You May Have To Pay Taxes On Any Amount Settled On Your Account
If you settle an account for less than what you owe, the IRS essentially considers that you have already spent money that you are now not going to repay . In their eyes, this is the equivalent of income, and you will likely have to pay income tax on it. In fact, the creditor will send you a 1099-C form at the end of the year if they have forgiven $600 or more of debt. Even for smaller amounts, though, the IRS still notes that you are required to report it as other income on your tax return.
Lets say you settled a $10,000 debt for just $6,000. The $4,000 of forgiven debt is now considered taxable income. If your household pays income tax in the 20% range, you will now owe the government another $800 with your tax return.
In some cases, households have low enough incomes that the forgiven amount will not change their taxes owed. Not surprisingly, settlement companies seize on these scenarios to downplay the likelihood of a consumer having to pay income tax after a successful settlement.
Can You Pay To Delete Bad Debts From Credit Reports
When exploring options for settling past due debts, you may come across references to something called pay to delete or pay for delete. This tactic involves paying creditors or collection agencies to remove negative information from your credit reports.
It usually involves writing a pay to delete letter to the creditor or debt collector, outlining your risk. If the creditor agrees, youd pay whatever fee they request and, theoretically, the negative information would be removed from your credit reports.
Theres just one problem with writing a pay to delete letter. When negative information, including settled debts or collection accounts, is accurate, only time can remove it. Pay for delete isnt an option and it may even be construed as illegal. Again, accurate negative information can stay on your credit reports for up to seven years. So, whether you pay in full or negotiate a debt settlementeither on your own or by engaging a debt settlement companytheres no way to make negative marks associated with those accounts simply disappear.
The Pros Of Professional Debt Settlement
Although debt settlement does have many great benefits, its not the only solution available to those in need of debt relief. A professional will assess your specific situation and do their best to pick the best option, be it debt settlement, or any other of the many options including:
- Debt consolidation
- Consumer proposal
- Personal bankruptcy
When youre negotiating a debt settlement, creditors will generally attempt to get as much money out of you as possible. Without the help of an expert debt negotiator, you may not get the most beneficial terms to settle your debts. In other words, you may end up paying more than you would have needed to settle your debt. You could negotiate with creditors on your own, but, it is safe to say that with an experienced professional you will get a better settlement offer and you will end up paying back less.
Check out what questions you should ask your debt collection agency.
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Credit Settlement Will Hurt Your Credit Score
When you settle a debt, the account status will be noted as settled in full rather than paid in full. When an account is closed with a settled in full notation, it stays on your credit report for seven years from the date of final discharge. That notation is a bad mark on your credit history, which is the number one factor used in calculating credit scores. So, each debt you settle will damage your credit score.
But if your accounts are already in collections, they already count negative remarks on your credit report. If you already have multiple collection accounts listed in your report, the damage has already been done to your score. Essentially, its the old adage that you cant fall off the floor. If your credit score is already bad, theres less risk to settling your debt.
On the other hand, if you have a good score or even a fair one then you should expect the settlement to drag your score down. You need to consider carefully what will happen once you get out of debt. Its definitely possible to rebuild your credit, but you want to limit the damage whenever possible as you eliminate your debt.
Next Steps If You Want To Go Ahead With Debt Settlement
Do your research. The Federal Trade Commission helps protect consumers by trying to prevent unfair business practices in the marketplace. The FTC has useful information on debt settlement thats worth reading as you consider debt settlement options.
Pick a reputable debt settlement service provider. Before you enroll in any debt settlement program, the Consumer Financial Protection Bureau recommends contacting your state attorney general and local consumer protection agency to check whether there are any complaints on file. The state attorney generals office can also check if the company is required to be licensed and whether it meets your states requirements.
The Better Business Bureau has consumer reviews of businesses that could help you as you research a debt settlement service provider.
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Take Taxes And Fees Into Account
When you make a decision regarding paying your debt in full or settling it, its important to keep the tax implication of settling in mind. You have to pay taxes on forgiven debt. If the forgiven amount is more than $600, you will receive a 1099-C Cancellation of Debt tax form from the creditor or collection agency with whom you settled.
