When folks are heavily indebted to credit card companies and find they are unable to repay their entire debt, they will often seek debt settlement information as this not only provides an alternative to bankruptcy but can provide debt relief.
Debt Settlement Explained
Typically in debt settlement, the credit card company or collection agency will reduce the balance owing and the borrower will repay this amount (usually 35-50% of the original amount) instead of the original balance. Upon acceptance of the settlement, the borrowers will either have to provide a full payment up-front or will need to make regular monthly payments, much like a debt management system, to the creditor.
Debt Settlement Costs
Some companies who will negotiate on the part of the borrower will often charge a fee for their service. Some will charge up-front, some will include their fee in the monthly payment schedule, and others will take a lump sum only once the settlement has been approved by the creditor. Ideally, borrowers should look at companies who charge only a percent (20% is viewed as acceptable) of the reduced amount. So, if an individual has debt of $50,000 and the debt settlement company agrees to reduce the debt by $25,000, the borrower should pay $5,000.
Debt Management
Insofar as debt management is concerned, debt settlement is not a recommended debt management tactic. The reasons are abundant, namely that borrowers will suffer from reduced credit scores and settlement will only address credit card balances, not student loans, car loans or mortgages. With only credit cards eligible, borrowers are usually only addressing part of their debt problems, not the whole picture.
Tax Implications
When digging through debt settlement information, borrowers who decide to take this avenue should understand that there are tax implications to debt settlement. The bottom line here is that creditors will issue a 1099-C that the borrower will include when they file their taxes. The amount included as taxable income is the amount that the creditor agreed to reduce. As such, debt settlement may not be as attractive as bankruptcy options.
It should come as no surprise that there is an abundance of debt settlement information out there, especially now with the economic situation being what it is. In a few instances where credit card debt is the only (or almost only) type of debt, debt settlement makes sense. But as a debt management strategy, settlement is not all that great.