5 Things to Know About Debt Settlement

For someone drowning in credit card debt, debt settlement programs seem like a lifeline. Settlement agencies make big promises to “get creditors off your back!” and “pay your debts for pennies on the dollar!” but do these programs deliver as promised?

What is Debt Settlement?

When a lender believes that there is no possibility to recover a delinquent account, they charge it off their books and assign or sell it to a debt collector.

A debt settlement is an offer made to the collector to accept only some percentage of the outstanding balance and consider it resolved.

How do Debt Settlement Agencies Work?

When someone enrolls with a settlement agency, they are instructed to stop paying their creditors and, instead, make payments to the agency which are held in a trust account.

Once the accounts go to collections (and sufficient money is in the trust account), the agency attempts to negotiate a settlement for less than the full balances.

If the negotiation is successful, the agency pays the collector, who in turn notifies the borrower that the account has been settled and no further action will be taken to collect on it.

That sounds great! Why doesn’t everyone do that?

While debt settlement is real, there are 5 important things to consider:

1. Settlements Hurt Your Credit

Lenders almost never accept settlements directly; they are accepted by debt collectors. This means the account must already be delinquent and in collections before the process starts! Allowing accounts to go to collections has a severe, long-term impact on the credit score.

Additionally, if an account is settled, the collector reports it as “Settled for Less Than Full Balance” rather than “Paid in Full” on the credit report. This negative mark can stay on the credit report for up to 7 years.

2. Settlements Aren’t Always Accepted

There is no guarantee of success since a debt collector is under no obligation to offer or accept a debt settlement. They can, and often do, continue collection activity (including lawsuits) after a settlement offer is made.

3. Settlements Cost More Than You Might Think

The average settlement is between 40% and 50% of the balance, and could be as high as 80% depending on the debt and collector. That means that to settle a $10,000 debt, a borrow might need to have $5,000 or more saved before the negotiation begins.

4. Settlement Agencies Don’t Work for Free

Debt settlement agencies also charge fees based on a percentage of the amount settled. Depending on how much debt is settled, the borrower might be on the hook for thousands more dollars.

5. Settlements Might be Taxable

Even after the debt collector and settlement agency are paid, there is still someone with their hand out: Uncle Sam.

Collectors are required to report to the IRS and issue Form 1099-C for any settlement over $600. This means that the borrower will have to claim the settled amount as income for that tax year. If a $10,000 account was settled at 50%, the borrower would have to claim an additional $5,000 in income.

Depending on how much debt is settled, a borrower might find that they have an increased tax liability.

Dealing with debt can be overwhelming and the right way to go isn’t always obvious. Our Certified Credit Counselors can help you find the debt strategy that works best for you and sets you on the path to financial freedom. Visit us at www.christiancreditcounselors.org to learn more and to schedule a free consultation today.