How do Credit and Debt Settlements Work?
    Posted on 10/03/2022

Debt settlement is when a borrower offers to pay their creditor a lowered amount than what is currently owed, in return for absolving their account. Settlement is usually done with credit card companies, for instance if a borrower is $5,000 in debt, they may be able to negotiate (settle) with their creditor for only 75% or even 50% of the entire balance. In the past, debt settlement was rarely an option employed by credit card companies, but due to changes in the economic environment they are now much more open to going that route.

How Does Debt Settlement Work?

Essentially, credit or debt settlement is done by the borrower offering their creditor an amount that is less than what is fully owed. Usually the creditor wants the settlement to be paid in one lump sum payment, which is of course only if they even accept to settle in the first place. Creditors usually accept settlements on accounts that are very delinquent, because settling usually ends up costing them much less than it would to hire a collection agency, incur a judgment, file a lawsuit, and then finally try and get the payment from the borrower.

Advantages of Credit Settlement

There are some advantages to credit settlement that one can simply not overlook. For one, the borrower will be paying less in regards to their overall debt over a shorter length of time. Paying the debt off in one lump sum also means no more interest fees either.

Disadvantages of Credit Settlement 

Although there are benefits to debt settlement, there are also numerous drawbacks to it as well. For example if someone stops paying their bills in order to save up for a settlement payment, the creditor can still sue them, file a judgment, or even garnish their bank account and income. If the borrower goes as far as informing their creditor of their plan to settle, that still will not stop the lender from pursuing legal action against them because there is nothing holding them back from doing so. Another aspect of debt settlement that is typically overlooked is the fact that the IRS will view any debt forgiveness as income earned by the borrower. In short, the difference between the borrower’s original account balance and the balance of the settlement can be taxed by the federal government as income.

Closing Thoughts

Debt settlement is a legitimate option for many people who are in debt. Being fully informed on what debt settlement is, and the pros and cons of it, is essential to understanding if it is a wise decision to make. If you have evaluated all other options and come to the decision that settlement is the right way to go about solving your financial troubles, it might still be a good idea to seek an experienced financial planner to give you some further counseling on the matter. 

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