5 Settlement Fee Provisions to Examine Before Paying

For many, this process is simple: You want a lower monthly repayment on your business loan, and a settlement company will renegotiate that repayment for you in return for a percentage of the savings. But you may end up in a situation where you make monthly payments to the settlement company even before the settlement is finalized. Service providers in this space have a lot of variability in terms, specifically around fees. Before you sign, it’s a good idea to understand how much money will leave your account and when.

The contract can get technical, but look for 5 key terms: when a fee is due, what it is figured on, where your deposits are held, what happens if you cancel or make a partial settlement, and the disclosure of all the terms. Check each of these before signing.

A Fee Before Your Debt Settles

“Settlement” isn’t something that you can mark complete at the moment you agree to repay less than you owe. That’s why some debt settlement companies put you on a payment plan before your debt is actually settled.

Technically, a settlement company can charge you a fee before your debt settles. But if they take a fee before anything has settled, the company pays itself first. If you pay a settlement company before your debt is settled and then that company fails to settle anything for you, it can be hard to get your money back.

The FTC’s advance-fee ban only covers telemarketers, and it exempts most calls between a telemarketer and a business, so a business program may charge first. False or misleading statements remain banned. Before you make an agreement with a settlement company, understand whether and how much the company takes in fees and how you will pay them.

Some settlement fees are calculated as a percentage of the settlement: You pay a percentage of the money the settlement company saved you by reducing your debt. Other companies, though, charge a percentage of your initial debt. If you’re talking with a settlement company, find out from the beginning if your fee is based on the total debt you owed or on the debt you’ll owe once it’s settled.

Business debt settlement firms can be expensive. The CFPB says settlement firms often charge 20 to 25 percent or more of a settled debt. The CFPB sued Freedom Debt Relief. The firm’s fees were based on debts owed at the time of sign-up, not on amounts that were later settled, the CFPB said.

The basic idea in the debt settlement world is that you settle one debt at a time and pay as you settle. If the company settles one debt at a time, then the fee should match that debt’s share of the total amount enrolled, or the same percentage of the amount saved on that debt. The amount saved is the difference between what you owed when you enrolled and what you paid to settle.

Where the Money Goes

Different providers will collect money from you in different ways. Some will directly debit your account every month and use that money to pay the settlement. Others may direct you to make payments to a bank or a third-party payment provider, which keeps the money in trust until it is either settled with the creditor or returned to you. It’s a good idea to know where the money goes and how it is used. If you make payments to the company before it settles your debt, it should hold the money in an insured account that you own, not keep the money in its own account.

Just because you see a debit labeled ‘program payment’ does not mean your funder got paid. You should receive an itemized statement with the date and amount of each deposit, each fee, each payment to each funder, the amount of funds held, and the total amount paid to each funder. Then check that against your bank records.

Where the federal rule applies, the account is run by an administrator that is not affiliated with the settlement company. You may pay the administrator or escrow agent a reasonable fee for managing the account, but the funds and interest still belong to you.

You should also know what will happen to your money if the company fails to settle some or all of your debt or if you decide to cancel the service. What happens to the fees you paid in? You need to know the answers to these questions to figure out how much you’re likely to end up paying.

Thanks to federal regulation, consumers using a dedicated account can cancel service without penalty any time and have their savings returned, minus fees already earned, within seven business days. Your business agreement, however, may be different and you may have to ask for a refund to get the money you are due.

Consumer settlement firms must disclose all fees before the consumer signs up. If the fee is based on savings, they must disclose both the percentage of savings you will pay and an estimate of the dollar amount that will be paid. They must disclose if there is no refund for services rendered. And they must estimate the number of months it will take to make each settlement offer. Read the agreement before you sign. It should state exactly what they will do and when, and what you will pay and when. If it doesn’t, you need to know why.

Unexplained deductions, charges not matching your written agreement, and refusal to give you an accounting are all warning signs. Get answers in writing.

Your Total Cost

When you’re comparing service providers, you need to add up all the fees and charges and compare your total potential payout with the total potential cost.

Your total cost is your payments to your funders plus the fees you paid to get that settlement. Make sure you can afford it, because those payments must be made alongside the cash advances still unresolved.

Also, don’t be surprised by a tax bill on debt that was settled for less than full value. The IRS generally treats it as income unless the debt was subject to an exclusion, such as bankruptcy or insolvency, when it was canceled. If you get a 1099-C you may need to use Form 982 to avoid a tax bill for the forgiven debt. Before you sign, ask your tax preparer how your situation will play out.