When you're overwhelmed by debt, you may also find yourself overwhelmed by the options available to you. One option is asking for a hardship agreement with your creditors. Another is settling your debt for less than you owe. Both can get you out of debt, but one has more risks than the other.
Hardship Agreements
When the economy is distressed by unemployment and financial crisis, many lenders are willing to work with debtors to make arrangements. After all, something is better than nothing. The lenders offer to debtors who can no longer afford their monthly payments are often referred to as hardship programs or forbearance. A hardship arrangement changes the terms of your repayment, giving you a reprieve by lowering monthly payments, reducing or eliminating interest fees or extending the terms of your debt. These programs are designed to work for a limited time, with the understanding that you will eventually revert to paying your debt as agreed.
Debt Settlement
When a creditor agrees to a debt settlement on your account, the loan or other account is paid off for less than what you owe. Creditors rarely initiate debt settlement negotiations; rather, a third party, usually a debt settlement organization, often arranges debt settlement.
A Financial Pitfall
There's no wonder that debt settlement programs have gotten a bad name in the financial world---these programs rarely benefit anyone but the debt counseling companies who work with debtors to settle their accounts.
Debt settlement companies, who often advertise themselves as credit counselors, offer to settle your debts for pennies on the dollar. However, these companies often require you to save up thousands of dollars for payoff, during which time it is often impossible to make monthly payments to your creditors. Since the fees that the company charges to settle your debt often comes off the top, the process is drawn out even longer.
Another financial pitfall associated with debt settlement is the tax ramifications. Any debt forgiven above $600 is considered a gift, and is, therefore, taxable income.
Credit Report Ramifications
Debt settlement and hardship agreements can both have an impact on your credit. The difference, however, is the fact that creditors are working with you in one instance, but feel shortchanged in the other. If you ask your creditor for forbearance, ask how a hardship agreement will be reported to the credit bureaus. The good news is, since hardship agreements only last for a limited time, the damage can be mitigated as soon as you begin paying as agreed.
With debt settlement, the credit problem is much worse. You are often asked to miss payments in order to save money for the settlement, or to force the creditors hand, which automatically damages your credit. Once you've agreed to a settlement, your creditor will report your debt as settled for less than amount owed, which looks even worse, especially if you settle several accounts.
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