Here’s what it involves:

You stop making your payments to your unsecured creditors. Instead you start making a regular monthly payment to a separate savings account. (These payments are typically lower than the minimum payments you probably have been making.) After your debts go unpaid for several months, they will typically be charged off by your lenders. That means the  lenders write them off their books as bad debts, but they can still try to collect on them.

At the same time, you will build up your savings account. At that point, the company will negotiate settlements on your debts-sometimes as low as 25 cents on the dollar, but usually in the 50 percent to 75 percent range.

Under most programs, you will be completely out of debt (at least unsecured debt) in anywhere from twelve to thirty-six months depending on your total debt. Twenty-four months is a typical program. Your total payoff will usually be 50 percent to 60 percent of the amount of debt that you entered the program with, including the fees charged by the settlement company.

So if you have $20,000 in debt, you might enter a debt settlement program calling for two years of $500 monthly payments. After twenty-four months at $500 a month you would have paid $12,000 including fees to settle your debts, or just 60 percent of the $20,000 originally due. Of course the final numbers will depend on your individual situation but the plan can work in certain cases.

A few things to keep in mind about debt settlement:

• You need to make sure the money you send in for your savings account to settle your debt is held in a separate trust account away from the debt settlement companies’ operating funds.

• You’ll want the company to handle calls from creditors. In most cases, they will get a limited power of attorney to be able to communicate with your creditors for you. This can alleviate the harassment you may be experiencing if you are falling behind.

• Many consumers in a hardship situation are able to get those taxes waived by the IRS, but you’ll want to get advice from a tax professional.

• Debt settlement is for consumers in a hardship situation, not for those who just don’t want to pay back their debts or pay high interest rates. The debt settlement company should qualify you based on your financial picture.

One of the most common fears people face when considering debt settlementis the fear that they are somehow immorally wiggling out of debts they legitimately owe. Don’t be so harsh on yourself.

First of all, there is nothing immoral about paying back as much as you can. Life happens and people run into problems. The credit card companies know, when they extend huge credit lines and hike up interest rates to percent plus, that some people won’t be able to pay them back. They are still enormously profitable.

Secondly, if you are in a hardship situation and don’t take this step, then your next option will likely be bankruptcy. In that case, your creditors may get nothing.
So do what you have to do. Pay what you can. Then get on with your life so you can focus on building wealth, which benefits our entire economy (including the credit card
companies!).

Debt stress impacts our relationships as well as our physical and mental health. The divorce rate is well over 50 percent and reportedly the number one reason for divorce is financial trouble. Couples argue more about money than any other relationship issue.

Stress, anxiety, and depression are common for those with uncomfortable amounts of debt. Feelings of guilt, shame, and failure all impact self esteem and lead people to feel as if they are out of control or powerless. Add to this the fears of what will happen if the bills are not paid, the aggressiveness of many creditors and debt collectors, and the constant pressure to continue spending, and it is no wonder that some Americans actually end up taking their own lives as a means to ending the spiraling feelings.

Debt stress has also been linked to substance abuse and the accompanying health problems (including an increased risk of violence) associated with this illegal activity. On the legal side of substance abuse, many people react to stress by abusing alcohol or legal prescription drugs. Spending has become such a problem for some people that the pharmaceutical industry has taken notice. Shopping has long been recognized as an addiction for those whose spending interferes significantly with their lives. In fact, it is estimated that 8 percent of American adults (90 percent of these being women) suffer from this addiction. Research has shown that this compulsive spending is
linked to low serotonin levels in the brain. Drugs that increase serotonin are now being tested to treat compulsive shopping.
Another serious health concern related to financial problems is the fact that people will often forgo treatment for physical (or mental) illness in an attempt to control debt. This too often leads to more serious ailments and even death. In addition, those in financial turmoil are more likely to go against doctor’s orders and return to work sooner in order to pay the bills-medical bills included-thus increasing their chances of reinjury or relapse.
In one 2004 survey, 63 percent of Americans said that debt was making their home lives unhappy. The online survey of 5,000 consumers by Consolidated Credit Counseling Services, a nonprofit money management organization, found that:

• 43 percent reported a debt-to-income ratio of 50 percent or more.

• 58 percent of participants stated that their credit cards were at or near their maximum credit limit.

• 62 percent of participants did not have a savings account.

• 92 percent had no emergency fund for three months of living expenses .

• 37 percent had taken cash advances from one credit card to make monthly payments on another credit card.

• 59 percent paid only the minimum amount due on credit cards each month

Paying Old Debts Might or Might Not Hurt Your Credit Score

For years, a quirk in the credit-reporting process meant that paying old debts could actually hurt your credit. When the creditor or collection agency updat¬ed your credit report to reflect the payment, the FICO formula was often fooled into thinking the old, troubled account was newer than it actually was. Because the formula is designed to weigh recent behavior-good and bad- more heavily than past behavior, anything that looked like you had incurred recent problems could really hurt.

Fair Isaac worked with the credit bureaus to fix this problem. The issue can still pop up, though, if your lender is using an old version of the FICO formula to compute scores. Fair Isaac spokesman Craig Watts said the company doesn’t know how many lenders use the old versions, but he thinks it’s a “very small percentage” of the total. Still, it’s possible that paying old debts could hurt you in the eyes of some creditors.

Just Contacting an Old Creditor Can Leave You Vulnerable to a Lawsuit

Each state has different guidelines on how long a creditor can sue you over a debt, but some states have provisions that allow this statute of limitations to be extended if you make a payment on an old debt or even acknowledge that you owe it. You could be making a good-faith effort to pay your bill or be talked into making a “token” payment as part of negotiations with a collec¬tion agency, and the creditor could use that as an excuse to haul you into court and get a judgment against you-an action that might not have been permitted if you had just left the debt unacknowledged and unpaid. The judgment would be a new and serious black mark on your file that could be reported for another seven years.

You’re Often Not Dealing with the Original Creditor

The company that you owe the money to might have long since cleared the debt off its books, taken a tax write-off for the loss, and sold the debt, usually for pennies on the dollar,to a collection agency. The original creditor might not accept money if you tried to offer it, but would instead direct you to the collector. Many people understandably feel less obligated to a collection agency that bought their debts for a tiny fraction of face value than they do to the company that originally extended the credit.

You Might Be Exposing Yourself to Some Pretty Nasty Characters

Despite laws designed to curb them, many collection agencies employ people who lie to, harass, and abuse borrowers. They might scream at you, use obscene language, or threaten you with jail time. (All of these actions are, of course, illegal, but if you don’t believe they happen, you need to take a look at my mailbag.)

Even if collectors are polite to your face, they might do things behind your back to further endanger your financial life. Collectors might promise to drop a harmful remark from your credit file, and then not follow through or make the black mark even worse. They might arrange a deal that they say will settle your debt, and then sell the unpaid portion to another agency that renews collection activity. Or they might report any debt you didn’t pay to the IRS, which can tax the so-called forgiven debt as income.

More than a few collectors feel that anything they do is justified because, don’t you know? debtors are bad people. The fact that owing money is usually not illegal-but that violating fair credit¬reporting and collecting laws is-remains a distinction that completely escapes them.