Not being able to pay your debts, for whatever reason, is stressful. The collection calls can become relentless. Many people eventually settle their debts for less than the amount owed, whether through the original creditor or through a collection agency. Though settling your debt for less sounds great, there are some drawbacks to keep in when considering debt settlement.
Tax Implications
Settling your debt for less than you owe can lead to tax implications. If the settlement amount is far less than the amount owed, you may owe the IRS. The IRS rule states that if you settle a debt for $600 or more below the total amount owed, you have to claim the unpaid amount of the debt (Canceled Debt in IRS speak) as income.
Credit Report
Settling a debt for less than you owe does not report the same on your credit report as paying off the debt. The balance of the debt on your credit report will read 0 or paid, but oftentimes creditors add a little note stating that you paid the account for less than the balance owed. This creditors note can cause problems when you apply for credit in the future. Sometimes, it can cause lenders to deny your credit applications completely.
New Credit
Even if you pay off your debt through debt settlement and your credit report shows them as paid, your ability to obtain new credit at a decent rate will be extremely difficult. This is because the debts, whether paid or not, still show as negative items on your credit report for seven years. You can opt for bad credit credit cards and loans in an attempt to rebuild your damaged credit, but you will pay high interest rates and be subject to costly application and processing fees.
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