Understanding Debt Mediation

How debt mediation works

The debt mediation process generally follows several key stages, though the specifics can vary depending on whether you’re working with a professional mediator, a debt settlement company, or negotiating directly with creditors yourself.

1. Initial assessment: The process begins with a thorough evaluation of your financial situation. This includes documenting all debts, income sources, essential expenses, and assets. Understanding the complete picture is crucial because it determines what you can realistically afford to pay and helps establish your negotiating position. If you’re working with a debt mediation company, they’ll typically conduct this assessment during your initial consultation.

2. Account setup and savings: Many debt mediation programs require you to stop making payments to your creditors and instead deposit money into a dedicated savings account. This serves two purposes: it demonstrates to creditors that you’re unable to meet your current obligations, and it builds up funds that will eventually be used to make settlement offers. This stage can be controversial because letting accounts go delinquent damages your credit score and may result in collection calls and potential lawsuits.

3. Negotiation: Once sufficient funds have accumulated, or if you have a lump sum available, the negotiation phase begins. The mediator or settlement company contacts creditors on your behalf to negotiate reduced payoff amounts. Creditors may agree to accept 40-60% of what’s owed, sometimes even less, particularly if they believe the alternative is receiving nothing through bankruptcy. The success of negotiations depends on various factors including the type of debt, how delinquent the account is, the creditor’s policies, and the negotiator’s skill and relationship with the creditor.

4. Settlement and payment: When a creditor agrees to a settlement, the terms are documented in writing. This agreement specifies the reduced amount to be paid and confirms that this payment will satisfy the debt in full. You then pay the agreed-upon amount, either as a lump sum or through an arranged payment plan. It’s crucial to get all settlement agreements in writing before making any payments.

5. Resolution and recovery: After all targeted debts are settled, the mediation process concludes. You’ll need to obtain written confirmation from each creditor that the debt has been satisfied. Then begins the work of rebuilding credit and recovering financially from both the original debt crisis and the mediation process itself.

Types of debts suitable for mediation

Not all debts are equally amenable to mediation and negotiation. Understanding which debts can typically be negotiated and which cannot helps set realistic expectations.

• Unsecured debts are the most suitable for mediation. These include credit card debt, medical bills, personal loans, and some private student loans. Because these debts aren’t backed by collateral, creditors have limited recourse if you can’t pay, making them more willing to negotiate. Credit card debt is particularly common in debt mediation because credit card companies often sell severely delinquent accounts to collection agencies for pennies on the dollar—they may prefer negotiating a partial payment directly rather than taking that loss.

• Secured debts like mortgages and auto loans are more difficult to mediate. Because these debts are backed by property, the creditor can repossess the collateral if you don’t pay. While loan modifications exist for mortgages, traditional debt mediation isn’t typically applicable. If you default on a car loan, the lender will likely repossess the vehicle rather than negotiate a reduced balance.

• Priority debts generally cannot be negotiated through debt mediation. These include tax debts, child support, alimony, and federal student loans. These obligations have special legal protections, and the entities collecting them have powerful tools to ensure payment, including wage garnishment and tax refund seizure. While some of these debts may have payment plan options or special programs (like IRS installment agreements or student loan income-driven repayment plans), they don’t work through traditional debt mediation.

The difference between debt mediation and similar options

Debt mediation is often confused with other debt relief options. Understanding the distinctions helps you choose the right approach for your situation.

• Debt mediation vs. debt consolidation: Debt consolidation involves taking out a new loan to pay off multiple existing debts, leaving you with a single monthly payment, often at a lower interest rate. You still owe the full amount; you’ve just reorganized it. Debt mediation, by contrast, aims to reduce the total amount you owe through negotiation. Consolidation is better for those who can afford their debts but want simplified payments, while mediation targets those who cannot afford to pay their full obligations.

• Debt mediation vs. credit counseling: Credit counseling agencies work with you to create budgets and may establish debt management plans where they negotiate lower interest rates with creditors while you pay the full principal. Credit counseling is educational and organizational; mediation is negotiation-focused. Credit counseling is often free or low-cost and typically doesn’t harm your credit as severely as mediation. It works best for those who need help managing their finances and can pay their full debts with better terms.

• Debt mediation vs. bankruptcy: Bankruptcy is a legal process that either eliminates debts entirely (Chapter 7) or creates a court-supervised repayment plan (Chapter 13). It offers stronger legal protections, including an automatic stay that stops collection actions immediately. However, bankruptcy has more severe and longer-lasting credit implications, costs money in court and attorney fees, and requires detailed financial disclosure. Debt mediation is less formal, potentially faster, and may be less damaging to your credit in the long run, but it doesn’t provide the legal protections of bankruptcy and isn’t appropriate for everyone.

Advantages of debt mediation

When considering debt mediation, understanding its potential benefits helps you weigh it against other options.

• Reduced debt burden: The primary advantage is potentially paying significantly less than you owe. Settlements commonly reduce debts by 30-50%, though results vary. For someone with overwhelming debt, this reduction can mean the difference between eventual financial recovery and continued struggle.

