How to Settle Debts When You Can’t Pay Them Back

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How to Settle Debts When You Can't Pay Them Back

Being in debt isn’t great. Being unable to pay your debt is even worse. While no one likes dealing with debt collectors, doing so can help make your debt more manageable—and maybe even reduce how much you owe through the process of debt settlement.

This post is part of our Evil Week series at Lifehacker, where we look at the dark side of getting things done. Knowing evil means knowing how to beat it, so you can use your sinister powers for good. Want more? Check out our evil week tag page.

Debt settlement is the process through which companies can collect payment on a debt that you can’t necessarily payback. To put it simply, life happens. You take out a car loan and the economy crashes and you lose your job. You buy a house, but then a family member gets cancer and the bills are too much. Or even something as simple as buying a gadget on a credit card but getting overwhelmed by the terminology and ending up buried under fees. It happens to everyone. Debt settlement, in general, allows you to negotiate with creditors (or collection agencies) to reduce the amount you owe so you can pay something and get back on your feet.

Before we get started, let’s address a couple things. First, settling your debt for less than you owe is generally bad for your credit score. This is because settling says to creditors that you asked to borrow money and were unable to pay it back. Naturally, creditors are unlikely to want to lend you more money based on that.

The other thing to consider is the relative moral grey area debt settlement exists in. On the one hand, failing to pay back money you promised to pay back is, in some eyes, tantamount to stealing. On the other hand, the system is built in such a way offer debt forgiveness, flexible payment plans, and even punishments (in the form of the aforementioned credit score ding), so arguably utilizing debt settlement if you need it should be considered a natural, expected part of the system. This is Evil Week at Lifehacker so we’ll leave you to discuss the morality in the discussions below, but for now, here’s how it works.

How the Debt Settlement Process Starts

How to Settle Debts When You Can't Pay Them Back

There are two main ways that you can end up negotiating to settle your debt: either with the original creditor, or with a collections agency. If you have failed to make a payment on your debts for a period of more than 3-6 months (typically around 150 days), your debt can be sold to a collections agency. In those situations, your creditor is paid a percentage of the debt (say, 10%), and walks away. Some money is better than no money, after all. At that point, you won’t deal with the creditor anymore. You’ll deal with the collections agency.

If your debt is still owned by the original creditor, however, you’ll go through a different process—and we’ll explain both in separate sections below. However, in both cases, your situation is the same: you owe money, you can’t pay it all back, and the person who owns your debt wants to get as much as they can.

This is important to keep in mind. You do technically owe the entirety of your balance. However, if you find yourself in a bind where you cannot pay it all back, the company you owe money too would still like some of it. A debtor that settles is better than one who defaults entirely. This gives you some room to negotiate. Not a ton, but some. In most cases, the first thing that any debt collector will want is the entire balance, but depending on what you’re able to pay, you can sometimes negotiate the balance down or arrange a more optimal deal for your situation.

How to Negotiate with Your Original Creditor

How to Settle Debts When You Can't Pay Them Back

The key to negotiating with the original creditor is convincing them it’s in their best interest to settle your accounts. This process won’t start until you haven’t been paying your bills for about 90 days. This type of late payment is reported to credit agencies and dings your credit score, so it’s not the type of thing you want to do unless you absolutely have to. However, it does send the message to your creditor that you’re either unable or unwilling to pay.

In the time before thos 90 days arrive (or as soon as possible), go over your budget and identify exactly how much money you have to work with. Itemize your bills, categorize them by necessity, by optional expenses, and what you have left over. You’ll need to identify exactly what you’re capable of paying back and stick to it. In a way, this negotiation is a bit easier because your limits are built into your budget. Assuming you do your homework correctly, the upper limit on what you can pay back immediately is however much cash you have, and the limit on what you can pay back monthly is what’s available in your budget. You may not want to volunteer that information immediately, but at least know what it is and don’t offer to pay more than that. Lest you end up in the same situation.

Your creditor will likely send you letters and/or call you to discuss your situation. At this point, you can negotiate what you’re able to pay. Initially, they will want the entire amount due. This is the time to ask to negotiate. Be up front with the fact that you are unable to pay the entirety. If they’ve reached the stage of calling to ask you for payment, they’re familiar with this already. It may be a devastating call for you, but it’s fairly routine for them.

There are three main areas you’ll want to focus on “winning” in when negotiating with a credit agency:

  • Your total amount owed: Let’s say you owe $ 10,000 in credit card debt. You might negotiate to pay back half of that. That may be payable in a lump sum, or over time. However, this is the part where you can actually save money and try to get out from under the debt.
  • Your monthly payment: In addition, you can also negotiate a lower monthly payment. This is tied into how much you owe, but the monthly payment will be what determines how well you’re able to handle it over time. This isn’t the place to get ambitious. Make sure you are up front about what kind of payment is manageable and what’s going to be too cumbersome.
  • Your account’s standing: This is the part that affects your credit score. Your account can be in various states that negatively affect your credit. Explaining the differences between states is a complex topic, but your aim when everything is done should be an account that is at least listed as “Settled” if you’re paying off the entire debt for a lesser amount at once. If you’re renegotiating your monthly payments or interest rate, you may be able to ask that your account be listed as “Paid as Agreed” when you’ve finished paying it off.

