John Dickinson: Breaking down debt

The director of DebtX Mediation Services explains debt settlements vs. debt agreements, and what it means for your clients

By MPA

19 Mar 2018

We are often asked what the difference is between a debt settlement and a debt agreement. As there seems to be a lot of misunderstanding around this, I thought I would set the record straight.

In short, a debt settlement is typically an informal agreement between a borrower and a creditor to settle a debt for a reduced amount in a lump sum payment.

A debt agreement usually refers to a formal arrangement for a percentage of a debt to be paid off over a period of time, via an administrator.

A debt agreement

Usually referred to as a Part IX, this is a formal insolvency, and despite how nicely some companies tie a bow around it, they are an act of bankruptcy. I’m not pointing this fact out to be negative or to scare anyone; I only mention it as there are some companies that are very fast to enter people into these arrangements when it may not be in their best interests.

Words like insolvency and bankruptcy are often left out of the sales pitch and it’s not until it’s too late that people know the full extent of what they have signed up for. Once entered into such an arrangement, there’s no going back.

Of course, in some situations a Part IX is an appropriate solution for a person in financial trouble, just not every time.

Some of the benefits of a Part IX are:

Interest is frozen
Legal action must stop or cannot commence
An affordable repayment plan can be set
The borrower will be released from the debts once the agreement is finished

Some of the not so good stuff includes:

The borrower’s credit rating will be seriously impacted
A record will be held on the Personal Insolvency Index
During the Part IX term, obtaining credit will be very difficult/impossible

There are qualifying criteria to be eligible for a Part IX, such as income and asset ratios. Secured loans, such as homes and vehicles, typically cannot be included in a debt agreement. Most people who enter a Part IX are doing so as they are insolvent and cannot keep up with their debts, and it enables them to protect assets from their creditors.

Now onto Debt Settlement

This usually refers to an agreement to settle a debt, given a lump sum payment can be made. Such agreements are typically informal and are offered directly from the creditor to the borrower. There are several positives with a debt settlement. One of the main ones being the borrower’s credit file can often be preserved, not to mention the borrower can often save many thousands of dollars.

While it is a little known fact, banks and other creditors will often agree to settle an account for less and forgive the balance. Why would they agree to this?

The fact is unsecured debt, such as credit cards and personal loans, produce tremendous income for a credit provider, after all, where else can they generate up to 18% return? The trouble is, once lent, these accounts are not secured by anything, so when they go wrong it can be a big problem for the creditor as well as the borrower. While a credit provider can jump up and down demanding payment, this does little if the borrower can’t pay what is owed. If the debt remains unresolved, it will most likely be passed to a collection company for a small percentage of the amount outstanding— not a great outcome for the creditor.

If a correctly structured settlement proposal is presented to a creditor that points out the reasons why it would be in their best interest to accept a reduced amount now, rather than most likely get even less later, they will seriously consider it and often accept the proposal.

One of the great things about a debt settlement is the borrower can often save thousands of dollars and protect their credit file at the same time, so they can live to fight another day.

Regardless of what direction a borrower decides to move towards, the most important thing is for them to do their homework so they fully understand the process, how it will affect them and to be sure they are dealing with an experienced and ethical company.

DebtX is a debt mediation company focused on helping people regain financial control through the reduction and elimination of their debts. Learn more at debtx.com.au.