Requirements for Including Secured Debt in Settlements
Settling debt can be a great way to resolve financial issues, but it gets complicated when secured debt is involved. Secured debt refers to loans backed by collateral that creditors can seize if you default, like a home mortgage or auto loan. So what happens if you want to include secured debts in a settlement agreement? Let’s break it down.
What is Secured Debt?
Secured debt is any loan backed by some form of collateral the lender can take if you fail to repay [6]. Common examples include:
-- Mortgages – backed by the home itself
- Auto loans – backed by the vehicle
- Home equity loans – backed by a portion of home equity
With secured debt, the collateral protects the lender if you default. Unsecured debt like credit cards or medical bills have no collateral, so lenders take on more risk [6].
Now let’s look at how secured debt works in settlements.
Settling Secured Debt in Bankruptcy
If you file for Chapter 7 bankruptcy, secured debts are usually unaffected. You can choose to surrender collateral like a home or car, allowing creditors to sell it. Or you can keep making payments and retain the collateral [4].
With Chapter 13 bankruptcy, you keep assets like your home or car while repaying debts through a 3-5 year repayment plan approved by the court. The plan must pay secured creditors at least the value of their collateral [4].
-Settling Secured Debt Outside Bankruptcy
You may also try settling secured debt through debt settlement companies. This involves negotiating directly with creditors for reduced payoffs. However, there are risks [2]:
- High fees – Settlement companies often charge 15-25% of enrolled debt.
- Credit damage – Settling debt can further hurt your credit score.
- Tax issues – Settled debt may be taxed as income.
- Lawsuits – Creditors can still sue you during the process.
And keep in mind, creditors are not obligated to accept settlement offers. According to one study, only 34-58% of consumers successfully settled their debts using debt settlement companies [3].
Secured Debt Settlement Process
If you do pursue debt settlement on secured loans, here is the typical process:
- You stop making payments to creditors and instead deposit funds in an account.
- The settlement company negotiates with creditors after several missed payments.
- Creditors agree to accept a reduced lump sum payment, such as 40% of the balance.
- The saved settlement funds are used to pay the reduced payoffs.
This can take anywhere from 2-4 years. During this time, late fees and interest will accrue, damaging your credit score [3].
Risks of Settling Secured Debt
Settling secured loans has unique risks to consider:
-- Foreclosure – Mortgage lenders can foreclose if you default on payments.
- Repossession – Auto lenders can repossess your car if you stop making payments.
- Tax liens – Settled debt may be treated as taxable income.
Additionally, settled accounts will show as “settled for less than owed” on your credit report, further damaging your score. Missed payments can also hurt your credit [3].
When Settling Secured Debt Works
Despite the risks, settling secured debt can still be an option if:
- You can’t afford monthly payments.
- You have equity assets creditors want to preserve.
- Your credit is already damaged.
For example, a mortgage lender may accept a settlement if you have substantial home equity they want to protect. The settlement may be less damaging than foreclosure [5].
-Alternatives to Settling Secured Debt
Other options to consider:
- Loan modifications – Adjust loan terms to reduce monthly payments.
- Refinancing – Get a new loan with better terms.
- Selling assets – Sell the collateral and pay off the debt.
- Credit counseling – Work with a nonprofit agency to repay debt.
Loan modifications and refinancing allow you to become current on payments. Meanwhile, selling assets or credit counseling provide alternatives to settling debt altogether.
Key Settlement Requirements
If you do pursue debt settlement on secured loans, be aware of key requirements:
- Get settlement terms in writing – This includes fees, services, and settlement amounts.
- Know cancellation rights – Many states allow 3-10 days to cancel.
- Review company reputation – Check complaints, reviews, and licensing.
- Understand tax implications – Settled debt may count as taxable income.
Reputable companies will explain these details upfront. Avoid any company that promises to eliminate your debt or tells you to stop communicating with creditors [2].
The Bottom Line
Settling secured debt is risky but can be an option if you have equity, poor credit, or can’t afford payments. Consider all alternatives, know the risks, and get settlement terms in writing. With the right approach, settlements may help resolve secured debts – but tread carefully.