The Pros & Cons of a Credit Card Debt Settlement

Blog Post03/22/2016
Credit Advice

Under the terms of a settlement agreement, you might be able to pay back less than what you owe your creditors, while avoiding lawsuits or judgments. Unfortunately, there are some downsides to credit card debt settlement.Under the terms of a settlement agreement, you might be able to pay back less than what you owe your creditors, while avoiding lawsuits or judgments. Unfortunately, there are some downsides to credit card debt settlement.

What Is Debt Settlement?

Credit card debt settlement is an agreement between a credit card company and a debtor. Typically, settlement requires you to pay a certain percentage of the debt you owe immediately, in exchange for forgiveness of the remainder of the debt. For example, if you owe a credit card company $10,000, you might be able to negotiate a settlement in which the company will accept $6,000 as payment in full.

Why would a company accept such a deal? If it seems unlikely you’ll be able to pay off the full balance, some companies may accept a “take-what-we-can-get” attitude. In other cases, the cost involved in taking you to court for the full amount owed may exceed the money lost in a settlement offer.

Credit Scores and Taxes

If you settle a debt for less than what you owe, your credit score may be affected, as you’ve shown that you’re either unwilling or unable to pay off debts. With low credit scores, you may have to pay higher interest rates on car loans, home mortgages and credit cards in the future — and that’s if a company is willing to extend you a loan in the first place.

Many banks and financial firms offer free access to your credit scores, which contain a detailed history of your credit activity and accounts. You’re also entitled to a free report if you’re ever denied credit.

One of the hidden dangers of negotiating a debt settlement may not become apparent until you file your taxes. Since the IRS considers forgiven debt to be income, you’ll have to pay income tax on the amount of debt you don’t repay. For example, if you negotiate a $20,000 debt down to $14,000, that remaining $6,000 becomes taxable income to you.

Counseling and Debt Payoff Options

Sometimes, using a debt settlement firm to negotiate a deal may do more harm than good. Some settlement firms ask for high upfront fees and counsel you to stop paying your credit card debt until the firm can work out a plan with your creditors. The problem is that many creditors won’t work with settlement firms, and you’ll be assessed late fees, penalties and interest charges while your debt goes unpaid each month. At the end of the day, you may be left with lower credit scores and even higher debts.

If you don’t know where to start, the Federal Trade Commission (FTC) offers some resources on how to find reputable debt counseling or just answers to all your questions.

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