Advertisements for consumer credit repair and debt settlement are designed to prey on desperate individuals who view their own situation as hopeless. Often debts can be settled for a fraction of the balance, saving consumers money and lifting the weight off their shoulders. It does benefit some people. However there are dangers to be aware of when considering settlement as an option to get out of debt.
Scams
Many debt settlement companies advertise the ability to reduce their client's debts by drastic amounts. These claims sound good, but the reality of the situation is that if you're not already behind in your payments, you will be. Some debt settlement companies take your payments and hold them until a large sum has been saved up to pay a settlement. They also may advise you to stop making your monthly payments. This delinquency will decrease your credit score and may cause other charges to be added to your balance such as late fees.
Taxes
The federal government, particularly the Internal Revenue Service, considers any amount of debt you do not have to pay as additional income. For example, if you were to settle a $5000 balance for $2500, you would have to pay taxes on the $2500 which you didn't have to pay to the creditor. Depending on the amount of debt you settle and how much you settle it for, you may owe a substantial amount of money in taxes the following year.
Future Collection Action
Agreeing to a settlement and making a payment without getting confirmation in writing from the creditor or collection agency could create huge problems in the future. Collectors can say anything over the phone and while it may sound nice, if you do not receive the settlement offer in writing, there is no proof they agreed to it. For example, you could settle an account today for 25 percent of the balance owed but if you do not have their agreement to accept this as full satisfaction on the account, they could try to collect the remaining 75 percent a year or more down the road.
Credit Score and Legal Ramifications
Settlements will negatively impact your score if you stop making your monthly payments. Creditors also have the option of filing a lawsuit against you which could result in garnishments and judgments added to your credit report, further damaging your score.
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