When you have a large credit card balance, you may be tempted to try to settle your account for less than you owe. While this can help you save a considerable amount of money on repaying your debt, it can also have some negative consequences of which you need to be aware.
Settling Credit Card Debt
To settle a credit card debt, you typically have to be delinquent on your account by several months. Once you have shown that you are unwilling to pay your credit card debt, the company may offer to settle your account. When this happens, they offer to take less than the full balance of your account in exchange for closing out your account. You can often pay less than half of what you owe with this strategy.
Credit Impact
Even though settling your debt can work to your advantage in the short term, it can have long-term consequences to your credit. When you settle debts, it can hurt your credit score by as much as 125 points, depending on how good your score was to begin with. The debt settlement will stay on your credit report for seven years and every creditor will be able to see the settlement on your report when you try to obtain credit.
Tax Consequences
If you are not necessarily worried about your credit score right now, you should still think about the tax consequences of using this technique. When you have a debt forgiven, the credit card company writes it off and sends a document to the Internal Revenue Service stating that they forgave your debt. The IRS counts this as income and you will have to add it to your annual income for the year. This could raise your tax bill, depending on how much money you have withheld in taxes.
Using Debt Settlement Company
Many people in this situation hire a debt settlement company to help them negotiate a settlement. While you could do this, it will not usually be to your advantage to do so. You can negotiate a settlement yourself without having to pay anyone to do it for you. Some debt settlement companies are frauds and will not actually help you after taking your money. If you are going to pursue a credit card settlement, you should be able to do it without assistance.
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