Understanding Debt Settlement

Recently, I have received a lot of Advice Team questions about debt settlement. While paying less than you owe sounds appealing, there are several things consumers need to consider before attempting to settle a debt.

First, in order to settle, you must prove a need. Because a creditor is unlikely to settle on an account that is current, allowing your account to become delinquent may be an undesirable requirement. Unfortunately, this process can negatively impact your credit history for years to come. The Fair Credit Reporting Act states that derogatory information can remain on a person's credit bureau file for seven years. Even if a settlement agreement is eventually reached, it would not remove or change the poor prior payment history from your report.

Missed payments are also likely to result in late fees and increased interest charges, increasing the total amount owed. If you miss payments prior to reaching a final approved settlement amount, you can expect to receive collection calls and letters. And, if an agreement is not met, you may even be sued for payment, possibly resulting in wage garnishment.

Even if you are successful in negotiating a settlement, there are some downsides to consider before you make a final decision about how to handle the debt.

-“Settled in full” is a negative notation. When your settlement is final and approved by the creditor, the lender will typically note on their credit bureau report that there is still a balance remaining but the account has been "settled in full." The derogatory notation of "settled in full" will remain on your credit bureau file for seven years.

-Mortgage lenders might require you to pay in full. If you apply for a mortgage loan with a “settled in full” notation on your credit report, it is possible that the lender may require you to repay any amounts that were “written off” by your creditors in a settlement.

-There may be tax implications. The IRS considers $600 or more of forgiven debt as taxable income. You should consult with an accountant to avoid any tax time surprises.

When it comes to debt settlement, the old adage “buyer beware” holds true. For information concerning debt settlement companies, visit FTC.gov.

Kim McGrigg is the former Manager of Community and Media Relations for MMI.