Somehow, you’ve acquired a mountain of credit card debt and it just keeps getting higher. You’ve seen ads on TV from companies claiming they can get you out of debt for “pennies on the dollar.” Eureka! You found the light at the end of your tunnel. But not so fast.
The solution the ads offer is called debt settlement. The companies do settle your debt for less than you owe. Yes, it may be the answer you’re looking for, but there are risks and pitfalls you need to consider before deciding that debt settlement is right for you.
“Pennies on the Dollar” Claim
Pennies on the dollar sounds really good when you’re so deep in debt you don’t see any way out. It even sounds like you can get out of debt with loose change you find under the cushions of your couch.
According to the American Fair Credit Council, on average, you’ll pay 48% of the amount you owe. For you, how much is that? You may still pay a lot to get rid of your debt.
Monthly Payments Continue
Debt settlement reduces the amount you have to pay back, it doesn’t eliminate it. So, you need to generate money for a settlement. Here’s how it works.
- You enroll in a settlement program through a debt settlement company.
- The company creates a monthly “set aside” account to accumulate the funds needed to make settlement offers.
- You make monthly payments into the account.
- When there are enough funds, the debt settlement company negotiates with your creditors.
- As settlement are negotiated, funds are taken out of the set-aside account.
A settlement program can take between 12-48 months to complete, depending on how much you owe and how much you pay into the account each month.
If you’re trying to figure out how to make the monthly payments, reputable debt settlement companies will help you with a budget. Disreputable companies may tell you to stop making payments to your creditors and use that money for the monthly set-aside account. If that happens, RUN! It’s illegal for a debt settlement company to advise you to stop making payments to your creditors.
Debt Settlement Will Hurt Your Credit Score
When you settle a debt, the credit reporting agencies list it as “settled in full” rather than “paid in full.” It shows that you only paid a portion of the debt and that you were delinquent on your payments. When the creditor reports that information to the credit reporting agencies your credit score goes down—a lot.
Settled accounts stay on your credit report for seven years, the same amount of time as a bankruptcy notation. So, anytime you try to open another credit card or apply for any type of credit, the lender will see your low credit score and the debt settlement information. It’s the number one factor used in calculating credit scores. It usually takes between 6 and 24 months before a credit score begins to improve.
Debt Settlement is a Taxable Event
Even if you settle a debt with a creditor for less than the full amount, or a creditor writes off the entire debt, you still owe money—to the IRS. The IRS treats the forgiven debt as income and you have to pay taxes on the amount that was written off. For example, if you owe $50,000 and the creditor settles for $10,000 you have to claim $40,000 as income in the year the settlement was completed.
Any financial institution that forgives or writes off $600 or more of a debt’s principal, which is the amount not attributable to interest or fees, must send you and the IRS a Form 1099-C at the end of the tax year. These forms are for reporting income, which means when you file your tax return for the tax year in which your debt was settled or written off, the IRS will make sure you report the amount on the Form 1099-C as income.
Even if you don’t get a Form 1099-C from a creditor, the creditor might very well have submitted one to the IRS. If you haven’t listed the income on your tax return and the creditor has provided the information to the IRS, expect a tax bill, or worse, an audit notice, either of which will add interest and penalties to the amount you owe for the forgiven debt.
Settlement Works Best for Debts with Third-party Collectors
You may settle for as much as 80% of what you owe if your debt is still with the original creditor. They want to get back as much as possible. But if the debt has been sold to a third-party collection agency, the agency bought the debt for a fraction of what you actually owe, and the third-party will accept a lower settlement amount.
No Fees Until the Debt is Settled
Don’t forget, you have to pay the debt settlement company for working on your behalf. But Federal Trade Commission (FTC) rules say the company can’t charge you any fees before settling or reducing your unsecured debt. Accredited Debt settlement companies generally charge a percentage of the debt that was settled.
Statute of Limitations
Every state has a statute of limitations for how long a debt collector has to sue you in civil court to collect what you owe. The maximum statutes across the country are 10 years. After that, they may still attempt to collect, but they have no legal recourse.
If the debt collector continues to bother you, you can send a cease-and-desist letter. It’s best to have it drawn up by an attorney. If the wording is not correct and you acknowledge that you owe the money, it can reset the clock on the statute of limitations.
There is certainly a place for debt settlement agreements. But don’t be blindsided. Know the good, the bad and the ugly before you say yes.
Disclaimer
This information is presented for informational purposes only and does not constitute an offer to sell, or the solicitation of an offer to buy any investment products. None of the information herein constitutes an investment recommendation, investment advice or an investment outlook. The opinions and conclusions contained in this report are those of the individual expressing those opinions. This information is non-tailored, non-specific information presented without regard for individual investment preferences or risk parameters. Some investments are not suitable for all investors, all investments entail risk and there can be no assurance that any investment strategy will be successful. This information is based on sources believed to be reliable and Alhambra is not responsible for errors, inaccuracies, or omissions of information. For more information contact Alhambra Investment Partners at 1-888-777-0970 or email us at info@alhambrapartners.com.
