What Is Debt Settlement?

Summary: Debt settlement is used by debtors who have large amounts of debt as a way to reduce their debt without having to file bankruptcy. It is often a last ditch effort to avoid bankruptcy! A debt settlement is when you negotiate with creditors in order to get a pay-off amount that is less than the total amount owed, and typically has to be paid back all in one lump-sum. Why would a creditor consider an amount that is less than what you owe them? When you are having extreme ...

Debt settlement is used by debtors who have large amounts of debt as a way to reduce their debt without having to file bankruptcy. It is often a last ditch effort to avoid bankruptcy! A debt settlement is when you negotiate with creditors in order to get a pay-off amount that is less than the total amount owed, and typically has to be paid back all in one lump-sum. Why would a creditor consider an amount that is less than what you owe them? When you are having extreme financial difficulties, a creditor realizes that your next step is likely to be a bankruptcy. When creditor's clients file bankruptcy, they end up receiving no money at all. It is better for the creditors to receive money that is less than the total amount owed than to receive nothing at all for the account, and often, creditors will agree to settle as it is in their best interest to obtain some money even if it is not the full amount owed. What Does Debt Settlement Do to Your Credit Report? After a creditor has agreed to settle with you for an amount less than what was originally owed, you'll have to send them the amount in a single payment. Once the debt is "settled" the creditor will then send you a letter that states your legal obligation to repay the debt has been fulfilled. The credit bureaus will be notified that the account and the debt has been "settled for less than the full amount", or "settled", or "paid". The harm to your credit report isn't actually how they report the account as being paid or settled. Instead, the problem comes from the way in which a person is able to obtain a debt settlement in the first place! Creditors will never agree to "settle" a debt for less than the full amount owed if you have been making regular payments on the account. If your account is current and in good standing then you will not be able to settle the debt. As the account falls behind and you don't keep up with the payments, each month you are late or don't pay, that scenario is reported to the credit bureaus and it is the late reporting that actually lowers your credit score. The credit report will show that you are behind with your payments until the settlement has been completed and the creditor reports the account as being paid. How Debt Settlement Affects Taxes If creditors agree to negotiate and settle the debt with you, keep in mind that the IRS will consider the amount of the forgiven debt to be taxable income. So, if you owed $3000 to a creditor that agreed to settle for $1500, then you will have to claim $1500 on your taxes as taxable income. (Sometimes, you can fill out IRS form #982 and claim a special hardship to avoid paying taxes on the settlement). Debt settlement is one method of getting yourself out of serious debt, in a short period of time, and without having to come up with the full amount that you actually owe. Debt settlement is also a method for avoiding bankruptcy, even if you feel like that is your only option. While you probably do not have a lot of money to use to pay off your creditors, in many situations it may be wise to borrow from a friend or relative in order to settle your debts- and then you can have a single payment to your friend/relative in order to pay them back. (A single payment each month is certainly easier than trying to pay several accounts each month, and cheaper than paying interest, late fees and finance fees on multiple accounts, too)!