Negotiating with a creditor is going to be better for you in the long run, since credit agencies are fairly heavily regulated. We’ll discuss some of the additional hurdles in the next section, but suffice to say if you can get your credit agency to agree to certain new terms, that should be enough. It can’t hurt to get an agreement in writing, but it’s not entirely necessary to demand it.

Depending on your situation, the deals you can work out vary. If you’re dealing with temporary financial issues, you can ask for a forbearance which allows you to avoid payments for a short period while you get your income levels back. You can negotiate workout arrangements that allow you to pay off what you owe while limiting or cutting off your interest entirely. Or, you can pay off what you can immediately and get the account settled. You can read more about these various forms of plans here, as they all have their advantages and disadvantages.

How to Negotiate with a Debt Collection Agency

How to Settle Debts When You Can't Pay Them Back

If your account past due longer than 150 days, your creditor may end up selling your debt to a third party. This changes the stakes a bit, as it means that the creditor is no longer involved (as far as you should be concerned at this stage, anyway). You shouldn’t bother calling your credit card company at this stage. They won’t talk to you anyway.

Moreover, the agency you’ll be talking to bought your debt for what is likely a much smaller percentage than what it’s actually worth. So, say you had $ 10,000 in credit card debt. Your creditor may have sold it for $ 1,000. The debt collection agency paid $ 1,000 for your debt, so anything above that is a win for them. Obviously, they still want the entire amount—they are legally entitled to it now, after all—but since they paid much less than your original creditor for it, they have good incentive to accept less. A general guideline is that you shouldn’t attempt to pay back any more than 40-50% of the total amount owed by this point.

There is a downside to this avenue, though. Since your debt is no longer with your original creditor, there’s a bit less accountability. While it may not be legal for a collections agency to lie or manipulate you, it can happen. And chances are if you can’t pay your credit card debt, you can’t hire a lawyer to fight for you. Moreover, your debt can be sold from one third-party to another, which means there’s room for confusion. This is why every piece of advice regarding collections agencies will center around one piece of advice: get everything in writing.

When you negotiate with a collections agency, here are the specific things you will want to get in writing:

  • The amount you are agreeing to pay back and what it’s for: Paying $ 2,000 against your principal is a very different thing than paying $ 2,000 to settle your account. When you agree to pay off a certain amount to a collection agency, be sure that the agreement you get in writing includes what the payment is for.
  • Which debt the payment is for: If you’ve reached this stage, it’s possible you have multiple debts in collections. Or it could be that your credit agency is choosing to be vague. Either way, you’ll want something specific in writing to what debt you’re paying off. The name of the original creditor and account numbers should be accessible to the collection agency. If they can’t or won’t provide that information, at the very least, get a statement saying what the debt was for. Again, be specific. A debt for “Medical bills” is not specific. A debt for “Visit to Dr. Realname on October 12th, 2013” is specific.
  • When your payment is due: Some settlement offers will have a set deadline. Others will require you pay them “within 30 days.” Either way, if you don’t pay by the deadline, the offer you make may be voided, meaning all your hard work negotiating may be for nothing. Be sure to get a copy of the deadline in writing to ensure you have proof you paid on time.
  • Who you’re paying off your debt to: As stated before, your debt may move from one agency to another. Be sure that you acknowledge in writing who you are paying along with what accounts you’re paying for. If you do everything else right, but accidentally pay the wrong agency, you may end up still owing money and no way to retrieve the payment you made.
  • The terms of your account standing after payment: As with the previous section, one of the things you’ll want to negotiate—and get in writing—is the standing of your account once the deal is completed. You may not be able to reverse any negative marks that your original creditor made on your credit record, but you can potentially prevent any new ones.

You can check out this post from Reddit user collectionsattorney for more recommendations on what to watch out for and what to get in writing (note: everything). And, once more for posterity, be sure to get everything in writing. Not only the terms of your deal, but anything you can. Any conversations you have, any details you discuss, and anything you can keep a record of, hold on to. If it’s legal to record phone calls in your area, it couldn’t hurt to do that either.

It’s also important that you not pay anything until you have an agreement in place for your entire debt. You may be coaxed to make a payment up front to get things started, and then come back for the rest later. However, if you make a payment, it may be counted as going towards your original account and your ability to negotiate more workable terms is gone until you’re late all over again. Naturally, this hurts your credit score even more, which puts pressure on you to pay up. For this reason, you should never pay a cent until you have a full and complete agreement in writing.

No matter what part of the process you’re currently tied up in, usually there are mechanisms available for working with you when you can’t pay back your debt. This isn’t the type of situation you want to get yourself in on purpose. There may be ways around paying back every cent you owe if your situation has changed, but it’s very difficult—if not impossible—to get around being marked as a potential liability in the eyes of the credit bureaus. Your ability to borrow money may be severely damaged, but at least you can get back on your feet.

Photos by Bryan Brenneman, TheTruthAbout, and Keith Williamson.

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