How Debt Affects Your Credit Score
When you can’t afford to pay your debts, you may want to negotiate a debt settlement agreement with your creditors or with a collection agency.
Negotiating a settlement could close your past-due account, but even a fair settlement has some drawbacks. You may need to part with a lump sum of cash, for example.
In this post, I’ll cover the basics of how to reach agreements with your creditors.
Steps To Negotiating a Debt Settlement
- Step 1: Validate the Debt is Really Yours
- Step 2: Check the Statute of Limitations
- Step 3: Plan a Repayment Proposal
- Step 4: Time for Settlement Negotiations
Step 1: Validate The Debt is Really Yours
You don’t need to settle the debt when the debt is not yours, to begin with.
Federal laws require debt collectors who contact you about debt to prove the debt is yours — if you ask within 30 days of the collector’s first contact with you.
If you don’t request a debt validation within 30 days, you’re basically agreeing that the debt is yours.
So if a debt appears on your credit report, or if a collection agency starts sending you letters and phone calls, don’t ignore the debt collector.
Instead, write a debt validation letter and send it to the debt collector. Within 30 days you should receive documentation that the debt is yours with the accurate amount due and account number included.
If the debt collector can’t prove the debt is yours, it’s required by law to remove the debt from your credit history and stop contacting you about payment.
However, if the collection agency validates the debt as yours, you’ll need to find another way to resolve the debt — possibly by reaching a debt settlement agreement.
Note: If you’re not sure how to write letters, check with the Consumer Financial Protection Bureau which has sample letters to send to a debt collector, or see our debt validation letter template.
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Step 2: Check the Statute of Limitations
You should also know the statute of limitations on your debt before making an offer to settle.
The statute of limitations creates a deadline after which creditors cannot sue you for unpaid debt. Different states have different statutes for different kinds of debt.
In some states, partial payment can restart the clock on your statute of limitations on a debt.
This is bad because you’re exposing yourself to more legal action unnecessarily. This can also extend the account’s lifespan on your credit report.
If the statute of limitations is about to expire, a collection agency may be more willing to negotiate with you and give you favorable terms.
If the statute has expired, you can ask a judge to dismiss any action the debt collector has filed against you.
Even if the statute has expired and you can’t be sued, you still owe the money, and the account can remain on your credit report.
If you do reach agreements to settle your debt, make sure the terms of the settlement close your account completely even if you don’t pay the full amount.
Step 3: Plan a Repayment Proposal
A collection agency wants one thing: your money. They make money only when you make payments on your debt.
They can’t seize property or pull money from your bank account unless they sue and get a civil judgment and permission to garnish wages.
As a result, the agency should be willing to work with you — if you’re reasonable and propose a fair settlement.
Coming up with a realistic repayment proposal is a good start to repaying your debt.
Be realistic about how much you can afford to pay each month. Review your other bills and make sure that tackling this debt won’t lead to more credit problems.
Write down your monthly take-home pay and all of your monthly expenses, including your existing debt repayments. Try to have money left over for emergencies and unexpected expenses.
Gathering this information will help you determine a total amount you can pay to settle the entire debt as a lump sum or via monthly payments for a certain amount of time.
Don’t propose a settlement amount that’s more than you can afford. In fact, your first offer should be well within your ability to pay.
Step 4: Time for Settlement Negotiations
By now you know the debt is yours, and you know how much you can afford to pay in a settlement agreement.
So now it’s time to put all this knowledge into action by reaching out to the collection agency or debt collector.
Make an Initial Offer
Begin the negotiation process by making an offer. For example, if you owe $3,000 on a credit card account that was sent to collections, offer to pay $1,000 to close the account.
Expect a counteroffer. The debt collector may send a demand letter asking for $2,000 instead. This is good news because it means the settlement process is underway.
Continue Settlement Discussions
You can continue the settlement discussions by making another counteroffer of your own.
