Debt settlement: not a good idea

Q:  How would my credit be affected if I do a debt settlement?

-Elijah, Hattiesburg, Miss.

A: Let’s start with the basics.  When you attempt to arrange a debt settlement you are asking your creditors to take less than you owe them.  Typically, they will only do this if they are uncertain about your ability to pay what you actually owe.  Getting something is better than nothing, in their view.  Companies that charge big bucks to settle your debts can further this uncertainty by collecting money from you and paying NOTHING to your creditors for several months.  They may see the payment you make to them as their fee while you are thinking they’re aggressively making progress on your debt.  So, you must tread carefully there and do your homework.  If debt settlement is your answer – and it is NOT a magic bullet – then consider going straight to the financial institution you owe.  I believe you can do for yourself what you pay an “expert” to do for you. 

There are downsides to debt settlement to be sure!  And you hit the nail on the head in terms of this path negatively impacting your credit report and score.   Ultimately, these debts will be noted as “settled-in-full” on your credit report, indicating that you settled the account for less than what you owed.  All future lenders will see those notations and definitely consider that information as they decide on interest rates to charge you should they decide to lend you money at all.  Another reason not to settle debt is you could be issued an IRS Form 1099c for the “forgiven” amount.  Not only are you creating a negative entry on your credit report for up to seven years, but you may also have taxable income out of the deal.  I call that a double whammy. 

So, I would consider charting a different course.  Contact a credit counselor through the National Foundation for Credit Counseling at www.nfcc.org.  They will work with you to right your financial ship, and if it is absolutely necessary, will help you implement a debt management plan (DMP).  A DMP will allow you to make one payment each month to the counselor’s agency and that payment will be distributed to your creditors (right away!).  This approach will likely take longer than a settlement, but will have less of an impact on your credit score.  It will also demonstrate to future lenders that you willing to take personal responsibility for your debts!  Good luck!

Comments

[Oliver Darraugh]

Around 600 million pounds has been been paid off in personal debt which has helped to reduce the nations 1 trillion borrowing on credit cards and loans. Individuals may have turned to seeking debt management help and ways to get out of debt or it may be down to the fact that low interest rates have allowed homeowners to save on their mortgage which they have then ploughed back into reducing their debts.

[Debt Negotiation Settlement]

Excellent article, I think it's important that we are all made aware of the ins and outs of debt settlement; many people tend to have a preconceived notion of it which isn't helping anybody.

[Singing Dragon]

This is somewhat limited advice. Some debts you can pay off and some you can't. Get good advice. Search the web for more information, here are two URLs to start.
http://moneycentral.msn.com/content/Savinganddebt/Managedebt/P65141.asp
and http://www.cnn.com/2008/LIVING/personal/02/29/rogue.debt.collectors/index.html
She's right about not paying an agency. The taxpayer paid agency system she recommends can be good for getting reasonable amounts of debt under control. If you have lots of piled on penalties, the settlement agencies can get some or all of the penalties rolled back. Never agree not to go bankrupt (which is the settlement agency's purpose) until you know that you really don't need to go bankrupt. And never agree to it unless all of your creditors sign off on the proposed settlement.
Some debts loads are unpayable. That's what the bankruptcy court determines, if you get there. There are limited bankruptcies, where you pay your debts or you pay re-adjusted debt loads and there are total bankruptcies, where all debts are dismissed. It usually depends on your circumstances and the type and extent of debt. You should have an attorney's evaluation tell you what is best for you.
Act quickly to get the advice you need. Don't let your feelings get in the way of your getting help. Penalties can be stopped on many debts, even though you may still have to pay interest, if you know what to write (certified,return receipt requested letter) to the creditor. So, act quickly, get good legal and financial advice.
Also, look for an up-to-date book at your library or at a used or new book store. I bought one a few years ago, after I was late on medical and school loans.