DailyWorth

By Gerri Detweiler and Mary Reed Sent: Thursday January 21, 2010

This post is a follow up to "Debt Diet, Part I."

Gerri Detweiler and Mary Reed are co-authors of "Debt Collection Answers: How to Use Debt Collection Laws to Protect Your Rights." They also answer debt questions at DebtCollectionAnswers.com.

Debt settlement is the “liposuction” version of a debt diet, eliminating the excess debt that’s weighing you down.

If you can’t pay your credit card debt—and if credit counseling fails because the payments are too high—creditors may let you pay less.

But negotiating debt away requires moxie and muscle.

1. You must stop paying your credit cards before creditors will even discuss a settlement. (They won’t make a deal if you’re paying on time or making the minimum.)


2. Once you stop paying your bills, you must save the cash to build a war chest for settlements. Most settlements are paid in one lump sum.

As you fall behind, some creditors may approach you with deals: e.g. an offer to settle a $5,000 balance for $3,000.

Or, you can make the first move, once you've fallen a few months behind, by offering to pay what you can. (Caution: If you strike any deals, get them in writing before you pay a penny!)

PROS: When settlement works, it lets you zero out your balances much faster than if you tried to pay off everything on your own.

CONS: Your credit rating will tank, and you may owe taxes on the amount forgiven by your creditors. (If you are insolvent by IRS standards, you may not have to pay taxes on the forgiven debt, but ask a tax accountant first.) Also understand that there is a risk that some creditors won’t settle, and may sue.

If the risks seem worth the possibility of gaining debt freedom, this could be the route for you.

Listen to an interview with debt settlement expert, Mary Reed, here.