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Debt Settlement: Interchangeability of Terms
In the world of the financially distressed, a lot of terms get thrown around that may mean different things depending on who is using the term. Those terms are debt settlement, debt negotiation, debt consolidation and credit counseling.
Unfortunately, there is no universally accepted definition for any of those terms. When seeking a professional to help you get out of debt, be careful when you throw these terms around. What matters is what that professional intends to do for you and how he or she intends to go about it.
Debt settlement usually means paying an agreed upon amount, less than the total amount owed, usually over no more than 3 payments. For this to work, you must have adequate funds on hand to pay the settled amount. If this is your goal, our firm requires that you pay money monthly into a separate account that is used solely for settlement purposes. For example if you owe $6,000 on a debt and get an offer to make a one time payment of $2,000 to settle in full, you won’t benefit from that offer if you do not have the $2,000.
Another thing to consider is that when you settle a debt, you may get a tax document called a “1099” that states that the amount of debt that was forgiven is actually income. If this happens to you, there’s a pretty good chance that you would not have to pay tax after discussing your situation with a competent CPA.
Debt negotiation is the process of communicating with creditors and collectors to resolve a particular debt. Like debt settlement, it often has the goal of a reduction in principal owed. If you still owe money to the original creditor, debt negotiation could result in a reduction or cessation of fees and/or interest. At our firm, debt negotiation is a critical part of debt settlement. Knowledge of the collection laws and credit card agreements is critical to this process as we can often use violations of those laws to help get you a better deal.
Debt consolidation generally means reducing all or most of your monthly debt obligations into one payment. This is usually accomplished by getting a loan for the total amount owed, where that loan has an interest rate that is lower than the average effective rates for all the individual loans. The debt consolidation loan pays off the individual loans such that you have only one (and hopefully lower) payment on one loan. This only works if you have adequate cashflow to make the monthly payments on the new loan. A chapter 13 bankruptcy is not a debt consolidation, but it often feels like it because most (and many times all) of your creditors are taken care of by one payment to a third party.
Credit counseling is the process of having a third party negotiate lower interest rates with your creditors so that you can be on a plan to be debt free in a certain amount of time. A true, ethical, credit counselor would charge a reasonable fee (usually about $50 a month) and will also be honest with you about whether your cashflow is such that you could achieve success on the plan. Although there is likely more than one ethical credit counselor, the one that we regularly send people to is Money Management International.
Remember, it does not matter if the person states he or she will do negotiation, consolidation, settlement, or counseling for you. The world of “professionals” helping people who struggle financially is filled with untrained charlatans simply out to make a buck. You could easily speak to someone who uses all four of the above terms interchangeably. What matters is what steps they say they will take for you and whether you have the cash flow to follow through.
Read the other articles from our Debt Settlement Primer
1. Debt Settlement Primer
2. Step-by-step timeline
3. Beware of the charlatans
5. Interchangeability of terms
6. Do’s and Don'ts
Click this link to download the Texas Debt Settlement Primer (PDF)