Debt settlement sounds good on the surface. You can normally settle your debt for 40-60% of the balance and never owe that creditor for that debt. There are additional costs however that you may not have considered that can destroy the savings of debt settlement.
Debt Settlement Company
If you choose to use a debt settlement company, understand that they will generally deduct fees that amount to 25% of the debt. Meanwhile, your credit continues to worsen and your debt collectors get nothing. All of the monthly payments that you send end up being held in trust by the settlement company rather than going to pay the debt.
At some point in the future, you might have paid enough for the settlement company to pay off a negotiated balance. By this time, the original $10,000 debt has ballooned to over $12,000 due to interest charges. You would need a lump sum of $6,000 to pay off the debt. This is in addition to the $3,000 that you paid in fees.
When the smoke clears, you could end up paying over $9,000 on a debt that was only $10,000 when you first stopped paying on it. That's when you think its all over.
It is a federal requirement that any debt collector settling a debt must issue a 1099-C form any time the savings are $600 or more. As a debtor, you would receive a 1099-C form with the savings listed as a form of income known as “forgiven debt. " You could end up paying taxes on $6,000 in forgiven debt. That equates to an additional $1,500 if you are in the 25% tax bracket.
This can come as quite a shock to someone that has been trying to rebound from debt problems. An additional tax bill of $1,500 can cause additional financial problems that can be difficult to overcome. If you are considering settling on your debt, you can do so on your own for free. Keep in mind that you would still owe taxes on any forgiven debt of $600 or more.
Alternatives to Debt Settlement Companies
Monthly payments are also possible if you negotiate payments with your collection agencies directly. They usually want an upfront payment, but if you propose a high enough monthly payment, most will allow it.
If your accounts are all in collections, then settlement can be worthwhile if you settle your own accounts. Credit counseling can be a better option if your accounts have not yet been charged off. If you need help, contact your local credit counseling agency for assistance.
Kenneth Long began his public service with nonprofit organizations in 2001. He has since conducted workshops teaching other nonprofit executives how to integrate credit counseling with volunteer tax preparation programs. The most recent of these include a workshop at the National Community Tax Coalition annual conference in Los Angeles.
Long has contributed additional information on debt settlement .