Far from a “get out of jail free” card, debt relief is a very serious step and should be regarded carefully. You should be very clear about what a debt relief plan is—and isn’t—before availing yourself of this option. You should also take some time to consider the other options you may have before going this route. If you have done so already and you’re thinking debt relief is your best course of action, here’s what you should know.
Debt Relief Can Help—Unless…
Only certain types of debt qualify for debt negotiation programs. Secured debt such as home loans and car loans usually do not qualify. This makes sense when you think about it. After all, if you can’t pay, the lender can simply repossess the item against which the loan was made. However, credit card debt, revolving charge accounts and medical debt can generally be negotiated. Better companies will review your situation and let you know if your debt is serviceable in this fashion before you sign with them.
How Debt Settlement Works
Debt settlement companies negotiate with your creditors to reduce the amount you owe. Overall reductions in the 40 percent range are fairly typical.
You’ll be asked to start an account the company can use to pay off your creditors when they agree to a settlement.
Truly reputable firms like Freedom Debt Relief use FDIC-insured accounts to keep your money safe. You’ll be informed of agreements as they’re reached—once the balance of the account is sufficient to begin paying your settlements. Payments will be only made from the account with your approval. Reputable negotiation firms do not request payment until a debt is settled. In most cases, settlement programs take from 24 to 48 months to complete.
There Are No Guarantees
While debt settlement can be a useful tool, its success depends upon a number of factors. One is choosing a reputable company with which to work, another is being in a position to see the program through to completion. This means taking a careful look at your finances to be certain you can make the deposits needed to build up your settlement account. Another factor is the debt settlement company’s ability to negotiate a deal. Longstanding organizations are usually in a better position to accomplish this because they already have relationships with the lending institutions.
Your Credit Score Will be Lower
Remember how we said debt settlement isn’t a get out of jail free card? While it’s true creditors will agree to allow you to pay less to settle your debts, they will often report the debt to credit ranking firms as some form of “settled”, as opposed to “paid in full”. Then again, creditors can report the debt to credit bureaus in many ways including “settled in full”, “paid”, “paid by settlement” or “settled for less than the full amount.” This will impact your credit rating. Of course, if things have progressed to the point at which settlement is looking like a good idea, your score is probably already diminished. With settlement, at least it’s lower and you’re largely debt free.
We say “largely” because of the tax implications.
When a lender agrees to forego part of your debt, the IRS considers the forgiven portion income. You’ll be expected to report it on your tax return only if the amount was $600 or greater and it was reported to the IRS. In some cases, a creditor won’t report the settlement. However, to be safe, you should always check with your tax preparer to see what the taxable income will be on your particular settlement.
When you’re considering what a debt relief plan is and isn’t, negotiation is almost always preferable to filing bankruptcy if you can afford it. While a settlement usually shows up on your credit report for approximately seven years from the date the debt was reported as settled, bankruptcy stays there 10 years from the date the judgment was rendered.