How to Settle Debt: A DIY Guide

(Last Updated On: January 3, 2019)

Learning how to settle debt can change your life. At the very least, it can make a HUGE difference on your household finances and credit score!

Shortly after my husband was discharged from the Army, I began working for an eccentric art gallery owner. She was very sweet and very elderly. She was also very concerned when she realized that my car was going to be repossessed because we were unable to make our payments and pay our rent.

As my boss and my friend, she gave me an unbelievable opportunity. She asked for a full list of our household’s outstanding debt and offered to give me a payday advance equal to the total amount of our debts. She said, “But if you’re smart, you’ll call and negotiate each one of these debts so you’ll have something left over.”

I was just 19 years old and deeply in debt. That was the first time I’d ever heard about negotiating your debts. However, with a little research and some experimentation, I was able to find several do-it-yourself debt settlement techniques. With what I learned, I was able to successfully settle almost all of those debts for around half of the original amount I owed!

I still use these techniques today to settle debts for myself and my friends. They really work!

What is debt settlement?

Debt settlement happens when the creditor, or the person you owe, decides to accept less than the total amount you owe them. Usually, this happens when you offer to settle debt with a reduced lump sum payment. For example, I once settled a $23,000 debt with a single $3,000 payment.

Is debt settlement legal?

Yes, debt settlement is legal everywhere in the United States. However, it does require the creditor’s cooperation. You can’t just decide to settle an agreement without your creditor’s agreement.

As we’ll discuss later, you’ll also need to make sure that you get the creditor’s agreement in writing. If the creditor changes their mind later, you want to make sure that you have that documentation to protect yourself in court.

How does debt settlement work?

Debts settlement isn’t very complicated. A lot of companies make it sound more complicated than it needs to be, just so they can charge you for their assistance. You don’t need the help – or expense – of a debt settlement company in order to figure out how to settle debt.

Before we get into the nuts and bolts of what you’ll need to do, you first need to understand how debt collection works in America.

What does it mean to have a debt “sent to collections?”

If you’ve ever been past due on a bill, you’ve probably been told that your debt would “be sent to collections” if you didn’t pay within a relatively short amount of time. What does that mean? Where does your debt actually go?

There are usually three stages of debt collection.

For a while, the creditor will hold on to the debt in the hope that you will pay the account. This usually lasts for about six months or so.

After this period, the lender will usually assign the account to a debt collector in an outside agency. This company is simply trying to collect on the debt, which is still owed to the original creditor. When you make the payment, the debt collector will earn a commission off the collection but the bulk of the money will go to the original company you owed.

If the debt isn’t settled within a certain amount of time, the original creditor will write off the debt as a loss. They then sell the right to collect the debt to a different outside collection agency. These agencies are sometimes known as debt buyers.

Debt buyers pay pennies on the dollar for the rights to collect the debt. If you finally pay the debt, the debt buyer keeps all of the money and none of it is sent to the original company you owed. There is a HUGE profit margin on those debt payments.

In 2017, TV host John Oliver announced that he had bought $14,900,900 ($14.9 million) worth of medical debt for just $60,000. He also gives a very detailed explanation of how the debt buying process works in his YouTube video.

It is important to understand who is collecting your debt.

It is important to know who you’re dealing with and what their relationship is to the original creditor. That’s easy to do when you’re dealing with an internal department of the original company. However, it gets a lot more complicated when debt collection companies are involved.

You need to be very careful because debt collectors lie often. They also lie convincingly.

When we were attempting to buy our house in 2015, I spoke with a company called Pacific Consolidation Services (PCS). This company allegedly held an $814 power bill from my previous residence. When I called to negotiate the debt, they said that they couldn’t negotiate because the debt was still owned by the original creditor.

I called the original creditor, Puget Sound Energy, but they had never heard of PCS. They assured me that they had no further interest in the debt, because they had sold the debt to a different company. That company had eventually sold it to PCS.

I called PCS back, armed with this new information. I was transferred about five times before I reached someone who was willing to admit that they weren’t actually working with the original creditor.

Debt collectors want you to pay your debt. It’s their only goal. Do not expect them to be honest and do not expect them to play fair in the process.

If all else fails, debt collectors can sue you.

You are legally required to pay on the debts you owe. If you don’t pay, they can report your delinquency to the credit bureaus and even sue you!

A lawsuit can lead to a wage garnishment. That means your employer will take money out of your paycheck to pay your debts. You won’t even see the money because it will be taken out before you are paid.

Most debt collectors file hundreds of lawsuits at a time. They don’t check to make sure the paperwork is in order. In most cases, a lawsuit is simply an intimidation tactic to encourage you to pay.

The easiest way to lose a lawsuit to a debt collector is to ignore the lawsuit altogether. You absolutely always need to answer a lawsuit when you are served.If you don’t answer, you will lose by default. The debt collector can get a “default judgment” for just about anything they’re asking for, including attorney’s fees and other penalties.

However, even if you’ve been sued, there are some things you can do to avoid a judgement and even settle the debt out of court.

This is what you need to know before you settle the debt yourself.

For the best chance of success, you need to do some work before you reach out to the creditor. Don’t try to settle debt when the creditor calls you unexpectedly. This is something that requires preparation.

I prefer to negotiate the settlement through email or postal mail. This provides written documentation about the negotiation. Documentation provides an important legal defense.

First, gather the information you have about the debt.

