are within a year of the statute of limitations, then you may be better off simply letting them age off of your credit report. Most creditors will stop all collection efforts once a debt has been on the books for more than seven years. 

How Debt Settlement Affects Your Credit Score

Debt settlement is almost never good for your credit score. By the time you get to a settlement, your creditors will have reported missed payments to the three major credit bureaus. This can cause your score to drop dramatically. Your creditor may also charge off your account or send it to collections in the meantime. This will further damage your credit score and make it that much harder to get new credit in the near future. You may also still be subject to collection efforts such as phone calls, written notices, or even lawsuits while you are negotiating your settlement. 

For these reasons, it may be best to research other debt relief options before deciding on debt settlement. A debt management plan or debt consolidation loan may be a better idea. You can also try consumer credit counseling or even bankruptcy in some cases. 

If your accounts are already several months past due or have been sent to collections, you’ve probably already seen your credit score drop as a result. Since the damage has been done, it might make sense to consider debt settlement in this case. After a debt settlement, most accounts will be reported as settled on your credit report. This doesn’t look great but it is better than having an open collections account.

Hiring a Debt Settlement Company vs. Doing It Yourself 

You can hire a debt settlement company to negotiate with your original creditors for you if you don’t feel comfortable speaking with your lenders yourself or you’re too busy to do so. But debt settlement companies can be expensive. It’s not uncommon for them to charge you 15% or more of the amount of debt that is forgiven. They may also be better at bargaining than you are because they do it for a living, so you’ll have to weigh the pros and cons. You should also consider the tax implications for debt that your creditors forgive. Forgiven debt over $600 is considered taxable income.

Since scams and fraud are common in this industry, be sure to do your homework on any firm that you’re thinking of hiring. You can use the Better Business Bureau (BBB), the Consumer Financial Protection Bureau (CFPB), the Federal Trade Commission (FTC), and your state attorney general’s office to research companies. See whether the firm that you are considering has had any complaints lodged against them or disciplinary history. You can also look online to see what kind of reviews other customers have given them. 

Remember: No debt settlement company can do anything for you that you can’t do for yourself. And some debt collection agencies will not bargain with a debt settlement company under any circumstances. You can potentially save money by negotiating with creditors yourself, but you’ll need to be comfortable and confident in your skills.

A Good Debt Settlement Agreement Should Be Specific, Comprehensive, and in Writing

No debt settlement agreement is valid until it is put into writing and signed by both you and your creditor. In many cases, your debt collector will be glad to furnish you with a debt settlement letter with all of the information already filled out. And this may be better for you as well, as it will give you a copy of the letter on your creditor’s letterhead. This agreement will serve as a valid legal document that both you and your creditor are bound by going forward. 

All valid debt settlement agreements will have at least the following nine pieces of information in them: 

  1. The original creditor and debt collector’s company names;

  2. Your full name;

  3. Your account number;

  4. The total amount of the full balance that is owed;

  5. The settlement amount that was agreed upon;

  6. If the payment is not a lump sum, the terms and amounts of any payment plan to be made for debt collection;

  7. The date(s) that payment(s) on the outstanding debt must be received by (due dates);

  8. Words indicating that the account will be satisfied in full when the settlement amount is paid; and

  9. How the account will be reported to the credit bureaus (settled, settled — paid less than owed, or settled —zero balance, etc.). This is also negotiable — anything showing “zero balance” or “paid in full” looks better on your credit report.

They may also include:

  • Any necessary or required disclosures, disclaimers, or warranties.

It is vital that you insist this agreement is filled out completely. Any ambiguity or open-ended language in this agreement may make it invalid. Don’t hesitate to seek out legal advice if you are unsure of what to include in your settlement offer. 

Let’s Summarize...

Although they are difficult to obtain, a debt settlement agreement can be your best debt relief option in certain situations, such as when bankruptcy is not an option. More and more people have successfully used this tactic in recent years. Some creditors are more willing to forgive a portion of the debts borrowers owe them in the hopes of collecting something rather than nothing. If you decide debt settlement is your best option, make sure your agreement is specific, comprehensive, and a good fit for your financial situation. It might just turn out to be one of the best debt management strategies you could have chosen. 



Written By:

Mark P. Cussen, CFP® , CMFC

LinkedIn

Mark has over 25 years of experience in the financial industry, and has worked with investments, insurance and mortgages as well as income tax preparation and comprehensive financial planning. His writing work includes insurance and securities training manuals and educational art... read more about Mark P. Cussen, CFP® , CMFC

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