Understanding debt settlementsPosted: Updated:
More and more Americans are turning to debt-settlement companies as an alternative to bankruptcy, according to the United States Organizations for Bankruptcy Alternatives. Changes to federal law have made it harder to qualify for personal bankruptcy, which has left some debt strapped consumers feeling there is no way out from under the burden of debt.
There are several paths someone can take to reduce debt, and debt settlement is just one of many options. A debt settlement is when the creditor agrees to settle for a reduced amount to be owed. While paying less than you owe always sounds appealing, there are several things consumers need to know before attempting to settle a debt. The experts at Money Management International (MMI) offer the following considerations before you make a final decision about how to handle your debt.
In order to settle, you must prove a need. A creditor will be unlikely to settle on an account that is current, but allowing your account to become delinquent will leave a negative mark on your credit report for up to seven years. Even if a settlement agreement is eventually reached, your history or late payments will not be erased and could affect future credit applications like home or car loans.
"Settled in full" is a negative notation. When your settlement is final and approved by the creditor, the lender will typically note on their credit bureau report that there is still a balance remaining, but the account has been "settled in full." The derogatory notation of "settled in full" will remain on your credit bureau file for seven years.
Missed payments are likely to increase the total amount owed. If you miss payments prior to reaching a final approved settlement amount, you can continue to expect late fees and increased interest charges. And, if an agreement is not met, you may even be sued for payment, which could result in wage garnishment-meaning the creditor would receive money directly out of your paycheck.
Mortgage lenders might require you to pay in full. If you apply for a mortgage loan with a "settled in full" notation on your credit report, it is likely that the lender will require you to repay any amounts that were "written off" by your creditors in a settlement before granting you another loan.
There may be tax implications. The IRS considers $600 or more of forgiven debt as taxable income, which could greatly affect the amount owed to the government on April 15. Speak with an accountant before settling your debt to avoid any tax time surprises.
Settlement companies can charge substantial fees. Be sure to research the company's background with the Better Business Bureau as well as their state Attorney General or Commissioner of Banking. When it comes to debt settlement, the old "buyers beware" adage holds true so be wary of any offers that seem too good to be true.
During a time when every penny counts, it's smart to take steps to understand your options and make informed decisions about your money and your financial well-being. If debt settlement is the option you are considering, do your homework and select a company that is affiliated with a credible and trustworthy association.