Definition
Debt settlement, also known as debt negotiation, is a process where a distressed debtor may reach a compromise with a debt collector. Both parties may agree to certain terms in order to terminate the account.
Impact of Settlement
Accounts settled will be listed as negative records on your credit report. Also, you will be expected to pay taxes on any forgiven debt, which is automatically reported to the IRS on Form 1099-C. There is also the possibility that a settlement could trigger increased collection activity by other debt collectors that notice your newfound ability to repay.
Who Benefits?
Debt settlement can benefit debtors that have charged-off accounts that are between 1 and 5 years old. A settled debt is normally better than an outstanding, unpaid collection account.
Debt collectors benefit by clearing the account from their accounts receivable registry and ending costly debt collection attempts. They also turn a nice profit, since most debt accounts are purchased for a fraction of the stated balance.
Impact on Credit Score
Until 2007, credit bureaus penalized debtors that settled an old collection account because it restarted the 7 year clock on the credit bureau listing. However, changes in the scoring formulas by Fair Isaac and Company eliminated this penalty. It now logically rewards you for responsibly resolving accounts in default.
Debt settlement is better than bankruptcy, judgments and ignoring debts in default. However, it reflects on your credit report that you paid less than the amount that you originally agreed to pay in the card holder agreement or loan contract. This will cause future lenders to charge higher interest rates or deny credit requests altogether.
When to Settle
Credit card companies will not settle on any account less than 4-5 months delinquent. It must be nearing 6 months delinquent before they will try to prevent the inevitable charge-off. Credit and debt counseling can provide much greater benefits if the accounts have not been turned over to outside collection agencies.
Accounts already in collections could be good settlement prospects. If you can repay your more recent collection accounts in full, that provides the greatest credit boost. However, you might be better off to save money and settle.
Collection accounts that are dormant for more than 5 years can generally be ignored. The statute of limitations has likely expired (varies by state), so there should be almost no risk of judgment or other legal action for consumer debt accounts. Negative debt records (excluding public records) are removed from your credit report after 7 years.
How to Settle
You may contact the debt collector by phone or letter to request a settlement. Normal settlement arrangements involve a lump sum payment of 40-60 percent of the stated debt balance. Older debts may be settled for even less.
Find out how to settle on your own. There are several letter templates you can use to negotiate a settlement. Do not, under any circumstances, utilize a debt settlement company. These companies are expensive, largely ineffective and cannot protect you from legal action.
