How to Settle Debt With Creditors

Financial hardship, like a job loss or major illness, can easily turn your life upside down. When hardship makes your debts unaffordable, it's natural to look for solutions to get your finances back under control.

Debt settlement could be the way to get rid of your debt and start over. Settling your debt means negotiating with your creditors to accept less than you owe and forgive the rest of your debt. Creditors are most likely to settle when you can show financial hardship that makes it impossible to pay your full balances.

You can enroll in a debt relief program so experts negotiate with your creditors for you, or you can do it yourself. This step-by-step guide explains how to settle debt with creditors and get the fresh start you need.

When Debt Settlement Could Be Right for You

Debt settlement may be a good option for people who can't afford their current unsecured debts. That means debts not backed by collateral, or something of value—think credit cards and personal loans.

Debt settlement doesn't require good credit or a high income. As long as you can show financial hardship and save up something to negotiate with, you could be a candidate for debt settlement.

Consider debt settlement if:

• You have at least $7,500 to $10,000 in unsecured debt. It makes the most sense to settle debt when you owe a lot. If you owe only a small amount, repaying what you owe may be easier—and better for your finances overall.

• You can't afford to make your minimum payments. If you're struggling to make your minimums or have already fallen behind, settlement might be a good option.

• You are experiencing financial hardship. Creditors are more willing to negotiate when they believe full payment isn't possible. If you show that you lost your job, are experiencing medical issues, or are otherwise struggling, you have a better chance of convincing creditors to accept less than you owe. 

Steps to Settle Debt With Creditors

If you're wondering how debt relief works, review the steps involved in settling with creditors.

Assess your financial situation and prepare to make offers

When you settle debt, you offer creditors part of what you owe. You need to figure out how much you can afford to pay before you start the process. To calculate this key number:

• Determine exactly how much you owe. Add up your total amount of debt by looking at your credit card and loan statements. You can also review your credit report for free at AnnualCreditReport.com. Remember, only unsecured debts are good candidates for settlement. Lenders don't reduce balances on things like mortgage and car loans that are guaranteed by your home or your car.

• Take stock of your current financial situation. Review your income and expenses to see what you can afford to pay each month toward your debt. Look for any extra money you can funnel into a settlement account. Many people who seek debt settlement choose to stop making payments to creditors while they save up for negotiations. This also signals to creditors that you're having trouble making your payments.

The more you can save for negotiations, the faster you could settle your debt. However, remember that missed payments will likely do some serious damage to your credit scores. It could also get your account sent to collections, which means debt collector calls and perhaps even a lawsuit. That said, if you're already behind on your debts or they're already in collections, then the additional negative impacts could be less noticeable.

Once you have enough money in your account to offer your creditors, it's time to negotiate a settlement. Do this with each of your debts in turn until everything you owe is paid off. 

Identify your financial hardship

Creditors are much more likely to negotiate if you have a financial hardship that means you can't pay your full balances. So explaining the cause(s) of your money problems could help make your debt settlement a success. 

Some of the most common financial hardships that you could demonstrate to your creditors include:

• Job loss 

• Cut hours

• Reduction in income

• Death of a spouse

• Serious illness

• Injury or new disability

• Divorce or separation

Your situation may qualify even if it's not listed here. The key is that the financial hardship prevents you from repaying the full amount you owe.

Contact your creditors

Once you have saved up a good amount to offer to your creditors, it's time to negotiate. If your account hasn't gone to collections yet, contact your original creditor. 

Many creditors will only hang onto a debt for about 180 days. At that point, the debt is usually written off (marked as a loss in the creditor's books) and sold to a debt buyer. Often, the debt buyer is a debt collection agency that also purchases debts.

If your account has been sold to a debt collector, request verification in writing of their right to collect the debt. If you're not sure who owns the debt, check your credit reports.

Be calm, polite, and professional. Though dealing with debt can be stressful, remember this is a business transaction. Try not to bring your emotions into the discussion.

Propose a settlement offer

The next step is the most important when you're negotiating debt settlement on your own—the actual offer to your creditor to settle your debt. Ask to pay part of your balance and for the creditor to forgive the remaining debt. When you make your offer, make sure it’s an amount you can truly afford. 

Creditors are generally more likely to accept a settlement offer that’s a lump sum payment over a payment plan (which is why you save up money in your account first). 

The specific amount lenders may forgive varies depending on many factors, including how much you owe, how much income you have, and the nature of your financial hardship. Creditors could forgive anywhere from 10% to 90% of your debt, although it's usually realistic to expect to pay about half of your balance. But this is highly specific to your situation, and not guaranteed.

