Debt Negotiation – Is It For You?

While our overall economy is getting better this doesn’t mean that we still don’t have problems. As an example of this unemployment increased in 30 states this past July. California’s unemployment rate was 7.4%, Alabama’s was 7%, Georgia’s was 7.8% and Nevada’s was 7.7%.

While there are more reasons than just unemployment to account for today’s consumer debt, it certainly is a big factor and helps explain why the average American household now owes $15,480 in total debts and why the average American is carrying $7115 in credit card debt alone. As you can imagine if the average is $7115 many people are carrying much more than this – to the point where they are likely drowning in debt.

Why have we become such a debt-ridden society?

Unemployment is certainly one big reason why so many Americans have fallen into debt. However, some of this problem is “self administered.” It’s just very easy to get into trouble with debt these days. Credit cards can be extremely easy to get and buying things on the Internet has become so simple and “painless,” that many of us just haven’t handled our credit sensibly. An even sadder fact is that a new study found that only 53% of Americans completely understand the terms of their credit cards. The rates on credit cards are often as high as 20% so if people are not careful they can quickly become snarled in debt. Beyond this, it’s hard to believe that so many of us are signing on to high-interest credit cards without knowing just what we’re getting into.

For that matter in 2012, the Securities and Exchange Commission ordered the Study Regarding Financial Literacy Among Investors. What this study found was that Americans know painfully little about how money works, including compound interest, which is capable of turning a reasonable amount of debt into a huge amount of debt faster than most people would imagine.

What to do if your debt has spun out of control

Debt can be like a quicksand pit. With quicksand you would feel as if you were just up to your ankles one minute, only to be up to your waist the next minute and then finally in over your head. While your debt might not yet be over your head right now it can spiral out of control very quickly. If this happens there are options available to help though some of them are definitely better than others.

Five options

Let’s say for the sake of an example that you have $25,000 in unsecured debts or those not secured by an asset such as your house or your automobile. In this case there are five options beginning with the one that would have the least impact on your credit score down to the one that would do the most damage.

The least damaging — find a way to catch up

The best option is to find a way to catch up on your debts. The easiest way to do this is probably to take on a second job. If you were to earn $10 an hour and worked 20 hours a week you would net around $160 or about $640 a month. That alone might be enough to help you catch up on the payments you’ve missed.

Second – get credit counseling

This is something you might do in conjunction with getting a second job. There’s probably a credit-counseling agency near where you live. The best ones are local and nonprofits. Some charge nothing for their services while others charge very little. When you go to one of these agencies you’ll have a counselor that will review your finances and help you develop a budget to pay off your debts. He or she will also work with your lenders to get your interest rates and maybe even your monthly payments reduced. If you’re in really bad straits the agency may develop a Debt Management Plan for you. This is where you send it a single payment each month and it then distributes the funds to your creditors. This can be an excellent choice for people who just can’t stay on a payment schedule.

Third — Apply for a Debt consolidation loan

The reason why we rank credit counseling and developing a plan to get caught up ahead of this option is because the first two options don’t require you to borrow any money. While a debt consolidation loan does have its advantages it does mean borrowing money. The two types of a debt consolidation loan are secured and unsecured. An unsecured loan is basically a personal loan that is made to you based on your credit history. These are sometimes called signature loans because all you have to do is sign for one. Secured loans are those where you are required to put up some asset as security. For most people that asset will be their homes in the form of a home equity loan or homeowners equity line of credit (HELOC). Secured loans generally have lower interest rates than an unsecured loan but has the risk is that if you fail to make your payments, the lender might repossess your house and you could find yourself out on the street.

Fourth — choose debt negotiation

This has become a popular option ever since the Great Recession. This is where you negotiate with lenders to settle your debts for less than you owe. The biggest advantage of debt negotiation is pretty obvious. It’s a way to get rid of all your creditors and for less than you owe. Some people are able to do debt negotiation themselves while others have turned to for-profit debt settlement companies. The benefit of both of these is essentially the same in that you get out of debt for less than you borrowed.

