Debt Settlement Pros and Cons
The process of settling on a debt involves negotiating a lower payoff amount to resolve the outstanding debt owed to a creditor. Debt settlement should normally not be considered an option if the debt is still held by the original creditor. If you are in this situation, and unable to bring the account to current status, you should seek the assistance of a certified credit counselor in order to discuss options for restoring your account to current status. Credit counseling is a process that can help you improve credit and eliminate debt.
Once your debts have been charged off by the original creditor and sold to collection agencies, then debt settlement may be an option you can consider. There is no guarantee that a collector will settle. Some attorneys acting as collectors may be particularly difficult to settle with. Larger collection agencies are usually easier to negotiate a settlement with.
Pros and Cons
There are some benefits to debt settlement. You can satisfy a debt in full while paying less than the full amount (make sure you get this in writing). This can save you a substantial amount of money. Some collectors will even agree to delete any negative information on your credit report, much to the chagrin of the credit bureaus. In addition, you no longer will show an open delinquent item on your credit report. Furthermore, debts resolved through settlement and other means no longer are subject to collection calls and legal action.
There is a dark side to debt settlement. Many of these will appear on your credit report as a settled debt rather than paid in full. If you fail to get a written statement from the collector that you no longer owe anything on the debt, they may sell the remainder to another collection agency. In addition, any savings are reportable to the Internal Revenue Service (IRS) as forgiven debt, which is considered a form of income. Collection agencies are required to submit Form 1099-C to the IRS to report any forgiven debt of $600 or greater. If you have negative net worth, you may be able to avoid taxation on forgiven debt. If this is the case, you should seek the advice of a professional tax preparer.
If you seek the aid of a debt settlement company, you may have even more problems. Debt settlement companies charge substantial up-front fees, often charge monthly fees and send nothing to your creditors until you have accumulated enough to settle. At that point, they even take a portion of the forgiven debt as a fee. Once your debts have accumulated additional interest over time, and factoring in the increased taxes you must pay on forgiven debt, you really are not saving much money at all. Plus your credit rating is guaranteed to be ruined. Debt settlement companies cannot do anything more than you can do on your own. If you can save money for a settlement and negotiate a settled amount, then you can settle your own debts without the assistance of a debt settlement company. If you still think you want to hire a debt settlement company, consider the negative ratings of debt settlement companies as well as the warnings from top regulators against dealing with debt settlement companies.
If you decide to settle on a debt, try to do it yourself. The key is to save enough money so that you can pay off the settled amount in one lump sum payment. Collectors will not accept payments to settle a debt. Some collectors will settle a debt for as little as 25% of the balance, but expect most to require 40-60%. Make sure you get a written statement showing that the total debt is satisfied upon your payment. If you can, also get the collector's written agreement to remove any negative credit reference on your credit report for that debt. Not all collectors agree to this, but some will.
Debt settlement should only be considered if your accounts have been charged off and you are getting hounded by collectors. You can save for and negotiate your own settlements without the assistance of a debt settlement company. What is important is that you protect your financial future by any means necessary.
Be sure to visit our debt settlement blog if you want more information about how debt settlement affects your credit and future liabilities. Additionally, if you would like to share your story about your interaction with debt settlement companies visit the debt settlement forum hosted by Debtors Unite.