How Debt Settlement Agreements Affect Your Credit - dummies

How Debt Settlement Agreements Affect Your Credit

By Steve Bucci

When a creditor allows you to pay off your debt for less than you borrowed, you’re settling a debt. And because no one likes to lose money, settling a debt is rarely easy. Although you may not have stiffed the lender completely, your actions did result in a loss of profit for the company, which isn’t an incentive to do business with you in the future.

Settling a debt also has a negative impact on your credit report, so you may want to consider what’s more important to you, the money or your credit history.

Considering a debt settlement offer

Some businesses may offer you a debt settlement option if they believe that they may never recover what you owe, or continuing collections becomes uneconomical, or they think that they can recover more by settling than by selling the debt to a third-party collection agency.

Although a settled debt is considered paid, the settlement appears on your credit report for seven years from the date of the delinquency leading to the account charging off, and you may have a tax liability if the creditor forgives more than $600 of the debt.

The IRS considers the difference between the amount you owe and the amount you pay as income. This thinking defies logic. But if your settlement amount allows for more than $600 to go unpaid, you’re responsible for paying income taxes on that amount.

For example, if you owe $5,000 and you work out a settlement where you pay only $3,000, the $2,000 that was forgiven becomes taxable income on your next tax return. As the saying goes, only two things in life are certain — and one of them is taxes!

If you decide on debt settlement as a payment resolution, get the settlement terms in writing and read them carefully before you send in a penny. You need to be on your guard when you’re negotiating a settlement or if you’ve been offered one.

You’re dealing with people who know settlements better than you do and who don’t mind if you make a mistake that is to their advantage and results in more of what you owe being collected. After you send in the money, you have no leverage with the collector, and any promises that aren’t in the written agreement are unlikely to be kept.

Hiring a debt settlement firm

You’re likely to see and hear advertisements for debt settlement firms, and you may even be contacted by one. These companies have come to the attention of the Federal Trade Commission (FTC) because most of them charge large fees and provide limited results for consumers.

New FTC regulations have curbed some of the abuses, but it’s still a good idea to try to settle on your own or use an attorney rather than a debt settlement firm. However, if you want to hire a settlement company, keep these points in mind:

  • Make sure that the company is a member of the Association of Settlement Companies (TASC).

  • Don’t pay an upfront fee. Companies are required to settle at least one account before charging the consumer.

  • Don’t sign anything if you feel pressured to do so.

Consider running any offer by an attorney. Doing so will cost you money, but it may save you big if you avoid making a mistake or if only a bankruptcy can solve your problem. A consumer debt goes away in a bankruptcy; an IRS debt from a settlement doesn’t.

Reach expiration dates on debts

Sometimes, procrastination has a silver lining. When a debt reaches a certain age (as defined by the statutes of your state of residence), it’s no longer collectible in a court of law. Each state has its own statute of limitations rules.