The effect of not paying off a debt is horrible. You will start getting reminding calls from creditors. It causes excessive stress, sleepless nights and financial crisis. The situation can be worse if your outstanding debts are sold to a collection agency.
If it happens, you will start getting calls from the collection agency (CA). The agents of the collection agency will ask you to pay off the outstanding balance. However, you can negotiate to settle the debt with the CA.
For common people, the situation can be overwhelming to understand how does settling their debts affect their financial health. Settling a debt is good but not as good as consolidation. Because, by settling, you are actually paying a reduced amount. Read the full article to know other effects of settling debts with the collection agency.
Things to consider before settling debts with a collection agency
Some people prefer to settle their debts because they think it is an easy solution. But, it is important to understand the cautions related to it. Because, according to the Fair Debt Collection Practices Act (FDCPA), there are some guidelines that a collection agency should follow.
Here you go:
1. As per the FDCPA rule, a collection agency can send you a debt validation letter of your debt within the 5 days of first contact. Most of the reputed collection agencies usually send the debt validation notice before contacting the debtor by phone.
2. Before agreeing to the settlement offer, you should check whether or not the debt collection agency is legitimate. Research online, read reviews and ask friends to know about the collection agency.
3. Remember, settling debts with a collection agency is different than settling debts with the help of a debt settlement company. To be honest, when you're hiring a debt settlement company, they will charge a certain fee. In return, they will try their best to negotiate with the creditors or collection agency to reduce the debt amount as much as possible. On the other hand, a collection agency will try to increase their benefit by not reducing the debt amount to a significant level.
The consequences of settling debts with a collection agency
People think, settling debt is good and a sign of showing financial responsibility.
Well, settling debt is good instead of not paying off the debt at all but it doesn't mean that you will be considered as a financially responsible person.
Your credit score plays the role of a report card of how much financial responsible person you are.
Once your original creditor sells your debt to a debt collection agency, your credit score will take a dip.
Again, when you decide to settle your debts with a collection agency, your credit score will drop by few points.
Here are a few more consequences of settling debts with a collection agency:
1. When you choose to settle a debt, you need to negotiate to reduce the total debt amount.
It means you are paying less than you owe. The FICO considers it as negative. As a result, your credit score will drop.
2. If your original creditors sell or transfer the debts to a collection agency, the third-party collection agency will be the owner of the debt. Your accounts will be updated as "charge off", which affects your credit score negatively.
3. Once you settle your debts, your account will be updated as “debt settled” or “partial payment” or “paid in settlement”, which signifies you as a risky borrower to the future lenders or creditors.
4. Considering the settlement process without checking the Statute Of Limitations on the debt is a blunder. Remember, old debts will stay on your credit report for 7 years. Thus, if you get calls from a collection agency to settle your old debts, you should check the SOL of the debts. If the debt almost crosses the 7 years, then settling the debts may not make a big difference.
5. You need to pay tax on your settlement. If the reduced debt amount is $600 or more, then it will be considered as taxable income.
6. Settling debt is beneficial if you decide to settle your debts before the creditor passes the debt to a collection agency. We all know that paying off the total debt is more beneficial than settling. But, allowing the debt to be charged off can affect your credit score more negatively. Try to pay off your debts before the creditor sells the debt to a collection agency.
Lastly, as I said earlier, irrespective of those negative sides of settling a debt, it is better to do it than not paying off the debt at all. Because in both cases, your credit health will suffer. If you don't pay at all, your credit score will drop even more.
However, according to the Rod Griffin, Director of Public Education, Experian, “The hit your score takes will depend on how high it is, to begin with. Generally, the higher your score, the larger of an impact negative activity has on it.”
Remember, debt settlement is a complicated process, and it’s not the purely financial cure for your debts. So, if you think, you can gather quite a bit of debts and settle it later, then you are wrong. It is better to deal with finances responsibly to avoid debt as much as possible.