7 Steps to Settle Bills You Can't Pay in Full

If you're willing to work with your creditors in good faith, there's no need to hire a company to settle your bills.

Settling your bills with creditors is also referred to as debt settlement. And to be clear, debt settlement is not for everybody. If you can make payments in full and on time, you're not a good candidate. Settling your debts plays havoc with your credit score. If you regularly miss payments and your credit score has taken a tumble, debt settlement can help you crawl out of the financial hole in which you find yourself.

What does it mean to settle a debt?

Successfully settling debt involves an agreement between you and a creditor. Let's say you owe $10,000 on a credit card, are out of work, and have not been able to make a full payment in months. Your credit score is in the basement, and you're looking for options.

The goal is to work with the credit card company in the hope it will eliminate part of your outstanding balance. In return, you either make a lump-sum payment or regular, on-time payments.

Three important factors to keep in mind

1. Creditors make a report to the "Big 3" credit reporting agencies each month -- Experian, TransUnion, and Equifax. Debt settlement will likely appear on your report as "settled for less than owed" or as a partial payment each month. In either case, your credit score will drop before it begins to recover.
2. Debt settlement agencies tend to advertise heavily and promise to settle your debt for a fee. Unless you absolutely don't trust yourself to take care of the matter, settling debt is something you can do yourself by having a direct conversation with your creditor.
3. Once you realize you have a serious problem, approach the creditor. The longer you wait, the more likely it is that the creditor will sell the debt to a collection agency. Collection agencies are far less pleasant to deal with than an original creditor.

Step One: Be prepared

If you've missed monthly payments, you may be surprised by how willing a creditor is to work with you. After all, they would rather receive some portion of the amount owed than none. Before you call, though, ask yourself the following questions:

• Do I have cash on hand that will allow me to make a one-time payment, or do I need a long-term payment plan?
• If I enroll in a long-term payment plan, what's the most I can afford to pay each month? Go over your current budget carefully. Decide what you must keep and which expenses can be jettisoned until your debt is paid off.
• What will my next step need to be if debt settlement doesn't work? For example, will you continue to miss payments or be forced to file for bankruptcy? It's important to have a clear picture of your potential next step to share with the creditor.

Step Two: Prepare your story

Ideally, you can tell your creditors what's going on in one or two sentences. If it helps, write down what you want to say. For example:

• I've been sick and unable to work. I'm currently living on disability payments.
• My spouse unexpectedly walked out, and I'm now responsible for paying the bills we once shared.
• I've been out of work for months and can't keep up with my financial obligations.

The easiest (fairest) thing to do is to be completely honest. That way, you never have to keep your story straight.

Step Three: Be prepared to take notes

Have a pen and paper (or your computer) in front of you. Make a list of each creditor you need to contact, and as you're having a conversation, make notes of what they say.

Step Four: Call your first creditor

Once you're on the line with a real person, briefly outline why you're calling. It's possible they will transfer you to another department that deals with debt settlement.

Step Five: Ask about options

Once you've explained your current situation, make it clear that you want to honor your debt but can only afford to repay a portion of it. They will undoubtedly ask how much you can pay today. Creditors tend to settle for less if you can make a single lump sum payment. However, if you're unable to do so, let them know. Ask if it would be possible to set up monthly payments.

One way to let a creditor know you're serious about making payments is to suggest they automatically withdraw the agreed-upon payment from your checking account each month. Now, most creditors will want (or require) auto-withdrawals anyway, but if you're the first one to make the suggestion, it lets them know you're serious.

Step Six: Get it in writing

Once you conclude negotiations, get the settlement or repayment plan in writing. Do not make a payment until you have a copy of the agreement letter in hand. Making a payment before you receive confirmation can cause you a great deal of trouble down the line.

Step Seven: Make all payments as promised

You might not think that missing a payment here or there will hurt. Nothing could be further from the truth. If you fail to live up to your bargain, the creditor has a right to rescind the agreement, and you're back on the hook for the original balance, plus interest.

Perhaps the most important thing you can do is to be sincere, polite, and patient. It may take many months to pay off your reduced portion of the balance and many more months for your credit score to recover. However, keep your eyes on the prize. If you stick with the payment plan and refrain from taking on any new debt, your credit score will one day look better than new.