What's the Difference between Debt Settlement and Debt Negotiation?
Last updated April 26, 2010
Many people are confused by the range of programs which proclaim that you can get out of debt:
In most people's minds, these two types of companies are the same. In my opinion, they are not. We're going to show you the difference between debt negotiation companies and how their operations are different from debt settlement companies. By the way, in case you're thinking we are advocating debt settlement firms, this is not the case. We are only explaining the difference.
What's Wrong With Debt Negotiation
Debt negotiation companies set up a "trust" for you - though they are not a licensed bank entity under the Federal Reserve, but hey, neither is Paypal. They also collect a monthly fee to maintain the account. On top of these fees, they ask you to put away a certain amount of money towards your debt. The idea is to create a savings account until the debt is paid off. Unlike consumer credit counseling services, they do not pay your creditors each month, they put money into your "trust". You creditors are not told of your "arrangements" with the debt negotiation company.
Debt Negotiation Companies Don't Consider Your Current Financial State. Also, unlike consumer credit counseling services, a debt negotiation company doesn't "qualify" you for the amount of the payment you make, so you can wind up paying very little towards principal of the debt. You can be in this kind of program for years - and the longer you are in the program, the more money these guys make in their "monthly admin" fees.
No Protection From Lawsuits. Even if the debt negotiation programs are run by lawyers, these programs offer you no legal protection. You can be sued by your creditors, they can get a judgment against you and your wages can be garnished! This debt negotiation scenario is also unlike consumer credit counseling where they handle all calls from the credit card companies (but they are also PAYING them for you.) YOU must deal with the nightmarish phone calls.
There are some credit card companies who are agressively suing non-paying customers right now, and if they decide to take you on, they will win. Being sued by the credit card company is not like being sued by a collection agency, who usually has poor documentation and no case.
Interest and Fees Are Not Negotiated. In addition to putting yourself in danger of being sued, there is no attempt to negotiation interest or fees. So they keep piling up on you. It could mean that while you think you are doing the right thing and making payments towards your cards, your debt continues to grow.
Only Credit Card Debt Qualifies You can't negotiate anything that is a secured debt, like an auto loan or mortgage. You also can't negotiate down student loans, tax liens or judgments.
Fees Are Uusally Paid Upfront. Usually your first 2-4 months of payments go towards fees. There is such a high drop out rate on debt negotation companies that these guys want to make sure they get paid FIRST. Currently, the FTC is considering a ban on such a practices.
Most debt negotiation companies claim to be able to negotiate your debt with the credit card companies for about 50% of what you owe. You must realize that after 180 days (6 months), if you are not sued, your debt gets turned over to a collection agency. The negotiation company is NOT planning on talking to the original creditor, but to a collection agency down the line who will accept debt settlement offers fairly easily.
Do You Know What's In Your Contract? Even if a debt negotiation company did clearly explain what was going on and it was in all of their documentation - based on letters from readers, none of the debt negotiation companies explained what they were doing. All of their victims had a vague recollection that they were paying a management fee, but they had no idea that their credit cards would go into COLLECTION while they were in the program.
The U.S. Government Accounting Office (GAO) released a report on April 22, 2010 regarding widespread abuse in the debt settlement and debt negotiation industry.
How Debt Negotiation Works
Example:
You have $20,000 in credit card debt and the debt negotiation company says all you have to do is pay $300 for 3 years and you'll be debt free for about 50% of the debt. $300 a month for 36 months is only $10,800, so you're saving $9,200 and you'll be debt-free in 3 years. Sounds like a good deal, right? Wrong. Let's do the math.
- You agree to a 3 year plan where you pay $300 a month to the settlement company. $10,800 total of payments.
- Your first 2 monthly payments are the "admin fee", so this is $600 - nothing gets put into your trust account until your 3rd month..
- The negotiation company keeps $50 of your $300 payment each month for the service fee. That means $250 a month is being added to your trust account.
- After 34 months, you have $8500 to settle $20,000 in debt. Remember, 3 years minus the first 2 months for admin fees is 34 months.
- The negotiation company, if you are still with the program, will negotiate your debts down to zero with the collection agencies using the $8500.
You save: $9200.
Debt negotiation firm makes: $600 + (34 * $50) = $2300.
Other Dangers Of These Programs
- So you say, what's wrong with that - I'm getting a good deal by saving $6000! Yeah, except almost any collection agency will accept 25% of the debt without much of a fight and many will accept 10%. And you don't have to pay and admin fee to pick up the phone or send in a debt settlement agreement. AND you can mostly make a settlement within 6 months to a year. And be debt free. Here is more about dealing with collection agencies and how they settle. It is REALLY easy to do it yourself.
- Let's say of the $20,000 in debt, one of the cards comes to $4000. If the negotiation company gets the collection agency to accept $2000, it will take you, it will take 10 months at $250 per month to have enough in your trust account to pay off just that one credit card. But remember, your first 3 payments to the settlement company only paid the admin fee. That means your first credit card settlement is 13 months *after* you started sending them money.
- Going back to the example above, if you pay them $20,000 over a 5 year time frame ($300 a month. 2 months admin fee and $50 "maintenance" fees). I'd call that a profit, especially since they might not have actually helped you in any way.
Doing it Yourself
Again, you can do this yourself. You can put away some money so you save up 25% of the $20,000, you'll have enough to have be debt free in 16 months, and it will only cost you $5000. I have to caution you, that this is not going to be a pain free process, you will still have to deal with creditors calling you, and there is the possibility that you will be sued. However, you will be enduring the same kind of telephone calls and possibility of lawsuits if you signed up with a debt relief company. I've written up an aritcle on what to expect.
How you can do the same thing without paying a company:
- Save $300 until you have about 25% of the total.
- 25% of the total is $5000.
- After 16 months, you have $5000 to settle the $20,000 debt with the collection agencies.
- You don't have to wait until you have the entire amount - you can settle individual debts along the way.
Abuse has gone rampant, and besides the GAO report we mentioned above, the FTC Has taken steps against some of these companies. Read about it here.
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