What Is The Legal Definition Of “Debt Settlement?”

Debt settlement confuses some people because it goes by other synonyms like “debt reduction” or “debt negotiation” or even “debt resolution.” They all mean the same thing. There are a number of means through which the process of debt settlement occurs, but in general the legal definition of debt settlement revolves around the act of settling debts through negotiation with a creditor. 

Because creditors realize that sometimes people dig themselves a hole with no way out (financially speaking, of course), they agree to forgive a portion of the debt. This is done because the creditor isn’t going to be paid through other means, and the debtor cannot pay through other means. Often, the agreement involves a single payment. The agreement is always written and signed by both parties because it is a legally binding contract.

Creditors are accustomed to dealing with debtors who cannot pay the full amount. For them, there are two options: pay off a debtor’s debt to a third party or seek payment without a middleman. If they go through a third party, the third party will seek to have the debt paid through more aggressive means.

Most banks choose the third-party option but other banks — like Bank of America — will usually attempt to acquire payment through other legal means such as civil litigation.

Debt settlement is often an alternative to declaring bankruptcy, although each method has its own advantages and disadvantages. 

How does a debt settlement transpire? Generally, the debtor will make the choice to reach a debt settlement either with the help of an attorney or by oneself. Either the debtor or the debtor’s representative will do their best to provide an honest evaluation of the financial situation that led to this meeting.

The debt settlement agency would make a sneaky arrangement that usually works like this: First, the debtor would agree to pay the debt settlement agency instead of paying their bills. These payments would usually be less than the payments owed to the creditor — and they would instead be put into a savings account. Eventually, when there is enough in the savings account, the debt settlement agency would contact the creditor to make a deal to reduce or eliminate the debtor’s debt. 

One portion of the money in the account goes to paying the creditor, while a smaller portion goes to the debt settlement agency. 

Keep in mind that a debt settlement agency isn’t always a part of this process. Some debtors prefer to eliminate the need for a middleman just like creditors who do the same.

There are two key advantages to debt settlement: You avoid bankruptcy and you pay less of the overall debt. But there are potential disadvantages as well. First, the settlement agency might not be able to reach a deal with the creditor. Second, the creditor could litigate (like Bank of America often does). Third, a person’s credit score will plummet during this process. And last but not least: if the debt settlement process fails, then the interest on the original amount will result in an even larger amount than the debtor would have paid in the first place.