Though some people with debt may be able to pay it off themselves, others may need outside help. If you’ve racked up thousands of dollars in credit card debt, it can be hard to deal with it alone. An attractive option for many consumers is debt settlement. On the surface, it looks like a great idea. You don’t have to pay off all the debt you owe, and a percentage of your debt may be forgiven. However, we urge consumers to be cautious and do their research. In fact, the best debt settlement advice we can offer is this: Look for other options! Here is why debt settlement is often a bad idea.
Negative Impact on Credit Score
Debt settlement negatively impacts your credit score because you are not paying off the principal amount that you owe. Essentially, you have failed to meet your financial obligations, which shows creditors you are not a trustworthy borrower. Additionally, when you start working with a debt settlement company, they are the ones responsible for sending your payments to creditors. However, the debt settlement company will wait several months before paying because creditors will not usually agree to settle on the debt unless they are worried they might not see any more payments from you. They won’t want to settle unless you’re seriously delinquent.
Missing or late payments will always have a negative impact on your credit score because payment history is one of the factors that determine your credit score. With debt settlement, not only are you missing payments, but you are also not paying off the full amount of the debt you owe. Because of these reasons, your credit score can take a massive hit.
Another piece of important debt settlement advice: Keep in mind, settling on your debt can have tax consequences. The IRS counts any debts that were forgiven or canceled as a result of debt settlement as income, so you will have to pay taxes on it. For example, if you had $10,000 in debt, but only paid $5,000 through a debt settlement program, the IRS sees the other $5,000 as income. If you are taxed at 20%, you’ll owe $1,000 in taxes just for that settled debt.
Lenders are required to issue a 1099-C form to the borrower. This shows the amount of the debt that was not paid. Many people are unaware of this tax implication when they enter a debt settlement program, so it’s often a nasty surprise when they learn that they have to pay tax on the settled debt.
It may sound counter-intuitive since debt settlement settlement companies claim to save you money, but they charge high fees. Many debt settlement companies are not completely transparent about how much their fees are. Most will charge you a percentage of the debt you eliminate through the settlement. These fees are not going towards paying off your debt, rather they go straight to the company itself. Remember, these are for-profit companies. Their main goal is to make money, not necessarily to help you. When you add up all the fees and the taxes you’ll have to pay, it might not even make financial sense to go through with debt settlement!
Debt Settlement Advice: Find Alternatives
The most important piece of debt settlement advice we can offer is to find alternatives to debt settlement. Nonprofit credit counseling agencies like ACCC offer you a debt management program to help you pay off your debt without paying high fees or hurting your credit score.
In a debt management program, you pay one monthly payment to the credit counseling agency, and they disburse it to your creditors. They don’t wait until your accounts are delinquent, and you pay off the entirety of the debt you owe. Your payments in a debt management program are lower than what you would be paying on your own because the credit counseling agency negotiates lower interest rates and waived fees with the creditors. By the time you finish the debt management program, your credit score may have be improved too. Your overall finances will be in a better position after completing a debt management program as opposed to debt settlement.
If you are struggling to pay off your debt, ACCC can help. Sign up for a free credit counseling session with us.