Commonly, creditors agree to forgive a large part of the debt: perhaps around half, though results can vary widely.
It is common that the debtor makes one lump-sum payment in exchange for the creditor agreeing that the debt is now cancelled and the matter closed.
With charge-offs (debts written-off by banks) increasing, banks established debt settlement departments whose staff were authorized to negotiate with defaulted cardholders to reduce the outstanding balances in the hope of recover funds that would otherwise be lost if the cardholder filed for Chapter 7 bankruptcy.
[2] Alongside the unprecedented spike in personal debt loads, there has been another rather significant (even if criminally[clarification needed] under-reported) change: the new legislation in 2005 that dramatically worsened the chances for average Americans to claim Chapter 7 bankruptcy protection.
As things stand, should anyone filing for bankruptcy fail to meet the Internal Revenue Service regulated ‘means test', they would instead be shelved into the Chapter 13 debt restructuring plan.
Essentially, Chapter 13 bankruptcies simply tell borrowers that they must pay back some or all of their debts to all unsecured lenders.
Repayments under Chapter 13 can range from 1% to 100% of the amounts owed to unsecured creditors, based on the ability of the debtor to pay.
For the debtor, the settlement makes obvious sense: they avoid the stigma and intrusive court-mandated controls of bankruptcy while still lowering their debt balances, sometimes by more than 50%.
[3][4] As a part of the settlement, the consumer can request that collection is removed from the credit report, which is generally not the case with the original creditor.
Typically, however, creditors simply begin collection procedures, which can include filing suit against the consumer in court.
[6] As long as consumers continue to make minimum monthly payments, creditors will not negotiate a reduced balance.
[8] Data released by the Colorado Attorney General showed that only 11.35 percent of consumers who had enrolled more than three years earlier had all of their debt settled.
[7] In a New York Times article, Cyndi Geerdes, an associate professor at the University of Illinois law school, states "Done correctly, [debt settlement] can absolutely help people".
[10] Legitimate settlement companies do not charge any upfront fees; this would be a Federal Trade Commission (FTC) rule violation.
[11] They may also take a monthly fee from customer bank accounts for their service, possibly reducing the incentive to settle with creditors quickly.
In the United States, debt relief companies are required to provide information in advance of a consumer signing up for the services, including the cost and the terms.
Accounts can also be held by creditors, or may be sold to a collections agency for an average of $0.15 on the dollar, in which case debt can still be negotiated.
For some people, it is worth it to have the peace of mind of knowing that they have a team of experts working to execute a plan of attack that will help them get out of debt quickly.
Consumers may face difficulty getting through to decision makers or long delays in any negotiations or paperwork processing with the creditors.
Settlement companies have customer service departments to assist consumers with any questions or difficulties that arise during their program.
The debtor should beware of fine print and carefully review any correspondence, proposed settlement or agreement with a creditor.
However, if a "paid in full" letter is obtained from the creditor, the debtor's credit report should show no sign of a debt settlement.
Recent law has granted special powers to student loans creditors, even those not federally subsidized, to attach bank accounts without possibility of Chapter 7 bankruptcy protection.
Under the Foreclosures and Repossessions section, the IRS mentions that the forgiving creditor must provide the taxpayer with a 1099-C tax form for "forgiven debt amounts" of $600 or greater.
[19] On May 19, 2009, the New York Attorney General filed suit against two "debt settlement" firms and their affiliates, alleging violations related to fraudulent business practices and false advertising.