Roadmap Roadmap

Debt Settlement Tutorial

We've discussed settlement as an option at several points in the program. In each case I have been, frankly, less than positive when discussing the topic of settlement unless you are involved in a lawsuit. But it is always an option, so let's look more closely at the pros and cons of debt settlement.

First, the basics: the concept of debt settlement is simple. In exchange for an agreed-upon amount of money, the creditor "forgives" the rest of the debt and reports it to the credit bureaus as settled. Say you owe a creditor $10,000. The creditor offers to settle the debt for $7,000. If you pay the $7,000, the creditor agrees that the debt has been satisfied and you don't owe any more money.

Why could settling work in your favor? An obvious benefit of debt settlement is that you pay back only a percentage of what you originally owed. Plus, all collection activities stop, and you can usually have your credit report updated and the effect of a negative entry reduced or eliminated. The downsides of debt settlement are: the amount you will have to pay in settlement (that you otherwise might have kept); the potential hit to your credit score (not all creditors will agree to update your report); and last, but in no way least, the potential tax liability on the amount forgiven. Tax liability is a critical issue. In the example above, the $3,000 that was "forgiven" may be reported by the creditor to the IRS as 1099 income (less than 20% of the time), and you will have to pay taxes on that "income".

Settling your debt should be considered a last resort in terms of this program, and doing so also voids the limited money-back guarantee that comes with my book. The reason settlement should be considered a last resort is simple: if you voluntarily settle your account(s) you are extremely likely—in fact, you're almost guaranteed—to pay back a larger percentage of what you owe. Why? If you settle, you pay some of the debt. If you don't settle and the debt is eventually eliminated due to the statute of limitations expiring, you don't pay anything. Last time I looked, something is always more than nothing.

Whether you decide to settle an account is ultimately up to you and is a decision you should never take lightly. The debt collectors and attorneys with whom you will be negotiating are professional negotiators. Their job is to talk you into agreeing to the best settlement for them, which, of course, will be a worse settlement for you. Keep in mind that they negotiate with people all day, every day; if you think used car salespeople are tough, wait until you deal with debt collectors and attorneys. If you want to hire a negotiator to work for you, just click here for a referral to an accredited negotiation professional.

Finally, debt settlement is only an option if you have fallen behind on your payments. Think about it: why would a creditor accept less than full payment when they are being paid in full each month? Sure, you might be trying to do the responsible thing by working out a settlement before you go into default, but no creditor will work with you while you are still current. That just won't happen. Remember, debt collection is a business; no creditor will consider working with you or making a deal unless they are actually losing money. If you are making your payments, they are making money.

So let's look at the basics of debt settlement, just in case it does become an option you want to explore. We'll look at your options during each phase of the debt relief process, starting with original creditors.

> Settling with Original Creditors