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Released: March 16, 2011
Help Desk FAQ
What are the pros and cons of settling my past-due credit card balance for less than I owe?
When you settle your credit card debt the credit card company agrees to accept less than your outstanding balance as full payment. This may sound like the perfect solution to your money troubles, but there are drawbacks to debt settlement.
A lower credit score: Generally speaking, creditors only consider settling with cardholders who are delinquent. During those months of missed payments, your credit score will fall. Once the settlement is complete, the creditor will report your debt as satisfied, but not “paid in full,” doing further damage to your credit score.
Taxes owed: If the amount of the forgiven debt exceeds $600, the card company will report the full amount to the IRS on form 1099-C. Unless you were insolvent (your debts exceeded your assets) before the creditor agreed to settle, you will be required to pay income taxes on the amount of the forgiven debt. If you don’t have the money to pay the IRS what you owe, you will likely have to pay a late fee plus interest on the outstanding balance.
Cash required: The card company will expect you to make the settlement payoff in one lump sum or over a few months. If you have no personal assets to draw on, you’ll need to borrow the money from friends, family or another source. If you pull money from a retirement account prematurely, you’ll pay a 10% penalty plus taxes on the withdrawal.
Before you make efforts to settle your debt, consult with a reputable credit counselor. (Read “How do I choose a good credit counseling agency?”) If bankruptcy is a possibility, consult a reputable advisor about that as well.
If you still see debt settlement as your best option, contact and work with your creditors directly rather than hire a debt settlement company. Debt settlement firms, which attempt to settle customers’ debt for a fee, are expensive and can’t guarantee they will succeed. And hiring a debt negotiator doesn’t stop collection efforts—you could still get collection calls and even be sued and have your wages garnished. You may be able to get concessions (such as reduced interest and monthly payments, and waived late fees) from your creditors on your own, and that may be enough to get you back on track.