Last updated June 18, 2019.
Struggling with debt? Did you know that debt settlement is an option? You might see ads on late night TV offering debt relief and debt reduction through settlement. Debt settlement is a real option for reducing the amount you owe and the interest rate you’re paying, but beware of debt settlement fraud, and make sure you understand that debt settlement involves letting debts fester in order to one day settle them.
Before we go into greater detail, let’s start at the beginning.
Credit and Defaulting on Debt
If you miss a payment on your credit card, you’re in default on the debt. You’re legally obligated to pay what you owe and the creditor has the right to collect. That means you’ll start getting phone calls and letters requiring payment.
If you still don’t pay, your creditor may freeze your account or assign it to a collection agency. Either the creditor or a collection agency may choose to sue you for collection. With a judgment against you, your creditor may garnish your wages, repossess your property, place liens on your home, or levy your bank accounts.
This whole process takes time — in California, a creditor must sue you for collection and win, then get a specific court order before you have to worry about garnishment or any of the other unpleasant collection alternatives. Lawsuits are slow and cumbersome, which means that you have the chance to stop the process before creditors take drastic measures.
In California, there is a statute of limitations on filing a suit over credit card debt, meaning that a creditor is required to file a claim against you within a specified period of time in order for it to be valid. As your agreement with your credit card company qualifies as a written contract, this statute of limitations in California is four years. In most cases, this period starts on the date of your first missed payment.
California Debt Relief Options
The first step to preventing unpleasant collection actions is to reach out to your creditor. If you’re going to miss a payment, call and let them know. Explain why you’ve fallen behind. They understand that things happen — illness, natural disaster, and layoffs, for example — and will in many cases be willing to work with you.
Your creditors want you to pay, but they don’t want to go to court. It’s time-consuming and expensive. If you simply don’t pay without notice, your creditor won’t have much of an incentive to help you out.
When you speak to your creditor, they may offer you several options. First, you could pay a lump sum as settlement. You’ll pay less than your full balance and they’ll consider the debt paid in full. You do need to have cash on hand, but you may be able to pay significantly less than you owe. A lump sum settlement may have tax consequences — the difference between what you actually pay and what you owe may be considered income, in which case you’d have to pay tax on it. Depending on the status of your account, the forgiven debt may not be considered income but may be considered a sort of deal between you and the bank.
If you have settled debt or are considering seeking debt settlement, speak to an accountant about how best to classify the transaction and how it will affect your tax liability.
If you’re short on cash or you can’t reach an agreement on a lump sum settlement, your creditor may lower your interest rate. With rates up to 30%, a lower interest rate can be a big help. Your debt won’t accrue as quickly, and keeping your minimum payment down may allow you to get back on track. Also, if you decide to settle your debt, it will likely show up on your credit report in a negative manner.
Debt Settlement Companies: Beware of Fraud
When you’re struggling with debt and you feel like you’re out of options, you’re looking for any way out. Debt settlement companies are in a position to prey on this vulnerability and take advantage of debtors. They’ll promise balance and rate reductions. They’ll offer to consolidate your debt into “one low monthly payment” and prevent creditors from taking your property.
Unfortunately, these promises are usually scams. They promise a debt-free future, but it’s just a way to get you to pay their monthly fee.
Debt settlement companies will generally recommend that consumers stop making monthly payments because creditors won’t settle on active accounts. The plan is for the consumer to save up instead of making payments and attempt to settle for a lump sum in a few months. Unfortunately for consumers, creditors aren’t bound by that plan. They can decide to sue before you’ve had a chance to save up. That means you’ll face the cost of a lawsuit and the potential consequences — if a creditor gets a judgment against you, it can get a court order for wage garnishment, bank levies, property seizure, or a lien on your home.
Meanwhile, the debt settlement company will claim it is still in the process of negotiating with the creditor, even though creditors don’t have to negotiate with debt settlement companies and don’t have to stop legal action when you hire one. While your account is going further off track, the debt settlement company will be collecting hefty monthly fees directly from your bank account. Not only do they rarely deliver what they promise, they may actually leave you in a worse position than you were in when you started. You’ll lose the big monthly fees they’ve been charging you and you’ll end up with a court judgment against you for the full amount of your debt. That’s a lose-lose situation.
A monthly fee structure means debt settlement companies are inclined to draw out the process. They get paid whether your settlement goes through or not. Creditors may act whether you’re involved with a debt settlement company or not, meaning you might end up with a judgment against you for the full amount of your debt and a bank account emptied by the debt settlement company’s fees.
Debt Settlement in California: What are my rights?
In California, debt settlement agencies must be licensed by the state. However, out-of-state companies who are not subject to California law can still extend services to California residents through websites. If you feel you’ve been wronged by a debt settlement company, contact an experienced attorney.
If you live in California and are struggling with debts, reach out to your creditor. You may be able to create a payment plan or work out a settlement that works for you. If not, there are many legal non-profit organizations in the state that can help you with your debt. Contact one of those agencies to learn about debt settlement either alone or with the help of an attorney. If that doesn’t work, either, you still have options.
Is bankruptcy an option?
If you’re struggling with debt, you’re looking for a way out. You may not want to file for bankruptcy, and debt settlement companies offer a great deal. They offer to take your debt away without destroying your credit score. They’ll tell you that you only need to pay pennies on the dollar for your debt.
In advertising, debt settlement companies show happy families in their homes and cite federal laws and bailout deals, suggesting that creditors either want to settle debts or are required by law to do it. Debt settlement companies paint a rosy post-settlement picture, but consumers almost never make it there.
Most people are at least a little bit afraid of bankruptcy. You worry about the credit impact and perhaps a perceived social stigma. Bankruptcy, however, isn’t a punishment. It’s an honest, legal way to deal with out-of-control debt. It’s also extremely common. Nearly 1 million people file for it each year in the U.S., with 20,000 of those cases alone coming from Los Angeles bankruptcy court.
When you file for bankruptcy, you get the protection of the automatic stay, which will stop foreclosure, repossession, and legal actions against you. Most consumers can keep their important assets, such as your car and your home, and pay only pennies on the dollar — without scams.
If you’re struggling with debt and would like to know more about debt settlement and bankruptcy, contact the experienced Los Angeles bankruptcy attorneys of Borowitz & Clark today.
Barry Edward Borowitz is the founding partner of Borowitz & Clark, LLP, a leading bankruptcy law firm that represents clients petitioning for bankruptcy protection under Chapter 7 and Chapter 13 of the bankruptcy code. Mr. Borowitz has been practicing bankruptcy law exclusively for more than 15 years. View his full profile here.