A common misconception is that debt settlement is a magic solution that wipes away all of your debts easily and without consequences. But even though it’s a great option for some consumers, that’s just not true. Essentially, debt settlement involves working with a creditor to reduce the total amount of debt owed. And while many debtors turn to it for relief, it does carry consequences and risks, namely, namely, an impact to your credit report and additional cost in the form of tax payments to the IRS. Not to mention, it can take years to accomplish.
Nonetheless, you may eventually decide that it is an option you want to pursue, particularly if you’ve been counseled well and are prepared to manage the resulting tax liability and impact to your credit history. Here, we will discuss the basics of how debt settlement works and how it can help you pay down your high-interest debts.
How Debt Settlement Works
Debt settlement involves close communication and negotiation with your creditors to either forgive a portion of your debt or to rework your repayment terms. In order to be successful, it is important to be proactive, approaching your creditors to ask for help before you default on a payment. You will also have to show concrete, compelling proof of the financial hardship that caused you to seek debt settlement in the first place, so that your creditors know you are approaching them out of true need, not just the desire to land a deal.
You can ask your creditors to either reduce the total amount you owe, to reduce your interest rates, or to extend your repayment timeline to lessen your burden. Most creditors are amenable to this if you’ve proven to be a reliable borrower who makes payments on time. Generally, creditors prefer to be paid something rather than nothing at all, so many of them are willing to work with consumers to devise a plan that’s feasible for both parties.
It’s unlikely that your creditors will agree to forgive the total amount you owe. Most often, they will reduce your debt by the standard amount, which falls between 40 and 60 percent of the original balance.
To get started, contact your creditor. Many creditors will periodically send you offers, but others will require you to initiate a conversation about settlement. Once your creditor has agreed to settle, they will send you a bill or final amount owed. Then, you and your creditor will make an arrangement to pay that amount off: either in full or in installments. Once you’ve paid off that final amount, your creditor will (or should) report the transaction to the relevant credit bureaus, and it will show up on your credit report.
Keep in mind that if you have a portion of debt settled that exceeds $600, the IRS will deem that taxable income, and you will be expected to pay taxes on it. That said, if you do have a substantial amount of your debt forgiven, it is advisable to ensure you come up with the funds to cover the remaining tax liability. Additionally, be prepared for an impact on your credit, especially if you have plans to borrow another loan in the future.
How Debt Settlement can Help You
The benefits of debt settlement are clear: reducing your overall tax burden. If you’re not a candidate for a low-interest debt consolidation loan, and you don’t have the monthly revenue to make large payments on your loans to beat the accrual of interest, debt settlement may be a viable option for you.
Also, debt settlement works best for certain types of debt, like high-interest installment loans, credit card debt, unsecured personal lines of credit, medical collection accounts, deficiency balances on auto loans, and payday loans.
If you decide to pursue debt settlement, make sure you approach the situation with full knowledge of both its benefits and detriments.
- If you choose to work with a debt settlement company, check Better Business Bureau to ensure no complaints have been made against it.
- Avoid working with a company that seeks upfront fees rather than a percentage of the eliminated debt.
- Steer clear of companies who guarantee or ensure your debt can be settled.
- Make sure you procure written copies of every transaction between you and your debt settlement company, or between you and your creditors.
- Make sure you have the funds to make the resulting tax payment and speak with your accountant about your resulting tax liability and how to report your tax to the IRS.
- Make sure you under-promise and over-deliver. In other words, if your lender agrees to extend your repayment timeline or reduce your amount owed, make sure you settle on a monthly payment that is feasible for you. If you default on a payment, your account will likely be sent to collections.
Here at Countrywide Debt Relief, we have more than three decades of collective experience helping consumers like you become debt-free using options like debt settlement. If you think you could benefit from exploring this option, or you’d like to learn how we can help you find financial freedom, we welcome you to contact us for a consultation.