Gather any information you have about the debt. This includes original creditor statements, debt collector statements and settlement offers.

Second, identify any debt law violations that have occurred.

According to the Fair Debt Collection Practices Act, debt collectors can be sued for violating debt collection law. They can be held liable for damages and an additional $1,000 penalty per violation.

You can save thousands of dollars just by knowing your rights under the FDCPA. I have had debt collectors completely erase debts because I threatened to sue for violations. It’s a very powerful law and you need to understand how it protects you.

For example, the FDCPA says debt collectors can NOT:

  • Discuss your debt with family, friends, neighbors or employers.
  • Call you during certain times of the day (or more than a certain number of times).
  • Swear, insult, threaten or use obscenities/slurs when talking to you.

It also outlines several things that they have to do. For example, debt collectors MUST:

  • Honor a consumer’s request to end contact.
  • Verify all debts – and if they cannot verify them, they must stop attempting to collect.

Be sure to read this post about your legal rights and this post about the most common debt collector scams.

Third, confirm that the debt collector can legally collect the debt.

Debt collectors have to be able to verify and prove that you owe the debt. That makes sense, right?

It’s easy to assume that the company trying to collect the debt has a legal right to do so. However, that’s a big mistake! In many cases, the paperwork required to legally collect the debt doesn’t transfer between buyers.

Demand the chain of assignment.

In order to legally collect a debt, the debt buyer must show something called a “chain of assignment.” Chain of assignment shows who has owned the debt. They must be able to show an unbroken chain of ownership back to the original creditor. Many cannot do this.

If they can’t provide it, they can’t continue trying to collect the debt!

Check the statute of limitations.

Old debts cannot be pursued in court. Although you may still legally owe the debt, the debt collector can’t force you to pay. These debts exceed the statute of limitations and are called “time-barred debts.”

The statute of limitations varies by state. It is usually between three and six years. However, it can be 10-15 years in certain states.

It also varies by type of debt. There are four primary types of debt. These include oral agreements (nothing in writing), written contracts (like medical debts), promissory notes (like mortgages and student loans) and open-ended accounts (like credit cards).

Here are the statute of limitations for all 50 states.

Fourth, motivate them to cooperate in the settlement.

Figuring out how to settle debt is easier when you have leverage. There are some things that should be mentioned in your settlement letter.

The ultimate last resort for most debt collectors is to sue you. If they win a judgment against you, they can garnish your wages. If you don’t have wages, they can even garnish your bank account. This provides them a sort of guarantee that they have some method of getting your money.

If you don’t have taxable income, they aren’t able to garnish your wages.

Depending on your financial situation, this may not be an option. If you bring that to the attention of the debt collector, they may be more willing to negotiate.

Declare your exempt income.

If you have exempt income that cannot be garnished, you can use this as leverage. Exempt income cannot be taken from you to pay a debt.

Exempt income includes:

  • Social Security Disability and Retirement Benefits
  • SSI Benefits
  • TANF Benefits
  • ABD Benefits
  • Unemployment Compensation
  • VA Benefits
  • Student Loans
  • Child Support (Received)
  • $500 in your bank account
  • $1,000 in additional cash

Your wages are also exempt if you earn less than a certain amount. In Washington State, that amount is $253.75 per week (or $1,099.33 per month).

Declare your disabilities.

If you are unemployed or medically retired due to a permanent disability, make sure that the creditor knows that. A permanent condition means they won’t be able to garnish you before the statute of limitations runs out.

If you’re a family caregiver, that’s important for them to know also. It means that you are so busy tending to your ailing family member that your employment prospects are limited.

For a long time, I was an unemployed, unpaid caregiver to my husband. He was a disabled veteran, so we did not have any taxable income whatsoever. During this time, I always submitted the summary page of our previous years’ tax returns when I was trying to settle a debt. This way, the debt collectors knew without a doubt that they couldn’t garnish our income.

They could still garnish your bank account.

Even though they won’t be able to garnish your wages, they can still garnish your bank account. This is a very annoying situation that can cause extreme financial distress to your household.

However, if you don’t have garnishable income, most creditors realize that you probably don’t have a lot of money in your bank account either… so they are more willing to negotiate.

Assemble this information in a professional settlement letter.

The best way to reach out to settle a debt is with a professional settlement letter. It is important to format the letter like a professional business letter. It’s also important to incorporate the necessary information from the steps above.

To save the most money, it’s best to start by verifying that the company has the right to collect the debt at all. You can do this with a simple letter to request the company’s chain of assignment.

Here’s a Sample Debt Verification Letter that is already formatted for you. All you need to do is add the information about you, the debt collector and the debt!

Once the debt is verified, you can use this Sample Debt Settlement Letter to negotiate the debt. The letter includes a number of fields you will need to customize to fit your situation. However, it’s already formatted for you.

(Don’t have Word? No problem! Just upload these files to Google Docs and edit them there!)

Always propose a settlement amount that is lower than your maximum offer.

Never use your maximum settlement offer during your first contact. You need to expect that the company will balk and try to negotiate for a higher amount. If you understate your offer in the first contact, you can appear cooperative. It also gives them a sense of winning when they negotiate a higher amount.

I usually offer 25-40% of the debt in the first letter. The final settlement is usually closer to 40-55% of the actual total debt amount.

Any questions?

I have negotiated a lot of debt over the years. If you have any questions, please let me know in the comments!



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