Debt settlement seems like a quick fix, but it isn’t the right option for every consumer. From an impact to your credit score, to the resulting tax liability, it can have financial repercussions down the road. Nonetheless, many debtors turn to it as an option if they’re prepared for the consequences and determine that the benefits outweigh the detriments. For many, it offers a chance to get out of debt more quickly, and for those who are prepared to meet the resulting tax liabilities, it isn’t a bad option.
Still, as with any other debt relief approach, caveats apply. There is a way to do it right, and a way to meet pitfalls. That said, before pursuing this option, make sure you fully understand how to navigate it.
Here, we will share the most common “dos and don’ts” for those pursuing debt settlement to get out of debt.
- Be proactive. Don’t wait until you’ve already fallen six months behind on your payments before seeking help. If you plan to contact your creditors, do it as quickly as possible, preferably before you fall delinquent. By being proactive, you show your creditors that you are serious about resolving your debts and that you’re credible and trustworthy. As a result, they will be much more likely to entertain a conversation about debt settlement.
- Keep your records in order. Before agreeing to settle, your creditors will ask for documentation of your income, assets, and liabilities, as well as compelling proof of the financial hardship that prompted you to ask for forgiveness. If you cant produce this type of evidence, you likely won’t convince a creditor to settle. Creditors are only motivated to settle with those who are experiencing true hardship, not those who are simply trying to save money.
- Get everything in writing. Procure a written record of every transaction and communication throughout the settlement process. That way, if you hit a problem down the road, you’ll be able to turn to your documentation to substantiate the terms of the transaction. You will also need to produce some evidence to the government that your debt was settled, so keep detailed records of every bit of documentation you receive throughout the process.
- Make sure the matter is actually settled. Once you reach a settlement agreement with your lenders, check to make sure it shows up on your credit report. Sometimes, creditors will fail to report settlements to credit bureaus (even though they’re legally required to), which will leave your credit report showing that your account is delinquent. Also, once you’ve settled, your creditors should no longer send you debt collection letters or contact you by phone. If that happens, contact them to confirm that the matter has settled and ask them to cease all contact with you.
- Overlook the consequences. If your amount forgiven exceeds $600, it will be considered taxable income. That said, make sure you’re prepared to make a lump sum payment to the IRS once your account is settled. While your creditors may choose to be flexible, Uncle Sam won’t – and many consumers get into hot water by becoming delinquent on their taxes after having their debts forgiven. Also, keep in mind that settlement will impact your credit report. Your report will list the account as settled for less than the total amount owed, which may signal to future creditors that you were not able to pay back the money you borrowed. This is important to keep in mind if you plan to borrow again in the future.
- Set unattainable goals. Your creditor may agree to let you pay your debt over time. If so, make sure you keep your payment amounts manageable. Don’t set a settlement plan that’s simply not realistic for you. If you over-promise, you will likely fall delinquent once again – and your creditor will refer you to a collection agency (which is likely to be far less accommodating than your original lender).
- Deplete your savings. Don’t use up all of your savings on the settlement process. Note that debt settlement isn’t always successful, and you don’t want to find yourself losing your assets while still entrenched in debt. In particular, stay away from your emergency fund and your retirement fund. Without these cushions, you may end up turning to credit cards or other forms of new debt to get you through financial hardship. Not to mention, you will face a penalty of up to 10% for withdrawing from your retirement account prematurely.
- Write off your other options. As you enter the negotiation process with your creditors, you might realize that settlement is not the right option or that you have serious reservations. If so, don’t feel pressure to proceed. There is a host of other options available, from debt consolidation to various forms of credit counseling, so always keep the door open to other possibilities throughout the process.