The IRS requires that you report any amount of forgiveness for that tax year because its considered income. When added to your taxable income, the money you just saved via a settlement could cost more than anticipated. In addition to taxes, you may also have to pay fees to settle your debt. Its important to pay attention to these extra expenses because as your savings diminish, the value in settling diminishes as well.
If settlement is the only way you can afford to pay off your credit card debt, just make sure you set aside enough money to pay those extra taxes.
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Myth No : Using A Debt Settlement Company Wont Cost Much
The truth: Debt settlement companies will charge you on a percentage basis, usually, a portion of your total debt or of the amount forgiven.
For example, Clear One Advantage charges a percentage of the total debt the consumer enrolls in the program. However, the company doesnt collect until it has made a settlement and the customer has approved it, Gordon says.
A legitimate company should never charge upfront fees. Not a one-time fee nothing, Gordon says.
Finally, debt settlement might cost you at tax time, too, because Uncle Sam may get a cut. The amount of debt that is forgiven by a lender is often taxable.
Advice On How To Settle Credit Card Debt From Accc
Given the potential downsides of debt settlement, its important to understand how to settle credit card debt most effectively. Thats where American Consumer Credit Counseling can help. Were a non-profit organization that provides free credit counseling to consumers looking for the best way to get out of debt. Our certified credit counselors can help you take stock of your finances, explore all your options for paying down your debt, and explain how to settle with credit card companies or eliminate your credit card debt in ways that wont damage your credit rating.
Start your journey out of debt call for a free credit counseling session with ACCC today to learn how to settle credit card debt most successfully.
American Consumer Credit Counseling is a non-profit dedicated to helping individuals and families find their way out of debt. As a nonprofit credit counseling, we provide free , and our fees for our debt management programs are among the lowest in the nation. Our debt counselor are certified to provide a wide range of services, including , bankruptcy counseling, housing counseling, student loan counseling, and assistance with other financial matters. At ACCC, consumers can work with a highly trained non-profit to get a clear picture of their finances and evaluate all their options for paying off their debt. As a highly reputable credit counseling company, we have an A+ rating with the Better Business Bureau, and we are a member of the National Foundation for .
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Enroll In A Debt Settlement Plan
This isnt the easiest process and it will hurt your credit scores, but it could be an alternative to bankruptcy if your situation warrants it. A debt settlement plan over a longer period of time will require you to negotiate an agreement with your creditors to pay back some of what you owe, either in installments or a lump sum. In general, a reasonable expectation is settling your debt for 50% less of what you owe if your account is five or more months late. For some, this could mean it could take a couple of years to settle all your debts.
Keep in mind that some credit card issuers are a little more flexible than others, says Bovee. He explains that in his experience helping people settle their credit card debt, Bank of America and Chase tend to be the easiest to work with. Citi, on the other hand, will probably want a larger settlement than some of the other companies. Discover and AmericanExpress tend to be fairly litigious, meaning they might sue you and take you to court, so its something to consider if youre deciding which bills to pay off or settle first.
Many Debt Settlement Companies Will Push You To Take Out A Settlement Loan Within A Year To Settle Your Debts
Relatively recently, many debt settlement companies have begun to act less like an advocate for their clients and more like a funnel to high-risk, high-fee lending institutions. Many debt settlement companies now push their clients away from the save-for-one-to-two-years-before-we-offer-a-settlement model toward companies that will make a debt consolidation loan to the consumer at interest rates as high or, more often, higher than the APRs on their original debts. These short-term loans typically carry terms of three to five years. These loans can easily put the consumer back into the situation of being unable to afford their monthly payment, leading to even more financial troubles in the future.
*Many settlement services are offered through respected attorney offices. Many others simply use attorney names to lend legitimacy to their business.
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Myth No : If I Dont Settle The Debt Stays Forever
The truth: There is a statute of limitations for collecting on debt.
