Settling Credit Card Debt

May 21, 2020 | by Jacob Hamilton

settling credit card debt

What if we told you that you could rid yourself of all your debt with one lump sum of cash? It’s not a crazy idea. Sometimes, creditors are willing to settle a debt for less than what is owed when people can’t pay the full amount. While this might sound great in theory, debt settlement won’t actually wipe your slate completely clean.

Understanding how debt settlement works and what it might do—or not do—is critical to knowing if this is the right step for you. Let’s talk about the risks that come with debt settlement.

How Debt Settlement Works

Debt settlement can help people who have fallen behind on their payments, missed their payments or had their payments go to collections.

Generally speaking, the longer a debt is unpaid, the less likely it is for a debtor to collect the full amount owed, meaning they’re more motivated to take partial payments. Plus, if you’re in collections, the amount owed might have been inflated substantially by fees and interest. Collectors will often accept a lower amount to get much of the original debt balance back.

If your payments are current, a lender probably won’t accept less than you owe, so debt settlement might not be an option for you. However, you may be able to ask about hardship programs or forbearance.

What to Expect During the Debt Settlement Process

Even though lenders might be motivated to get something instead of nothing, the debt settlement process isn’t easy, and it can be lengthy. But you can be prepared:

  • Expect creditors to want you to be very far behind on paymentsbefore they’re willing to talk about a settlement. But be proactive—don’t wait until the creditor has sued you. If you do, they may move to garnish your wages until they get the total amount back.
  • Expect to meet a deadline when making a settlement payment. Creditors might agree to take much less than what you owe if you pay immediately or within a short time period, such as a few days or a week. Save up money to make this possible if you’re planning to negotiate a settlement.
  • Expect your credit to suffer. Since you have to be substantially behind on payments, your credit score will have been impacted by any late payments or collections. A debt settlement may also appear as a negative item on your credit reports.
  • Expect to get things in writing. Don’t fork over the agreed-upon amount until you get it in writing that the creditor agrees to accept it as payment in full.

Debt Settlement Programs

Some companies offer debt settlement programs, stating that they will resolve your debts for a fraction of what you owe. In reality, there’s no magic solution here. These companies simply charge you to do what you can do yourself in negotiating with creditors.

The benefits of working through a debt settlement program are that someone handles a lot of the time-consuming tasks for you, and some companies might be better at negotiating with aggressive creditors. The downsides are that they can be expensive, and sometimes, these services are scams. If you plan to work with a service, make sure you research it and know what you’re paying for.

Common Questions About Debt Settlement

Does Debt Settlement Affect My Credit Score?

In most cases, your credit score will have already been affected by late payments, delinquencies and collections related to the debt you want to settle. While settling the debt results in a charge-off being reported on your credit history, it’s not typically as huge of a hit beyond what you’ve already experienced. It sounds scary, but settling this matter and moving on may help you make more positive credit and financial choices in the future.

Do I Have to Pay Taxes on My Settlement?

The IRS considers forgiven debt to be a form of income, which means you can owe taxes on it. Typically, the debt has to be more than $600 to be reported as income to the IRS. So, if you owe $10,000 and a creditor agrees to settle for $6,000, you could be on the hook for paying taxes on $4,000. Work with your tax adviser to determine your tax responsibility.

Are There Better Alternatives to Debt Settlement?

The best alternatives for you really depend on your financial situation and goals. Other options include debt consolidation loans, balance transfer credit cards and asking the credit card company for assistance before you start falling behind on bills. If you owe a lot of debt and can’t afford to make payments, you might want to talk to an attorney about additional options like bankruptcy. Be aware of your various options and which work best for your individual situation.

Are There Debt Settlement Risks?

If you’re not very careful and clear in your agreement, you might not be getting what you think you are. If you don’t have it in writing that the debtor agreed to settle for a certain amount, they might keep chasing you for the rest of what you owe.

Repairing Your Credit After Debt Settlement

If you decide to move forward with a debt settlement, know that it doesn’t automatically clear this item from your credit history. However, it does open the door for you to begin repairing your credit.

And know that no matter what items are on your report, you have rights as a consumer. If you see any items that are inaccurate—or if a lender has misreported anything—we know someone who can help you work to dispute it (spoiler: it’s us).


Jacob Hamilton

Jacob Hamilton

GM of CreditRepair.com

With his master's degree from the University of Phoenix, Jacob has been working as the General Manager for CreditRepair.com for 2 years. Jacob is passionate about consumer finances and doing everything he can to make credit repair accessible....

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