Debt Settlement – The Good, the Bad and the Ugly
Somehow, you’ve acquired a mountain of credit card debt and it just keeps getting higher. You’ve seen ads on TV from companies claiming they can get you out of debt for “pennies on the dollar.” Eureka! You found the light at the end of your tunnel. But not so fast.
The solution the ads offer is called debt settlement. The companies do settle your debt for less than you owe. Yes, it may be the answer you’re looking for, but there are risks and pitfalls you need to consider before deciding that debt settlement is right for you.
“Pennies on the Dollar” Claim
Pennies on the dollar sounds really good when you’re so deep in debt you don’t see any way out. It even sounds like you can get out of debt with loose change you find under the cushions of your couch.
According to the American Fair Credit Council, on average, you’ll pay 48% of the amount you owe. For you, how much is that? You may still pay a lot to get rid of your debt.
Monthly Payments Continue
Debt settlement reduces the amount you have to pay back, it doesn’t eliminate it. So, you need to generate money for a settlement. Here’s how it works.
- You enroll in a settlement program through a debt settlement company.
- The company creates a monthly “set aside” account to accumulate the funds needed to make settlement offers.
- You make monthly payments into the account.
- When there are enough funds, the debt settlement company negotiates with your creditors.
- As settlement are negotiated, funds are taken out of the set-aside account.
A settlement program can take between 12-48 months to complete, depending on how much you owe and how much you pay into the account each month.
If you’re trying to figure out how to make the monthly payments, reputable debt settlement companies will help you with a budget. Disreputable companies may tell you to stop making payments to your creditors and use that money for the monthly set-aside account. If that happens, RUN! It’s illegal for a debt settlement company to advise you to stop making payments to your creditors.
Debt Settlement Will Hurt Your Credit Score
When you settle a debt, the credit reporting agencies list it as “settled in full” rather than “paid in full.” It shows that you only paid a portion of the debt and that you were delinquent on your payments. When the creditor reports that information to the credit reporting agencies your credit score goes down—a lot.
Settled accounts stay on your credit report for seven years, the same amount of time as a bankruptcy notation. So, anytime you try to open another credit card or apply for any type of credit, the lender will see your low credit score and the debt settlement information. It’s the number one factor used in calculating credit scores. It usually takes between 6 and 24 months before a credit score begins to improve.
Debt Settlement is a Taxable Event
Even if you settle a debt with a creditor for less than the full amount, or a creditor writes off the entire debt, you still owe money—to the IRS. The IRS treats the forgiven debt as income and you have to pay taxes on the amount that was written off. For example, if you owe $50,000 and the creditor settles for $10,000 you have to claim $40,000 as income in the year the settlement was completed.
Any financial institution that forgives or writes off $600 or more of a debt’s principal, which is the amount not attributable to interest or fees, must send you and the IRS a Form 1099-C at the end of the tax year. These forms are for reporting income, which means when you file your tax return for the tax year in which your debt was settled or written off, the IRS will make sure you report the amount on the Form 1099-C as income.
Even if you don’t get a Form 1099-C from a creditor, the creditor might very well have submitted one to the IRS. If you haven’t listed the income on your tax return and the creditor has provided the information to the IRS, expect a tax bill, or worse, an audit notice, either of which will add interest and penalties to the amount you owe for the forgiven debt.
Settlement Works Best for Debts with Third-party Collectors
You may settle for as much as 80% of what you owe if your debt is still with the original creditor. They want to get back as much as possible. But if the debt has been sold to a third-party collection agency, the agency bought the debt for a fraction of what you actually owe, and the third-party will accept a lower settlement amount.
No Fees Until the Debt is Settled
Don’t forget, you have to pay the debt settlement company for working on your behalf. But Federal Trade Commission (FTC) rules say the company can’t charge you any fees before settling or reducing your unsecured debt. Accredited Debt settlement companies generally charge a percentage of the debt that was settled.
Statute of Limitations
Every state has a statute of limitations for how long a debt collector has to sue you in civil court to collect what you owe. The maximum statutes across the country are 10 years. After that, they may still attempt to collect, but they have no legal recourse.
If the debt collector continues to bother you, you can send a cease-and-desist letter. It’s best to have it drawn up by an attorney. If the wording is not correct and you acknowledge that you owe the money, it can reset the clock on the statute of limitations.
There is certainly a place for debt settlement agreements. But don’t be blindsided. Know the good, the bad and the ugly before you say yes.
Disclaimer
This information is presented for informational purposes only and does not constitute an offer to sell, or the solicitation of an offer to buy any investment products. None of the information herein constitutes an investment recommendation, investment advice or an investment outlook. The opinions and conclusions contained in this report are those of the individual expressing those opinions. This information is non-tailored, non-specific information presented without regard for individual investment preferences or risk parameters. Some investments are not suitable for all investors, all investments entail risk and there can be no assurance that any investment strategy will be successful. This information is based on sources believed to be reliable and Alhambra is not responsible for errors, inaccuracies, or omissions of information. For more information contact Alhambra Investment Partners at 1-888-777-0970 or email us at info@alhambrapartners.com.
