Ask Dr. Don By Don Taylor, Ph.D., CFA • Bankrate.com

A negotiated settlement is not debt consolidation

Dear Dr. Don,
I have been talking with a company about debt consolidation. They say they can take my current unsecured debt of $24,500 to $14,500.

This would reduce my monthly payments from $560 to $360 and would allow me to pay off all bills over the next 40 months. What questions do I need to ask, and would you suggest anyone else?
Thanks,
James Jubilation

Dear James,
Debt consolidation is when you take your current outstanding consumer loans and combine them into one loan. Debt consolidation helps consumers if the consolidation loan can reduce the effective interest rate or extend the loan term.

This company isn't really offering debt consolidation; they're offering to negotiate settlements with your unsecured creditors. Creditors will take partial payment if they can't realistically expect to get any more than that, but don't expect this to be a painless approach to debt repayment or credit repair.

The company states that they will get your creditors to state that the account was "paid in full" on your credit report. That won't erase the "credit not paid per agreement" listings on that report.

From its Web site, it appears that the company requires you to make monthly payments into a trust account, which is outside the reach of your creditors. You stop paying the bills on your unsecured credit, money goes into a trust that you don't control and creditors have to negotiate with the trustee to get a payment from the trust. That's where the company creates the leverage to get the creditor to agree to list the account as being "paid in full."

I don't see how this process protects you from judgments or the potential garnishment of your wages, but I'm not an attorney. By the way, the debt-negotiating firm isn't acting as your attorney either and suggests that you hire an attorney if you have legal questions. At a minimum you would want an attorney to review the trust agreement.

Federal law protects you from being dismissed from your job for garnishment relating to a single debt, but multiple garnishments can be a justification for dismissal. State laws concerning an employer's ability to terminate based on multiple garnishments will vary.

If you can't pay off your debts without getting your creditors to accept partial payments, then bankruptcy law offers you the ability to discharge your debt in a Chapter 7 filing or to design a repayment plan in a Chapter 13 filing. Desperate times call for desperate measures, but don't count on being better off using a debt negotiator instead of a bankruptcy attorney.

Being debt-free is different from having the ability to get credit. Despite the assurance of many debt-negotiating firms that your credit reports will reflect that your unsecured accounts that have agreed to settlement will be marked "paid in full," that doesn't mean that you'll have a good credit score or the ability to get a loan.

While bankruptcies stay on your credit report for seven to 10 years, individuals who have filed for bankruptcy can usually rebuild their credit history to the point where they can once again get a loan in two to four years. That's not much different than your 40-month solution using a debt negotiator.

I don't know enough about your financial situation to advise you on what your next step should be. The fact that you're considering debt negotiation to save you from repaying an estimated $10,000 in debt should mean that you're in way over your head.

If that's the case, you should consider bankruptcy as an alternative. If that's not the case, stop trying to finesse the reduction of these debts and find a way to repay them instead.

-- Posted: May 30, 2002