When you have debts that you can’t pay back in full, it is a good time to look at the possibility of settling your debt. A debt settlement is an offer made to your creditors to accept a lower amount than what you owe to settle your account. Before throwing out a debt settlement percentage offer to a creditor or debt collector, here is what you need to know.
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How much can you afford?
Never make a debt settlement offer for more than you can afford to pay. Any debt settlement arrangement is a legal agreement. If you fail to meet the terms of this agreement, any deal can become null and void. The starting point in determining a settlement percentage or offer is to review your budget and determine a monthly amount you can afford to pay.
If you are working with a Licensed Insolvency Trustee to settle debts through a consumer proposal, part of the process is to review your financial situation, including your income and expenses, to ensure you can afford your proposal payments.
Lump-sum vs payment plan
You can offer to make a lump sum settlement or suggest a payment plan. Creditors will generally accept a lower payout percentage with a lump sum arrangement than if you are making payments over several months or years.
If you are settling directly with a debt collector, plan to have the debt paid off in about two to three years.
Most proposals are for larger dollar amounts, generally above $10,000, which means payment plans are for longer periods – usually three to five years, with five years being the maximum.
Debt collection settlement percentage
When you are in arrears on debt payments, your account can be sent to collections. Initially, this may be your creditor’s internal collections department, but as the debt ages, it can be referred to a collection agency. Once your debt has been transferred to a third-party collection agency, you must deal with the debt collector and not your original creditor.
If you only have one or two accounts in arrears, you can try to negotiate a debt settlement on your own.
Negotiating with original creditors
If the account is still with your original creditor, they may not want to negotiate with you for less than what is owed. Original creditors generally won’t accept an offer of less than 70% to 90% of the balance owing unless the offer is made through a formal debt settlement program.
For example, if you have a large credit card debt and are struggling with payments, your credit card provider is unlikely to agree to write off some of the debt voluntarily.
You may be able to work with your creditor to freeze interest or lower the interest rate, but generally, original creditors will not negotiate a reduction of the principal owing unless you are several months behind on payments. And by that point, your account is likely with a debt collector.
Dealing with a collection agency
A collection agency, acting on behalf of a creditor, may be willing to accept up to 50% of the debt as a settlement offer.
Collection agencies earn a commission on the amount offered but also keep their business with their different creditor clients by achieving higher repayment settlements. Some creditors set limits on the reduction percentage a collection agency is authorized to approve.
What percentage a debt collector will accept depends on how much financial hardship you are experiencing, how much debt you owe and how old the debt is.
Here are some factors a debt collector will consider before they accept or decline your offer.
- How much is your income? If you are not working or have a limited income, a debt collector may be willing to settle for less. If, however, you have an income that can be garnisheed, there is less incentive for the collector to take a lower deal. Certain income cannot be garnished, including pension and ODSP income, so use this knowledge if appropriate when negotiating.
- How much debt do you owe? If you owe a small amount, a creditor will likely be more willing to negotiate as it would be too costly for them to take you to court. The more you owe, the more willing a creditor or debt collector will be to go to court to get a judgment and a garnishment order, so negotiating a settlement will become harder.
- How old is your debt? If the debt is about a year old, creditors are more likely to want 70%-80% of the debt repaid. However, a collection agent is usually willing to accept less for older debt. If the debt is beyond the statute of limitation period a debt collector may be willing to discount the debt owing by 50% or more.
- What type of debt do you owe? Certain debts can only be compromised in a consumer proposal, including monies owing to the Canada Revenue Agency for tax debts and Canada student loans. The CRA will not settle with you directly for any tax owing. They may agree to a one- or two-year payment plan and may forgive some penalties and interest, but you cannot settle tax debt except through a Licensed Insolvency Trustee.
- Assets you own. If you own property or other assets the creditor is aware of, they will be less likely to negotiate a settlement as they will want you to use your assets to repay your debts. If you have secured debts, like a car loan, your lender has the right to seize these assets to recover any amount owing.
- Active garnishment. If a creditor has already garnished your wages, they won’t want to negotiate a settlement for less. At that point, you will need to file a consumer proposal or bankruptcy to stop the garnishment if you can’t repay the full debt.
