As an alternative to bankruptcy, debt settlement seems like a pretty good choice because you end up paying half or even less than half of what you owe. Sounds great, right? What you might not know is that there are implications for settled debt.
How Debt is Settled
The process of settling does not begin with the negotiations. It actually begins with you, the debtor, missing or skipping many payments on your debt, because you aren’t allowed to, or the lenders will not agree to, settle your debt if you’ve only missed payments once but find it too overwhelming.
As you continue to be harassed by collection agencies about your many payments, you might then make call to or visit debt settlement agencies to do the negotiating for you. As you agree to the terms, a savings account will then be opened so you can deposit your money for the settlement agency to collect.
The settlement agency then goes to the lender to attempt to negotiate to settle your debts and bring it down to a more manageable level that you are more able to afford. Once the lender agrees, the agency pays the lender, and then receives payment for the settled debt it has successfully negotiated on your behalf. The payment may either come from a flat rate or percentage of the settled debt to be paid by either the bank or from you.
The word “settlement” here may mean two things: you settled your debt through payment of an amount with the rest forgiven, or that the bank or lender “settles” for an amount less than you actually owe.
Why Debt Settlement is an Option
Debt settlement is good when you think about the perks you’ll be getting. You’re going to pay less than the amount you actually owe, which could reach up to only 40% of the total amount, and the calls, threats, and harassment of the collection agency finally comes to a stop. That’s why many would still think of it as a viable option.
Why Debt Settlement Shouldn’t be an Option
As good as it may seem, it’s actually not worth it because there is a fallout.
Remember when you waited for months and skipped many payments to be approved for the settlement? Those missed payments and collection calls will reflect on your credit report. By waiting it out, you are actually hurting your credit score by choosing not to pay for all those credit card bills.
Another thing is that when debt is settled, your credit report will reflect the payment of debt, but it will not consider it as a full payment of the debt and will instead indicate that the debt has been settled, which could also affect your credit score. That is because you chose not to pay the full amount. What’s worse is that it may stay on your credit report for up to 7 years.
Lastly, settled debt is considered by the IRS as taxable income. For instance, your debt of $20,000 was settled and you only needed to pay $10,000. That $10,000 is considered income and will be taxed by the IRS. You are expected to include that when you file your taxes.
Consider the Alternatives
While debt settlement can indeed be considered a viable alternative, it should only be considered a last resort of sorts, before filing for bankruptcy, of course. You should, instead, choose other alternatives.
To still maintain, or mitigate the lowering of, your credit score, consider going to consumer credit counseling. Credit counseling agencies help you come up with a debt management plan and present it to your lenders, which could decrease your monthly payments but still have the ability to pay the entire amount in full.