Debt settlement: How it affects on your tax and credit score

Many people who are in drowning in huge debts consider debt settlement to get rid of their debts. Debt settlement is a good debt repayment option as it reduces the total debt amount.
You can approach your creditors for the settlement on your own. In that case, you should try to convince them about the settlement.
Since they are not getting the full debt repayment, they may not agree with the settlement offer. But if you make them believe that you are not able to repay the full debt amount, then they can agree for the settlement.
Since negotiating with the creditors is a difficult task, many people seek professional debt relief help to repay their debts. They enroll in a debt settlement program to get rid of their debts.
The debt settlement company will negotiate with your creditors or debt collectors to reduce the debt on your behalf. In most case, they can successfully reduce the total amount and provide relief to the debtor from the debt burden. But you should know how debt settlement affects your tax and credit score.

Advantages of the debt settlement that you should know before taking the plunge

Once you enroll in a debt settlement company, they will try their best to reduce the total debt amount. And who doesn’t want to pay back an amount that is much less than what they owe?

Here are some other advantages of debt settlement

You will be able to become debt free sooner

Debt settlement helps to become debt free within a short span of time. Usually, the period is around 24-36 months. But it may take longer if you have huge debt.

Reduce the total debt amount

Unlike any other debt relief option, debt settlement helps to reduce the total debt amount. In some cases, it reduces the debt in half. It is the biggest benefit for you as you don’t have to repay the high amount of debt that you owe the credit card companies.

You are required to make a single monthly payment

Once the debt settlement company convince your creditors for the settlement. You are required to make a single monthly payment to the debt settlement company. This money will be disbursed off to your creditors in due course of time.

Disadvantages of debt settlement that you should know before choosing this option

As a coin has its two sides, debt settlement has some disadvantages as well.
As you know that there’s no such really easy way to release yourself of debt, there’s always a cost that you have to incur for dealing with a third-party.

Debt settlement affects your credit score negatively

Debt settlement hurts your credit score

As you’re not paying back the entire amount that you owed this will be reported to the credit bureaus. The creditors will consider this as “Paid as settled” and not as “Paid in full”. This lowers your credit score.
However, you can again negotiate with your creditors to report your payment schedule as “Paid in full” so that it does not hit your score.
It is normal that the credit score of a debtor who is considering settlement is not good. So, the effect on the credit score doesn’t bother a debtor.
Once the debtor starts adding positive points, the credit score goes up.
If you can properly negotiate with your creditors, you can even re-age your accounts and bring them back to a current status. This will inevitably help you boost your credit score.

You need to pay tax to the IRS

Once you settle your debt, you will owe tax on the saved money. Since you are saving money on the reduced debt, you need to pay the tax on the total saved amount.
The IRS will charge tax on any kind of forgiven debt amount and therefore it is not that you will save the entire amount of money that is forgiven by your creditors. The debt you owe has to be paid in full. Since you are not paying the debt in full, it is fair enough to pay the tax.

Is debt settlement the right option for you?

Though it has two big disadvantages, yet it is truly beneficial for the debtors as it helps the debtor to avoid bankruptcy. If you feel that your debt situation has become too burdensome, and you can’t handle to pay off your debts through your budgeting efforts, debt settlement program provides you relief from the debt.

  • expertise badge
  • This site is verified as a Trusted Site by Best of the Web
  • TrustLink logo
    TrustLink logo
  • Customer ratings on BBB
  • IAPDA logo
  • Calchamber Member
  • Calbar Registered
  • D&B
  • Godaddy
  • yelp logo