When your debt is sold
A debt buyer is a company that purchases debt, usually old, from a creditor for pennies on the dollar. A debt buyer may be willing to accept a significant reduction in the amount owing, often less than 50%.
How to make an offer
If your debt is old, small, and you have a good explanation about why you can’t pay, begin with an offer of between 20% and 30% of the outstanding balance and see what they say. Be prepared for a counter-offer. Understand your position, including how much you can afford to repay and know your rights when dealing with collection calls.
Keep track of what is offered and get any agreement in writing before making any payments.
Is it better to pay in full or offer a settlement?
Missed payments remain on your credit report for six years from the date of your last payment or acknowledgement of the debt. A settlement offer can improve your score because you are now making payments on settled debts again. However, if you have not been making payments for 4 or 5 years, consider that the debt will fall off your report shortly if you do nothing. It may be better to ignore the calls and never pay a collection agency.
Clearing up that debt through a consumer proposal can also improve your credit rating if you have significant debt. While a note that you filed a proposal will appear on your credit report for up to six years, reducing your debt will help you rebuild your score since continued high debt utilization can harm your credit score long term.
How can you reduce debt by 70% to 80%?
If you have one or two small debts and room in your budget, you may be able to work directly with your creditors to arrange a settlement plan. However, if you have multiple creditors or your budget isn’t big enough to pay off your debts, you need additional debt relief.
One option is to negotiate a settlement through a consumer proposal arrangement.
A consumer proposal is a legislated debt settlement. It is an offer that is fair and reasonable to your creditors and affordable to you. Depending on your circumstances, a consumer proposal can offer up to an 80% reduction in your debt.
Your settlement offer in a consumer proposal will depend on your income and the value of any assets you owe. When negotiating a consumer proposal, your trustee will calculate what your creditors might receive if you were to file bankruptcy. Because a consumer proposal is paid out over time, creditors will expect to receive slightly more than they would get in a bankruptcy. Generally, consumer proposal offers of between 20% and 50% of your outstanding debt balances are the norm.
A consumer proposal differs from a debt management plan through a credit counsellor in that you can settle debts for less than you owe. Credit counselling requires that you repay your debts in full. A consumer proposal allows you to avoid bankruptcy yet repay less than you owe. In a consumer proposal, you keep your assets. After your proposal payments are completed, the remaining debt is forgiven, and you are debt-free.
There is also an immediate stay of proceedings when you file a consumer proposal, so your creditors cannot contact you or sue you without leave of the court.
A consumer proposal deals with all your unsecured creditors, including government debt and student loans and binds all creditors to the same settlement offer. Once the majority of your creditors accept your proposal, all unsecured creditors are bound by the same terms.
If you have a lot of debt, a consumer proposal is a great option to help you get out of debt sooner. You get a fresh start and rebuild your finances by dealing with your total debt load.
Debt settlement companies
What about a debt settlement company or debt consultant? A for-profit debt settlement company offers two types of settlement services; however, each can lead to unnecessary costs.
Debt settlement companies may offer to negotiate with creditors on your behalf, but most charge significant fees regardless of your ability to pay.
Informal debt settlement companies can only ask creditors to participate voluntarily. You will still receive collection calls during this process as the creditors won’t wait, and creditors can still take you to court and have your wages garnished. Creditors are not required to deal with the debt settlement company, and they often won’t.
We also caution against working with debt consultants who offer to help you file a consumer proposal. Again, they charge you high extra fees and cannot, despite what they claim, get a better deal than you can when working directly with a trustee.
When contacting a professional for help, check out their accreditation. Ask what formal credentials the individual providing any financial counselling or debt management services has, and only work with a Licensed Insolvency Trustee when discussing a consumer proposal.
Get professional debt advice
If you are struggling with debt, the best place to start is with a reputable Licensed Insolvency Trustee. We are licensed by the government and are the only people who can help you file a consumer proposal or a bankruptcy. When you call, we review all your options and help you find the right debt solution to deal with your debt. Contact us today for a free consultation.