So, if you can’t stay on top of the payback and decide you’re done fighting, you’ve got two options. With debt settlement, you or your company (or, more likely, a settlement company) asks the creditor if they will accept one lump payment that is less than what you owe, and then they consider the debt paid. For instance, if you owe $100,000 on a bunch of credit cards and you agree to pay $60,000, you’ll be relieved of the whole debt. In a workout agreement, you go directly to creditors and ask them for another payment plan, like a reduced interest rate or waived fees. The difference here is that a workout does not reduce your debt, just changes the way you’re going to pay it. It does not relieve you of the entire debt, but, hopefully, it relieves some of the pressure.
Debt Settlement
One upside to debt settlement is that you won’t be paying the full amount of your debts. You get a professional on the other end of the phone negotiating with your creditors to lower your debt, and it’s fairly common for business debts to be settled for 30-60% less than the balance you originally owed. That can mean tens, or hundreds of thousands of dollars in savings! Not only does settlement give you an alternative to filing bankruptcy, which can have adverse effects for many years, but even though settlement will negatively affect your credit, it will not hold as much negative weight in the eyes of future lenders and creditors. Lastly, since the payoff is lowered, you should be able to pay off your debts within two to four years rather than making minimum payments for many years.
There are some drawbacks. In order to settle, the business will typically stop making payments, and this can cause the business’ credit score to drop by 100 points or more, with the credit score not recovering for years even after all debts are settled (and creditors report accounts as “settled” on your credit reports). In addition, the forgiven debt may be viewed as taxable income (i.e., you may owe the IRS income tax on the amount by which your debt was reduced), although this is not always the case if the business qualifies under special circumstances (like insolvency), but the business should consult with a tax professional. Furthermore, creditors may choose to sue for late payments and collect the full debt. Settlement firms try to avoid situations in which creditors sue for repayment, but a lawsuit or bank garnishment is possible.
Then there is the settlement company itself. You’ll have to pay for the privilege. If they charge you a percentage, they’ll typically tack on 15-25% of your total debt, and then bill you over the course of the program, so $100,000 in debt could cost $15,000 to $25,000. And if they work on a flat fee, it will probably come out to 10-20% of your debt, and on average the fee will be between 15-20%. Just be wary of extra fees like a monthly maintenance fee, a fee for leaving the program early, fees for bouncing checks, late payment fees, and legal fees. Connecticut, Kansas, and North Carolina have all made it illegal for settlement companies to charge you upfront before you’ve settled your debt.
Negotiate with Your Creditors Directly
If you negotiate with your creditors directly for a reduced or other payment plan, you won’t pay the fees a debt settlement company charges. Any reduction in the interest rate or waiving of fees can help. Explain your financial hardship, submit documentation if requested, and keep trying several times; if you cannot get satisfaction, request to speak with the creditor’s manager. However, try not to contact the creditor so frequently that it’s considered harassment. A drawback of this option is that the creditor isn’t required to agree to the new arrangement, and the balance isn’t lowered, but only restructured. If your creditor won’t negotiate, there’s still hope, as a debt settlement program may be able to help you.
Both routes are alternatives to bankruptcy. Bankruptcy involves liquidating assets and a court ordered repayment plan; Chapter 7 discharges eligible debt while Chapter 11 is a reorganization. It’s a public court proceeding which comes with legal fees and court costs. A workout is more like debt consolidation or a debt management plan. With a workout, the debts are restructured but the total balance is not reduced. A debt management plan set up through a non-profit credit counseling agency usually last three to five years. Creditors are not obligated to accept the new terms.
Not every debt qualifies, either. Business credit cards, lines of credit, accounts receivable financing, outstanding invoices, and loans from banks or online lenders can all be considered for settlement. But not secured debts like equipment financing or commercial mortgages. The creditors will need to see that you really can’t afford the payments, through tax returns showing declining revenue, bank statements showing cash flow problems, or evidence of a hardship such as losing a major client or contract.
How long the settlement program will last depends on how much you owe overall and how many different creditors you’re dealing with. You can expect to be in the program for 2 to 4 years; it can take as little as 2 to 3 months on some accounts and debts over $100,000 may take longer. Once a settlement is made with a creditor, your account should be marked as such and your creditors should stop calling you for payment; however, always request a settlement agreement in writing. If you continue to receive collections activity on a settled account, contact the creditor to get it resolved.
If you’re going to go the route of a settlement company, make sure it’s legit. The American Fair Credit Council is the main industry association and its members have to adhere to a code of conduct; the International Association of Professional Debt Arbitrators is another way to tell if a company operates ethically. Look at reviews on Trustpilot and the Better Business Bureau, and see if the reviews are consistently positive and over a long period of time. If there are no reviews, steer clear. Also watch out for any company that isn’t transparent about the whole fee structure.
There’s no real good or bad choice, just different situations. A workout won’t cost you anything in fees, so you should try it first, especially if the debt isn’t too big and could be managed with a lower interest rate. Settling is better if the balance is too high to pay back, the debt isn’t secured, and you can prove you’re really struggling. In both cases, the trick is to plan. Create a budget, trim everything you can, stash away cash in a savings account, and don’t take on any new debt.