• Avoiding bankruptcy: For many, avoiding bankruptcy’s stigma and long-term consequences is valuable. Bankruptcy remains on your credit report for 7-10 years, while negative marks from debt settlement begin to age off after seven years. Additionally, bankruptcy may affect employment opportunities, security clearances, and other aspects of life beyond credit.

• Faster resolution: Debt mediation programs typically take 2-4 years to complete, compared to Chapter 13 bankruptcy which takes 3-5 years. If you can negotiate settlements relatively quickly, you may resolve your debt crisis faster than through other structured programs.

• No court involvement: Unlike bankruptcy, debt mediation doesn’t require court appearances, filing fees, or public records. The process is private between you and your creditors (or their representatives).

• Single payment or program: If working with a debt settlement company, you typically make one monthly payment to them, and they handle dispersing settlement payments. This simplifies management compared to juggling multiple creditor payments.

Disadvantages and risks of debt mediation

Debt mediation isn’t without significant drawbacks and risks that must be carefully considered.

• Credit score damage: Perhaps the most immediate consequence is harm to your credit score. Debt mediation typically requires you to stop paying creditors, causing accounts to become delinquent. Settled debts are reported to credit bureaus as “settled” or “settled for less than owed,” which is negative. Your credit score may drop 100 points or more, and these marks remain for seven years. If your credit is already poor, the additional damage may be minimal, but if you have good credit, the impact is severe.

• Tax implications: The IRS generally considers forgiven debt as taxable income. If a creditor forgives $5,000 of debt, you may owe taxes on that $5,000. Creditors typically issue a 1099-C form for canceled debt over $600. There are exceptions—if you’re insolvent (your debts exceed your assets) at the time of settlement, you may not owe taxes on the forgiven amount. However, this requires filing additional tax forms and documentation. Many people don’t anticipate this tax burden.
• Potential lawsuits: While your accounts are delinquent during the negotiation period, creditors may sue you. A lawsuit could result in wage garnishment, bank account levies, or property liens depending on your state’s laws. Debt mediation provides no legal protection against such actions, unlike bankruptcy’s automatic stay.

• Not guaranteed: There’s no guarantee creditors will agree to settle. Some creditors have policies against negotiating with debt settlement companies. You might complete a program having paid fees but with some debts remaining unsettled. Meanwhile, your credit has been damaged and interest and fees have accrued on unpaid accounts.

• Fees and costs: Debt settlement companies charge fees, typically 15-25% of your enrolled debt or the amount saved. These fees can be substantial. For example, if you enroll $40,000 in debt and the company charges 20%, you’ll pay $8,000 in fees. While regulations prohibit charging fees before settling a debt, these costs still reduce the financial benefit of settlement.

• Collection harassment: During the period when you’re not paying creditors, you’ll likely receive collection calls and letters. While you can request that collectors stop calling, this doesn’t prevent them from taking other actions like filing lawsuits.

Who should consider debt mediation?

Debt mediation isn’t appropriate for everyone. It works best in specific circumstances.

• Ideal candidates typically have several characteristics: significant unsecured debt (usually at least $10,000), an inability to make minimum payments, some income or access to funds to make settlement payments, and a determination to avoid bankruptcy. Those whose accounts are already seriously delinquent may find mediation particularly appropriate since their credit is already damaged and creditors are more motivated to negotiate.

• Poor candidates include those who can afford to make their minimum payments (even if it’s difficult), those with primarily secured or non-negotiable debts, those without any funds or income to offer settlements, and those who are already facing imminent lawsuits or wage garnishments. If you’re likely to need new credit soon—for example, if you’re planning to buy a house in the next few years—the credit damage from debt mediation makes it a poor choice.

• When to choose alternatives: If you have a steady income and can afford your debts with better terms, credit counseling and debt management plans are preferable. If your situation is desperate with no foreseeable ability to pay anything, bankruptcy may be more appropriate. If you have some assets or can borrow from family, you might negotiate settlements yourself without using a debt settlement company, saving on fees.

The bottom line

Debt mediation offers a potential path forward for those struggling with overwhelming unsecured debt who can’t afford their current obligations but want to avoid bankruptcy. By negotiating reduced settlements, debtors can potentially resolve debt for less than they owe and regain financial stability faster than through minimum payments alone.

However, this path comes with significant costs: credit damage, tax implications, potential lawsuits during the process, and substantial fees if working with settlement companies. It’s not appropriate for everyone, and alternatives like credit counseling, debt management plans, or even bankruptcy may be better options depending on individual circumstances.

The key is understanding your complete financial picture, knowing your options, and making an informed choice that aligns with both your immediate needs and long-term financial goals. Whether you pursue debt mediation with professional help or attempt negotiations yourself, or choose a different path entirely, taking action to address unsustainable debt is crucial. The worst choice is often doing nothing at all, allowing debt to grow while opportunities for resolution slip away.

There’s always JG Wentworth…

Do you have $10,000 or more in unsecured debt? If so, there’s a good chance you’ll qualify for the JG Wentworth Debt Relief Program.* Some of our program perks include: 

• One monthly program payment 

• We negotiate on your behalf 

• Average debt resolution in as little as 48-60 months 

• We only get paid when we settle your debt  

If you think you qualify for our program, give us a call today so we can go over the best options for your specific financial needs. Why go it alone when you can have a dedicated team on your side?