If you’re haunted by an overwhelming amount of debt that you can barely pay, you’ve probably considered bankruptcy. However, many people shy away from bankruptcy because it can be a lengthy process that stays on your credit report for at least 7 years and can follow you for life (since most major loan applications ask if you’ve ever filed bankruptcy). For many people, debt settlement emerges as an appealing alternative to bankruptcy.
Negotiating a Debt Settlement
Debt settlement is a process through which you and a creditor negotiate a payment that’s less than the original amount owed. The creditor agrees to accept this lower payment as full satisfaction for the debt.
Why would a creditor agree to a debt settlement? A creditor who’s being paid on time every month has little incentive to accept a settlement offer. You’re likely to continue making timely payments to preserve your credit score. However, on the other end of the spectrum, if you’ve fallen severely behind on your payments, the creditor would get much less from the debt, or nothing if you simply decided not to pay or filed bankruptcy.
Once you’ve reached a settlement with the creditor, you make payment and the deal is done. You can also settle with debt collectors if the debt has already been sold.
Debt Settlement Through a Firm
Some consumers are able to negotiate debts on their own, others choose to seek help through a debt settlement firm. It can be like the difference between representing yourself in court and hiring an attorney. Sure, you can learn the law and attempt to defend yourself, but you may be more comfortable paying someone who has more experience.
When you hire a debt settlement firm, they do the work for you. They contact your creditors and try to work out a settlement firm. They may collect money from you for the settlement payment and distribute it to the creditor when a settlement is made. If you don’t have the money upfront, the debt settlement firm could then set up a dedicated account in your name. You would make payments into the account each month and a lump sum payment is made to the creditor when the dedicated account balance is high enough to pay the settlement amount.
Disadvantages of Debt Settlement
There are some drawbacks to debt settlement and you must decide if these are better or worse than the drawbacks to the alternatives of debt settlement. You typically must stop making payments to your creditors for debt settlement to be successful. But, missed payments will be listed on your credit report.
When you settle debt, part of the total debt is canceled. If the canceled debt is $600 or more, then the creditor is required to report this to the IRS and you must include it as income on your tax return. This could increase the amount of tax you owe for that year. Increased tax liability could result in a lower tax refund or even require you to make payment or an increased payment to the IRS.
Debt settlement could take a few months depending on when your creditors finally agree to a settlement (if they agree at all) and when you’re able to make a settlement payment. But, when such process is completed, you don’t have to worry about that debt and you don’t have to live with the effects of a bankruptcy.