How about $1,500 which represents half the amount you originally owed? Yes, it’s more than your initial offer, but it’s still a pretty good deal.
Does It Matter Which Debts You Pay Off First?
Remember that from a debt collection point of view, receiving any cash from you is a very good thing.
It’s in their client’s interest to accept cash from you, especially if they paid only nickels on the dollar for your debt, to begin with.
Get Your Agreement In Writing
Once you reach an agreement, record the details of the plan in writing. Include the debt collector’s promises. These promises should include:
- That the debt collector will stop collection efforts and will forgive the remaining debt once you’ve completed the payments.
- That the debt collector will remove negative items from your credit report in response to getting your payment.
Get the agreement in writing before you make a single payment. If you don’t have the settlement agreement in writing, the debt collector may cash your check but not fulfill its promises.
When you follow up without written proof, the agency may refute your claim that it had promised to cancel the debt in response to your partial payment.
If this happens you could be worse off than you were before making the payment. The statute of limitations would restart on your debt. Plus, the negative items could stay longer on your credit report.
So insist on getting your settlement agreement in writing.
What to Consider When You Make a Settlement Offer
Getting your final debt settlement agreement in writing is essential. But it’s easier to reach agreements by talking on the phone.
When you reach an agent, ask for someone who has the authority to make settlement agreements. You may have to speak to several people at the collection agency to get what you want. Stand your ground and don’t let them bully you.
If the person on the other end of the phone wants to know why you can’t afford the full amount, explain your financial situation — but share only pertinent details.
Don’t discuss your income or other financial obligations unless you’re sure it will help in your negotiations.
You’ll do better to keep the conversation focused on what the debt collector has to gain. Mention how close the debt is to the statute of limitations. Let the agent know how much you can afford to pay as a lump sum.
The older the debt, the more likely you can convince the debt collector to accept less than full payment.
Remember that you’re no longer dealing with the original creditor, so the collection agency should have some wiggle room to negotiate a final amount to be paid, even if the agent initially claims otherwise.
Calling In the Pros
If you need help, seek legal advice from a credit counselor or a law firm.
Your local bar association should be able to share contact information for several attorneys who specialize in debt management.
But be wary of debt settlement companies that charge fees in advance to settle your debts for you.
Some of these companies promise more than they can deliver, and some creditors won’t work with them.
The debt settlement company may not be able to resolve your problem for you, and you’re often better off on your own or with legal advice from a law firm in your area.
Settling Current Credit Card Debt
If your debt comes from an existing credit card account, you can ask the credit card company to waive old late fees or reverse finance charges that resulted from interest rate increases. It never hurts to ask.
This reduction in your debt could help you manage to keep the account active instead of entering a debt settlement agreement.
If not, you could make a settlement offer to your credit card company before it sends your account into collections.
Even if you conduct settlement negotiations over the phone, get your final agreement in writing.
Make sure your payment will cancel the credit card debt and close the account before sending payment.
What About Settling Medical Bills?
Medical bills often include another variable: your health insurance company.
Sometimes, your medical bills go unpaid because your insurance company didn’t receive your claim the first time it was filed.
Your doctor’s office may need to refile Insurance claims to get the insurance company to pay its portion of your medical bills.
If you think the insurance company is wrong to deny your claim, you can appeal the denial.
And check with your hospital or medical clinic about charity care. If you qualify, this kind of relief could erase your past-due balances.
Bottom Line: You Have Power in Settlement Negotiations
Excessive debt feels hopeless. The feeling of powerlessness makes you want to give up.
But heavy debt doesn’t erase all your power. In fact, you still have a very powerful card to play: your cash payment.
Even a partial payment puts money in the pocket of your debt collector, and making money is the whole point of debt collection.
So don’t play your payment card until you know it’ll pay off — until you have a written agreement saying the creditor will cancel the debt and remove negative items from your credit history in response to your payment.
Find out how much you could possibly pay and make a settlement offer. It never hurts to ask.
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