When you’re drowning in debt, behind on payments, out of alternatives, and unsure what to do, debt settlement may be an alternative to consider. It is not for everyone, and there are certain repercussions to consider, but it may be the only alternative between you and bankruptcy.
In this article, I’ll go over the following consequences of negotiating a debt settlement with your creditors:
- Not every debt is eligible.
- Debt settlement companies charge fees for their services.
- There are high drop out rates in these programs.
- Creditors will want a lump sum payment.
- It damages your credit.
- The savings is considered taxable income.
Not All Debts Are Eligible
There are numerous loans that are immune from debt settlement and bankruptcy. As an example, consider student debt. So, don’t think of this as a one-size-fits-all strategy for getting out of debt. As a general rule, you can only negotiate a settlement on a charged-off account. So, unless you are far behind in payments, you may be ineligible.
Fees are charged by debt settlement companies.
They collect money because they provide a service. These fees are typically hefty and can amount to up to 25% of your debt. You must also ensure that you are working with a legitimate organisation that has a strong reputation with a wide range of creditors in order to negotiate the best deal for you. You should be aware that the debt settlement organization will not send any payments to your creditors until you achieve a specified sum. That means you could still receive collection calls and mailings, or worse, your creditor could sue you.
High Drop-Out Rates
This is not an overnight solution. You will still be making monthly payments. But, instead of making them to your creditor, you will instead be making them to a debt settlement company. Many people who take advantage of these services have still not learned how to budget, manage their money, and live within their means, so it isn’t uncommon for a person to continue piling up debts with other creditors because they suddenly have lower monthly payments. When they get behind yet again, they drop out of the program losing all of the money they had invested to the debt settlement company (because they will take that as their fee), and have not only their original debt but the new debt they have incurred as well.
You will be unable to make monthly payments if you choose to negotiate with your creditors on your own rather than using a debt settlement business (which I would recommend!). They’ll demand a flat sum payment. Tax season is an excellent opportunity to consider debt settlement (assuming you are getting a refund). When you receive your refund, you can contact your creditor and offer a lump sum payment ranging from 75% to 25% of the total amount owed. The benefit here is that you only have to make one payment and you can check this creditor off your list; the debt is gone.
If you’re like me, you probably consider this one a little bit silly. After all, if you have accounts that have already been charged-off, chances are your credit isn’t very good now. So, will having a debt settlement on your credit record hurt you any worse than the charge-offs and late payments? Probably not. But, it isn’t the same as your credit report saying “paid in full”. I would say you just need to weigh your options. For most people who are eligible for debt settlement, it’s probably worth it to get out from under your debt. Any negative marks on your credit will drop off, but it may take 5 to 7 years for that to happen. In general, your more recent (past 2 years) credit history will be given more weight than the distant past.
Consequences of Taxation
People who use debt settlement are frequently surprised by this. The IRS and many states regard the forgiven sum to be taxable income. So, if you owe $30,000 and are able to negotiate a 50% settlement, you will receive 1099 from your creditor at the end of the year for $15,000 of forgiven debt, which you must include on your tax return as taxable income. Again, it’s a little price to pay. Even if you are in a higher tax band and pay 40%, you will save $9,000. Just make sure you’re ready for the increased tax bill.
Again, debt settlement isn’t right for everyone, and it should only be considered as a last resort in order to avoid filing for bankruptcy. But, it is an option worth considering if you are deep in debt and looking for a way out.
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