Debt settlement—have you seen the commercials, ads, gotten the phone calls, or been handed brochures? It sounds so easy, right?! The offer may seem tempting, but is it legitimate? In many situations, the answer is no, and these claims end up being scams that take advantage of those desperate to get their finances under control.
Debt settlement is also known as “debt negotiation” or “debt arbitration”. The idea behind this is that via an agreement between a consumer and their creditors, the debt balance is reduced, fees are waived, and the lower debt amount is paid in one lump sum. Unfortunately, it’s not that easy and there are many debt settlement risks.
Credit Score Reduction: A debt settlement will negatively impact your credit score. Even though you are working with the creditors, the terms of the settlement will likely be reported to the three credit bureaus as, "settled for less than owed," affecting your future credit availability, loan terms, employment opportunities, and more.
Fees: Debt settlement providers charge outrageously high fees. The amount can be in the thousands and this money is not applied to the debt, but instead goes straight into the agency’s account.
Holding of Funds: A common scenario for consumers who utilize debt settlement is the holding of funds. This is where the agency requires you to pay a large amount which is earmarked for the repayment of the debt. This money can be held in escrow for months or years as the agency’s representative “negotiates” with the creditors. Even if no progress is made, the cash is still in their hands while you could be using it for other things. You might request the money to be returned to you, but many times the paperwork you signed states they can hold on it as needed.
Taxes: If the process works like it is supposed to and the creditor agrees to settle the debt for a reduced payment, you may still end up owing taxes on the reduction amount. For instance, if you owed $10,000 to a lender, but they agreed to a payment of $6,000, the creditor must notify the IRS of the debt reduction amount. You would then be required to add the $4,000 to your taxable income. The company will send you a 1099-C tax form and report the amount to the IRS.
If you find yourself contemplating debt settlement and have questions, contact us for the help you need.