Debt settlement is a popular debt management and credit repair strategy. It is considered an alternative to bankruptcy and allows you to pay off delinquent credit accounts for less than the full balance. The strategy works well with unsecured credit accounts such as credit cards. Secured accounts, such as automobile loans and mortgages, cannot be resolved through debt settlement. Those loans are secured by the automobile or home, which serves as collateral. Rather than negotiate a settlement the lender will repossess or foreclose on the property.
Missed Payments
Credit card companies and other creditors will consider debt settlement after your account becomes several months past due. The exact point in time varies with the creditor, but generally settlement offers are available sometime before the six-month mark. MSN Money reports that at six months creditors generally close accounts and list them internally as charged off. That's an internal accounting term that allows the creditor to consider the account a write-off for tax purposes.
Liability Continues
You remain liable for the debt even if it is charged off. The creditor may assign the account to an internal collections department or assign it to an outside agency. Or the creditor may sell the account to a debt collector, often for pennies on the dollar. Settlement is possible before or after charge-off, but MSN Money reports that the threat of a debt lawsuit increases after the debt is charged off.
Settlement Process
You can settle a delinquent account by contacting the creditor or debt collector directly. Asking for a settlement in writing creates a paper trail and allows you to clearly state your position without being bullied over the telephone by an aggressive debt collector. However, you can negotiate over the telephone if you like. The SmartMoney website reports that creditors and debt collectors often will settle for 20 to 75 percent of the balance. Once you have decided on debt settlement, your goal should be to settle for as little as possible.
No Guarantees
Creditors and debt collectors are under no obligation to agree to debt settlement. They can refuse all your requests for settlement and continue collection efforts which could eventually lead to filing a lawsuit against you in civil court. However, settlements are common.
Impact On Credit
Debt settlement does more for allowing you to put the past behind you than increasing your credit score. Experian, one of the major credit reporting agencies, reports that delinquent debts resolved through debt settlement will be updated on your account to show that they were "settled" rather than paid. That could actually hurt your credit score, according to Experian. However, paying off old debts -- even for less than the full balance -- is an important part of credit repair as it allows you to end the debt obligation and start rebuilding.
Pay-For-Delete
Another possible settlement option, pay-for-delete, could help your credit score. Some creditors or debt collectors may consider deleting negative payment information from your credit report in exchange for full payment on the delinquent account. Any removal of derogatory information from your credit report can give a boost to your score. However, creditors and debt collectors are under no obligation to accept pay-for-delete offers.
Tax Implications
The Internal Revenue Service may require you to report forgiven debt as income, adding to your tax bill and reducing savings gained through settlement. Credit card companies, banks, collection agencies and others accepting at least $600 less than the balance owed are required to send you 1099-C forms indicating cancellation of debt. The IRS will allow you to skip reporting the settlement savings as income if you can prove that you were financially insolvent at the time of the settlement. IRS form 982 allows you to apply for the exception. Insolvency means your total debts are greater than your total assets at the time of the settlement.
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