“Debt Settlement” & “Debt Management”. Four words. Two phrases. One shared word between the two phrases. And SO FAR APART!
Welcome to part 1 of 2 looking at debt settlement vs. debt management. As I talk with people out in the community, I find a lot of people are confused or mistaken about what each of these is, how they are different, and how they can impact your credit score. At times, the two terms are used interchangeably, sometimes even by those in the industry.
For part 1 this week, we are going to look specifically at debt settlement and its impact. Come back next week and we will talk about debt management so you can compare the two very different products.
Debt settlement is particularly set apart in that you and the lender agree that you will pay an amount less than you owe. The amount above and beyond that payment is simply written off as a loss by the lender. Owe $2000? They may agree to a settlement payment of only $1000 or less!
Hey now, that sounds pretty good. I mean, you owe it. But they are fine with you not paying the full amount. The rest just goes away. That’s what we call ‘a good deal’, right?
Well, it’s not quite that simple.
First of all, for a lender to accept a settlement agreement, you usually have to be behind on your payments. Keeping up with the minimums so far? Just skip a payment or three and they will then consider your settlement offer.
But wait. Each of those missed payments shows up on your credit report, even if the lender suggests you skip them. Each one of those impacts your score negatively, and the more you have the more impact each one has. Not to mention, you may be charged a late fee for each of the missed payments on top of the debt you already owe.
So you are already behind on payments without the suggestion of the lender. A settlement can still have a significant negative impact on your credit score. You will see a drop in score because, after all, you are not paying back the full amount you originally agreed to when you signed on the line and took on the debt. It’s probably going to hurt.
And for a third impact, the amount of debt written off by the lender will be reported to the IRS as income. That’s right. Come April, you are going to owe income tax on the amount of debt the lender agreed to write off. Paying 20%-25% tax is sure less than paying 100% of the debt, but it’s worse when you are surprised by it.
One other important point to discuss is the for-profit debt settlement companies that advertise their services to help you through the process. A big word of caution here – they will often encourage you to stop paying the lender and instead make payments to them so that they have money to use in negotiating a settlement (remember, you usually need to be behind on payments before they will consider a settlement). They may well ask for this before they have even contacted the lenders, let alone have a settlement agreement in place. They may never be able to reach an agreement with the lender, and in the meantime, you have missed how many payments, added how many fees, and further damaged your credit score by how much!
Did you know can negotiate with your lenders yourself to come to a settlement agreement? You can, and keep up what payments you can in the meantime. If you decide to work towards a settlement, you can do that without paying the for-profit settlement companies.
If you couldn’t tell by now, I’m not a big fan of settlement agreements. I do understand that there are a time and place where they may well be the least worst option. But there are other options available. Enter the debt management program. But that’s for next week.
If you are struggling with debt and not sure how to handle it best, the counselors at the Center for Financial Resources would love to talk with you. Aware of all of the options out there, they can help you consider all of the benefits and drawbacks so that you can make the best-informed decision for your unique situation. You can schedule a confidential appointment by going to our website or calling us at 605-330-2700.
written by Breck Miller, Community Relations Coordinator
images courtesy nwestiowa.com and sodahead.com, respectively
LSS Center for Financial Resources
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