What is a Debt Settlement Agreement?

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  • Written By: Lainie Petersen
  • Edited By: Melissa Wiley
  • Last Modified Date: 31 January 2020
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While creditors always want and expect debtors to pay their debt in its entirety, there are situations in which a debtor is overextended and simply cannot pay a debt as agreed. In these situations, a creditor may enter into a debt settlement agreement, which allows the debtor to pay off part of the debt in exchange for the creditor's willingness to cancel the rest of the balance. Creditors often consider debt settlement agreements if it is clear that a debtor cannot pay the debt and may either have to default on the debt completely or file for bankruptcy. On the debtor's part, a debt settlement agreement can be a way to reduce debt while avoiding bankruptcy and, in some cases, prevent further damage to a person's credit history.


In many instances, a debt negotiation take place directly between creditors and debtors, though in some cases a debt settlement attorney might facilitate the process. Many creditors, unwilling to give a debtor a free ride, may need to see proof of a debtor's financial problems before reaching a debt settlement agreement. Debtors who can demonstrate that their financial situation is serious but also show that they have some cash can often convince these creditors that it is better to take something than get nothing. If a debtor has a fairly significant amount of cash available to settle the debt, he or she may even be able to get the creditor to delete the troubled account from the debtor's credit report, which can serve to improve the debtor's credit score.

If creditor and debtor fail to come to a debt settlement agreement on their own, a debt settlement attorney may get involved. Contact from an attorney may make a creditor more willing to negotiate and may actually scare the creditor into believing that the debtor is likely to file a bankruptcy case. While debt settlement services do exist in some places, many debtors are wary of working with these organizations because some debt settlement businesses do not perform as promised. In many cases, a debtor is better off negotiating a debt settlement agreement by calling his creditors directly and offering them a reasonable percentage, likely 40 to 60 percent of the debt in a settlement.

Debtors should always make sure that they get their debt settlement agreement in writing before sending any money to a creditor. Unfortunately, debtors may suffer some consequences as a result of debt settlement in the form of a lowered credit score or tax consequences. For example, in the United States, canceled debt of more than $600 US Dollars (USD) can be regarded as a debtor's taxable income by the Internal Revenue Service. Plus, in cases where the debtor is not able to negotiate the removal of the settled account from her credit report, the creditor may choose to report the debt as settled for less than the amount owed, which can have negative implications for both her credit score and ability to get credit in the future.



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