Many collectors, whether the issuer or a person or entity who has purchased old credit card debt, attempt to collect debt that is often time-barred meaning the statute of limitations has run out, Ayers says.
The statute of limitations laws vary from state to state, but if a debtor has not made a payment on an account for enough years, the debt is no longer enforceable in court.
Some companies buy old and time-barred credit card debt and then send out letters trying to collect or, without actually trying to collect, offer to settle for, say, 10%, Ayers says.
Some courts have ruled that these non-collection letters do not violate the Fair Debt Collection Practices Act, but the U.S. Court of Appeals for the 5th Circuit has ruled that some actions can violate the FDCPA, he says.
The bottom line is these companies are essentially preying on consumers.
Paying off such debt, even at cents on the dollar, does little or nothing to repair bad credit, Ayers says. The debt had long since been written off and the partial repayment will never be reported to anyone, anyway.
In addition to the legal obligation dying out, the credit damage will also sunset. Negative information on your such as a failure to pay drops away after seven years.
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Is Paying Off Or Settling Debt Better For Your Credit
In general, paying off the total amount of debt you owe is a better option for your credit. An account that appears as “paid in full” on your credit report shows potential lenders that you have fulfilled your obligations as agreed, and that you paid the creditor the full amount due.
Accounts remain on your credit report for up to 10 years when they’re closed in good standing . Positive payment history on those accountsthe most important factor in your credit scorewill continue to strengthen your score during that time. The growing length of your credit history can also have a positive impact on your score.
You can pay less than the full amount owed if you negotiate with a lender to settle the debt. Debt settlement companies offer the option to settle debt on your behalf for a fee, but there are many drawbacks to this process, including shattered credit and high fees. Instead, negotiating with lenders on your ownor considering a debt management plan organized through a nonprofit credit counseling agencymay be better options.
No matter how you settle debt, anytime you don’t repay the full amount owed, it will have a negative effect on credit scores. The “settled” status will remain on your credit report for seven years from the original delinquency date of the account. If the account was never paid late, the “settled” notation will stay on your report for seven years from the date the debt was settled.
Researching Debt Settlement Companies
Before you enroll in a debt settlement program, do your homework. Youre making a big decision that involves spending a lot of your money money that could go toward paying down your debt. Check out the company with your state Attorney General and local consumer protection agency. They can tell you if any consumer complaints are on file about the firm youre considering doing business with. Ask your state Attorney General if the company is required to be licensed to work in your state and, if so, whether it is.Enter the name of the company name with the word “complaints” into a search engine. Read what others have said about the companies youre considering, including news about any lawsuits with state or federal regulators for engaging in deceptive or unfair practices.
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How Long Will A Debt Settlement Affect Your Credit Score
How long a debt settlement affects your credit score depends on who negotiates the debt settlement with your creditors. If you negotiate the settlement yourself, or you pay to use the services of a for-profit company, the settlement notation will remain on your credit report for 6 years from the date your payment is processed. While it affects your score more in the early years, as you work to build up other good credit, over time it impacts your credit score less and less.
However, non-profit credit counselling agencies have special arrangements with the credit bureau companies whereby we can instruct that the settled debts be removed from your credit report 2 years from when your payment is processed. To learn more about how our debt settlement programs work, contact us for a free, confidential appointment with one of our Credit Counsellors. They can explain the program and see if it might be an option for your situation.
Thinking The Settlement Process Must Be All Or Nothing
Lets say you have ten different credit card accounts that you want to settle, and lets say you want to get them all settled for .40 cents on the dollar or less. Thats a perfectly legitimate goal to shoot for.
However, just know your wish might or might not be granted. Its possible you could run into one or more stubborn creditors during the process.
For example, lets say 8 of your 10 accounts went perfectly according to your plan you settled them for 50% or less. But then one creditor wouldnt settle for less than $0.70 on the dollar and another would only accept a lenient payment plan.
Is this such a bad outcome? Of course not. You achieved a massive amount of debt relief without having to file bankruptcy, just not the maximum amount you were hoping for. But it still turned out really good for you.
Remember, keep things in their proper perspective and look at the big picture.
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