There are some substantial differences between DIY debt settlement and using a professional debt settlement company. The biggest of these is that DIY debt settlement doesn’t cost you anything. There are no upfront fees, no maintenance fees, and no other fees of any kind. This could be a good option if you consider yourself to be a relatively good negotiator and aren’t afraid to take on pros that work for your creditors.

How to do DIY debt negotiation

Assuming you believe you have what it takes to negotiate and settle your debts the first thing you will need to do is quit making payments for about six months. The reason why I say “about” is because after six months, many creditors will sell your debt to a third party such as a collection agency. It’s also because very few creditors are willing to talk settlement until you are six months behind in your payments. This means there is a very narrow window where your creditors would be willing to talk settlement before they sell off your debt.

The first time you call a creditor to begin debt negotiation you may be stymied. That’s an old golf expression that means there’s something between your ball and the hole that makes it impossible for you to hit directly to the green. In the case of debt negotiation a stymie is a gatekeeper or person that doesn’t have the authority to settle with you but will stall and try to prevent you from speaking with a person that does have the authority. You may have to make a number of phone calls and work through a number of different layers before you get to the right person. When you do finally reach someone that could settle your debt you need to be honest about your financial situation and lay it out in as much detail as possible. You essentially have to “sell” the idea of settling. In addition to being honest about your finances you will have to be a bit threatening that if a settlement cannot be reached you will have to file for bankruptcy. This means your creditor would get nothing. Finally, you’ll need to have the money available to pay off the settlement. In fact, this can be a very important bargaining chip that if you can reach a settlement number that’s acceptable to both you and your creditor, you will pay for it immediately either via cashier’s check or with a wire transfer.

This begs the question where would you get the money to pay for the settlements. If you are unable to borrow it from a friend or relative and if you don’t have enough in savings, you may have to take a more drastic action. For example, you might have to sell your house and downsize to a smaller one. Ditto your automobile. Or back to option #1, you might have to get a second job and save up those extra earnings during the six months you’re not making payments on your debts. Do you have an IRA or a 401(k)? If you have a 401(k) you could borrow from it and when you pay interest on the “loan” you would be basically paying interest to yourself. But be aware that if you don’t pay the money back to your 401(k) before six months it will be treated as ordinary income and taxed accordingly. And it’s about the same if you withdraw money from an IRA.

Hire a for-profit debt settlement company

If you don’t feel you could do DIY debt negotiation you could hire a for-profit debt settlement company. The way these companies work is that they will handle all the debt negotiations for you. You will send it a payment each month while it’s settling your debts that will be deposited in an escrow account. Once the company has settled your debts to your satisfaction it will use that money to pay your creditors. If there is not enough money in your escrow account to pay for all your settlements, you will be offered a payment program. Depending on the amount of debt you had, it may take you anywhere from two to four years to complete the program.

There are several advantages to using a for-profit debt settlement company. For one thing, it relieves you of all the stress and pressure associated with debt negotiation. Second, once you choose a debt settlement company it will get all those creditors and collection agencies off your back. Finally and maybe most important you’ll save money because a good debt settlement company should be able to get your debts settled for around 50% of what you actually owe.

However, there is no free lunch and it does cost money to use one of these companies. The ethical ones will reveal all their charges upfront, giving you the option of either hiring it or changing to some other option for debt relief.

The fifth and most damaging option — bankruptcy

The ultimate solution to getting out of debt is to file for a chapter 7 bankruptcy, which would get almost all of your unsecured debts discharged or eliminated. This would include credit card debt, medical debts and personal loans. However, not even a chapter 7 bankruptcy will get rid of child support, spousal support, alimony and student loan debts and it will have a seriously negative affect on your credit score. While no one knows for sure how much it would decrease your credit score many experts believe it could be as much as 180 to 200 points. A bankruptcy will remain on credit reports for either seven or 10 years. It’s very difficult to get new credit for two to three years after a bankruptcy and many landlords will not rent to a person that’s had a bankruptcy. However, filing for bankruptcy is really the only way to completely rid yourself of your debts without having to borrow money or pay back any of the money you borrowed.