Benefits and Risks of Debt Settlement

Debt settlement is a process in which you negotiate with each of your creditors to eliminate your debt. You agree to pay a certain sum of money that is less than the amount that was owed. Here are a few of the benefits and risks associated with debt settlement.

Benefits

  • Get rid of debt--The biggest thing that debt settlement does is to satisfy your accounts with your creditors. The debt settlement process can help you remove many of your debts. Some accounts, like certain loans, are not eligible for debt settlement. However, many accounts, like credit cards and medical bills, can be settled for less than you owe.  
  • Save money--The potential savings that a good debt settlement can net are large. When you have a large debt that has been outstanding for a long period of time, there is a good chance that the creditor will settle the debt for much less than the total. Many times, you can settle the debt for less than half of what was owed. For example, you might have a credit card bill of $4000. The credit card company might be willing to take $1800 in one lump sum payment and close out your account for good. This essentially gained you $2200 worth of pre-tax money. 
  • Start investing--One important part of financial success is building an investment portfolio. When you have debt hanging over your head, it is difficult to apply any money towards investments. You know that you have this debt and every extra dollar that you get tends to go towards it. Therefore, by eliminating your debt, you can improve your financial standing in the long run. After the process is over, you can then take the amount of money that you were spending on debt payments each month and use it to start investing. If you did not go through the debt settlement process, it could take years before this money was freed up to start investing.

Risks

  • Hurt your credit--The biggest risk that comes with settling your debt is damaging your credit. In many cases, the creditor will report the settlement to the credit bureaus, and it will remain a part of your credit record. This will make it very difficult to get a loan or open any credit accounts in the future. It could be a potentially long, drawn-out process to rebuild your credit to the level that it was at before. By comparison, you may be better off to develop a repayment plan and keep your credit where it is now. 
  • Tax liability--Another risk that you run when you settle large debts is creating a tax liability that you cannot afford. When you settle a debt, you have to pay taxes on the canceled amount. The creditor will be obligated to report that amount to the IRS, and they will send you a 1099-C tax form at the end of the year. You will have to file it on your tax return and potentially pay taxes on it. Since you did not actually receive any money, this could be hard to recover from. 

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