Understanding Debt Settlements

The thought of a debt settlement may be exciting when you think about the fact that your debt will be paid in full in just a few months. But slow down first and take a moment to understand debt settlement. You might be turned off from them when you learn about all that might be affected in the process.

The Basics of Debt Settlement

If you don’t already know, debt settlement basically means that you’re paying off a debt that you owe  to a collector in one lump sum. A company that you hire does the negotiating on your behalf to set the low price. When the price is determined, you take several months to save your money then pay the lump sum to the collector. Afterward, your debt is settled with the collector and you can move on with your life.

Sounds pretty good, right? Well, in essence it is. However, there are some downsides to taking this route. Here are a few:

  • You have to pay a large fee to the debt settlement company. Most debt settlement companies charge around 15% of your total debt for a service fee. If you’re already struggling financially, this may be a bit difficult to come up with.
  • “Settled in full” is negative. If you decide to work with a debt settlement company and work out an agreement to pay in full, the agreement will show up on your credit report as “settled in full.” This is considered a negative notation since you haven’t paid anything yet.
  • Negative payment history isn’t erased. Even after you pay your debt in full, the delinquent payments of the past will still show on your report for up to 7 years.
  • Fees may be added during your saving period. During the time that you’re saving your money to pay your lump sum, fees and penalties may continue to mount. If you don’t meet your end of the agreement, you may be sued for the original debt plus the new fees.
  • You may be taxed. Did you know that the IRS considers $600 or more in forgiven debt to be taxable income? So depending on how much you were forgiven in your debt settlement, you may be taxed on it at the end of the year.

While debt settlement may sound like an enticing idea, you want to know all the facts before make your decision. The last thing you want is to think you’re solving a problem when you’re in essence creating more.