Negotiate the terms

When you offer to settle debt, don't expect your creditor to accept your first offer. Back-and-forth negotiation is common. Stay calm, patient, and persistent as you negotiate a deal. Avoid getting argumentative. 

You may also want to negotiate details beyond how much you will pay. For example, you could negotiate how the creditor will report your account to the credit bureaus after you've made the settlement payment. An account reported as "settled" typically affects your credit worse than one reported as “settled in full” or “paid in full” instead. 

Get the agreement in writing

If you come to an agreement with your creditors, get a written agreement detailing all of the settlement terms before you send payment. This includes the amount you agreed to pay, the payment deadline, and a notation that the payment satisfies the debt.

If you don't have written proof of what you agreed to, it is possible the creditor could take your money and still try to collect the remaining balance. A written debt settlement contract helps you prevent that. 

Keep copies of all of the documents for your records. When you send payment, keep a record of that as well. This is important in case you need to show the terms of the deal and that you fulfilled them. 

Tips for a Successful Debt Settlement Negotiation

Negotiating debt doesn't have to be complicated. You just need to take the right approach. Here are some key tips for maximizing your chances of negotiating debt settlement on your own:

• Keep calm. Remember, this is a business transaction. You want to stay professional even if the conversation becomes tense. 

• Don't share unnecessary information. Don't provide extraneous information to your creditors. If something makes them think you'll be able to pay more in the future, they could be less willing to settle with you today. 

• Expect collection efforts to continue during negotiations. Don't be discouraged by collectors who still call requesting payments. Until the debt is officially settled, they will continue trying to collect, so just keep moving forward with negotiations. 

• Understand your rights under the Fair Debt Collection Practices Act (FDCPA). Debt collectors are not allowed to use abusive, deceptive, or unfair tactics, so be aware of your rights. You also have the right to request they stop contacting you, although this doesn't stop collection activities. 

Potential Drawbacks of DIY Debt Settlement

While debt settlement could get rid of your debt for less than you owe, there are some disadvantages to consider. Here are some of the biggest downsides: 

• Negotiating your debt can be time-consuming and emotionally draining. You'll have to deal with your creditors and craft a plan, which can be stressful. 

• Not all creditors will settle. You can't count on success with every creditor. And those who won’t work with you will still try to collect. 

• You could face taxes on forgiven debt. Forgiven debt is treated as income by the IRS, so you’re likely to owe income tax on the amount forgiven unless you are insolvent.

• Missed payments during negotiation impact your credit profile. How much your credit score drops depends on where it starts. If you're already behind, missing more payments may not hurt your credit score as much as you think. And it's generally a lot easier to rebuild credit after settlement without unmanageable debt hanging over your head.

When Professional Debt Help Could Make Sense

While you can negotiate your debt yourself, you may feel uncomfortable or uncertain about the process. If that’s you, there is help out there. Consider hiring a professional debt relief company to work on your behalf.

Professional negotiators have experience with debt settlement and often have a relationship with creditors. They understand how to approach the discussion, and know what to expect. This could lead to better results. 

Debt relief companies can also provide structure during repayment. For example, at Freedom Debt Relief, clients make one monthly deposit that's put into an escrow account (owned and controlled by the client) to build up money to settle debt. Expert negotiators handle communication with creditors, and you have a clear path forward. 

Schedule a free debt evaluation with Freedom Debt Relief to see if you could benefit from this professional assistance.

Other Options for Resolving Debt

Debt settlement won't be the right fit for everyone. You may also want to consider one of these strategies:

• Credit counseling: Nonprofit credit counselors may work with you to create a debt management plan (DMP) if you're eligible. This involves making one monthly payment to the credit counselor that's distributed to creditors. A DMP requires that you close your accounts, but may help you qualify for reduced interest rates. 

• Bankruptcy: Both Chapter 7 and Chapter 13 bankruptcy help you deal with your debt through the courts. Chapter 7 could eliminate your unsecured debt quickly, but requires liquidating assets. Chapter 13 requires you to enter into a three- to five-year repayment plan but could stop a foreclosure. 

• Debt consolidation: This involves taking out a new loan to pay off current debt. Ideally, the new loan has a lower interest rate and better terms than your current loans. Consolidation requires qualifying for a new loan, which typically requires at least fair credit and enough income to afford loan payments.

Taking the Next Step Toward Settling Debt

If you are feeling overwhelmed by debt, don't panic. You have options. In fact, even researching your choices is a key first step. To take the next steps in your journey:

• Determine how much debt you have.

• Figure out how much money you can afford to pay toward your debts.

• Schedule a free evaluation with a debt settlement company to see if it's the right fit.