Debt settlement

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Debt Settlement, also known as Debt Arbitration or Debt Negotiation, is an approach to debt reduction.

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[edit] Brief history of debt settlement

As a concept, lenders have been practicing debt settlement thousands of years ([1] Debt Forgiveness: Plainer Speaking, Please. by Stephen A. O’Connell). However, the business of debt settlement became prominent in America during the late 1980s and early 1990s when bank deregulation, which loosened consumer lending practices, followed by an economic recession placed consumers in financial hardships.

With charge-offs (debts written-off by banks) increasing, banks established debt settlement departments staffed with personnel who were authorized to negotiate with defaulted cardholders to reduce the outstanding balances in hopes to recover funds that would otherwise be lost if the cardholder filed for Chapter 7 bankruptcy. The settlements ranged between 25% and 65% of the outstanding balance ([2] Sworn Testimony of Dr. Robert Manning, author of Credit Card Nation).

[edit] Creditor’s incentives

The creditor’s primary incentive is to recover funds that would otherwise be lost if the debtor filed for bankruptcy. The other key incentive is that the creditor can often recover more funds than through other collection methods. Collection agencies and collection attorneys charge commissions as high as 40% on recovered funds . Bad debt purchasers buy portfolios of delinquent debts from creditors who give up on internal collection efforts and these bad debt purchasers only pay between 1 and 7 cents on the dollar ([3] MSN Money: Zombie debt collectors dig up your old mistakes). Collection calls and lawsuits often push debtors into bankruptcy, in which case the creditor often recovers no funds.

[edit] Common objections to debt settlement

There are five main objections to consumer debt settlement: damages credit, increased collection calls, possibility of lawsuits, tax consequences and the need to settle with all creditors.

[edit] You Can Still Be Sued

A debt settlement company does not make monthly payments on the debtor's accounts and they still remain in default. While the debts are still in default the creditor or its assignee can still file a lawsuit against a debtor. Most creditors and debt collectors want a lump sum payment to settle for less than the full debt. Although a debtor may make monthly payments to the debt settlement company, the amount is too small to successfully negotiate a settlement until after the debtor has made several months' worth of payments.

[edit] Damages credit

The debt settlement damages the scores in credit report. A credit report is used by creditors to judge past credit performance to see if the applicant meet their criteria for lending. Insurance companies uses a person's credit report to determine premiums and prospective employers review the credit report to establish the character of a job candidate.

[edit] Tax consequences

Another common objection to debt settlement is that debtors whose debts are partially canceled outside the bankruptcy system will need to report the canceled portion of the debt as taxable income. (IRS Publication 908)

The Internal Revenue Service considers $600 or more of forgiven debt as taxable income. The forgiving creditor must provide the taxpayer with a 1099-C tax form. This form will list the amount of forgiven debt and interest in Box 2. Taxpayers with portions of personal loans forgiven may not subtract the interest reported in Box 3 from the amount of reportable income on this form.

However, the IRS does not require taxpayers to report forgiven debt if the tax payer was insolvent at the time the creditor forgave the debt. Being insolvent means that the amount of a debtor’s debts are greater than his/her assets (how much money and property the debtor owns). However, the IRS adds that “you cannot exclude any amount of canceled debt that is more than the amount by which you are insolvent.” ([4] IRS Publication 525)

For example, if a taxpayer is $10,000 in debt and owns $3,000 in assets, he/she cannot exclude more than $7,000 of forgiven debt from his/her income tax. Any forgiven debt over $7,000 that year must be reported as taxable income.

[edit] Benefits of Debt Settlement

There are some benefits of debt settlement on which the entire debt settlement industry is running

[edit] Debt Settlement Trade Associations

Due to the rise of debt settlement as a debt relief alternative to bankruptcy, groups working in the industry established trade associations to help secure industry standards that will protect consumers against unethical business practices. These trade associations were also established to lobby state governments because many state legislatures are passing laws that restrict out-of-state companies from providing debt negotiation services to in-state residents. The two major trade associations are the United States Organization for Bankruptcy Alternatives (USOBA) [5] and The Association of Settlement Companies (TASC) [6]. Both of these organizations publish on their websites information about debt settlement and the debt settlement industry.

Individual Debt Settlement consultants can obtain thorough industry training and Certification as "Certified Debt Specialists" through The International Association of Professional Debt Arbitrators. (IAPDA) [7].

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