Sarah Edwards | December 14, 2022
Summary: When you settle a debt, you can relieve yourself of the overwhelming weight of debt burdens. You can end up saving money if you settle for a percentage of your debt, which many creditors and debt collectors are willing to accept. However, beware that debt settlement has its drawbacks, including its effect on your credit score and taxes. SoloSettle can help you reach a debt settlement for less and regain your financial freedom.
If you owe a debt that you can’t afford to repay, you may consider settling it. The settlement process involves paying a portion of the amount owed in return for wiping your account with the creditor clean. Sometimes, creditors agree to a settlement, especially if they don’t believe you can fully repay them.
Settling a debt can be advantageous to someone who can’t keep up with minimum payments or whose debt is in collections. You’ll move on free from further collections activity against you without needing to go through bankruptcy.
The debt life cycle starts with a debt you can’t afford to repay in full. Typically, your creditor will try to get you on board with repaying the debt according to your original agreement. If you fail to make any payment arrangements following a certain period — usually three to nine months — your creditor will charge off your account.
A charge-off occurs when a creditor has given up hope that a debt will be paid off. It is a derogatory entry on your credit report that can significantly hurt your score.
Following a charge-off, the account will go into collections. Some creditors use an in-house team for collections, while others sell overdue accounts to debt collectors.
Once your account goes into collections, it becomes easier to negotiate a debt settlement. The collections agency knows that it may be unsuccessful in collecting the total amount of the debt and that it won’t be worth it to pursue further collections against you.
Usually, debt collectors start the collections process by offering you payment arrangements. In some cases, they may provide you with an offer of settlement. You’ll receive a letter from them detailing the debt you owe and your various payment alternatives.
You should always ask debt collectors you’re unfamiliar with to validate your debt before engaging in further communications with them. You can do this by sending a Debt Validation Letter.
In your letter, ask them to include the following specific information in their validation letter:
If the debt collector provides you with the requisite information to validate your debt, you can decide whether you want to settle the debt or set up payment arrangements.
Debt collectors that fail to respond to these letters probably don’t have the information necessary to validate the debt. If they report any adverse information to the credit reporting bureaus, you can ask them to delete it.
Let’s look at an example.
Example: Annie falls seriously behind on her credit card payments, and after almost six months of missed payments, the credit card company charges off the account and transfers it to collections. When the debt collectors come calling, Annie uses SoloSuit to send a Debt Validation Letter. Unfortunately, they have everything they need to verify the debt amount she owes. After a few more months, the collection agency files a lawsuit against Annie. She responds to the lawsuit to give herself time to work out a plan. Next, Annie uses SoloSettle to reach out about a debt settlement plan. She ends up settling the debt for 75% of the original amount, saving her money and the stress of worrying about the debt any longer.
Paying an overdue, validated debt in full has certain advantages. You’ll be able to move on from a difficult situation without fear of further collection activity against you.
You won’t receive any additional phone calls from a debt collector concerning the obligation. In addition, your creditor will report the debt as paid in full.
Even though the debt entered collections, paying it means there will no longer be outstanding collections on your credit report. Your debt-to-income ratio will decline, which will improve your credit score over time.
Paying your debt in full also increases the chances of obtaining credit. If you don’t have any outstanding debts, there’s less reason for a lender to deny you credit.
While paid collections remain on your credit report for up to seven years, some newer credit score models don’t include them when calculating your credit rating. If the credit score model includes the account when calculating your score, its impact will decline as time passes.
Settling a validated debt is best when you know you can’t afford to repay it. While settling debt won’t be as favorable for your credit score, it does stop future collection activity. You won’t need to worry about being the subject of a debt lawsuit. The harassing phone calls, emails, and letters will also stop.
When you settle a debt, you agree to pay a portion of its total value. Some debt collectors and creditors will allow you to settle for as little as 30% of the obligation. However, settlements of 50% to 60% of the debt’s value are more likely.
Usually, you’ll need to make a lump-sum payment to settle the debt and halt further collection activity. Some collection agencies will allow you to stagger payments over several months if you can't make the full payment at once.
If you don’t have the money to settle a debt, it’s best to set up payment arrangements. That way, you can continue to save toward a settlement while avoiding potential legal actions against you. As long as you remain compliant with your payment arrangement, debt collectors won’t call you, and you won’t receive a sudden summons for a lawsuit in the mail.
Once you settle a debt, the debt collector or creditor will report your account as settled or partially paid. It will stop negatively reporting your account to the credit reporting bureaus. You may not see much immediate change to your credit score, but it will increase over time.
If you stay on top of your other credit obligations, your credit score will eventually improve. Some people can see double-digit score increases within six months, especially if they pay their debts following their agreements and eliminate any other obligations currently in collections.
You can set up a payment arrangement if you can’t afford to pay off a debt in collections through full repayment or settlement. A payment arrangement won’t help your credit score since there will still be an open collection account on your credit report. However, this arrangement can prevent the debt collector from filing a lawsuit against you.
If you set up a payment arrangement, adhere to it. In the meantime, make every effort to save enough money to settle the debt or repay it in full.
Beware: the IRS considers forgiven debt taxable income. This means that if you settle your debt for less than the original amount, you will have to include the remaining amount as part of your income when filing taxes the following year.
In other words, if you settle your debt this year, you may end up owing more in taxes to the IRS next year. That being said, debt settlement is still worth it, especially if you feel like you’re drowning in debt and want to start over again.
After you’ve weighed the pros and cons of settling your debt, consider doing it yourself. You can follow these three steps to settle a debt:
Check out this video to learn more:
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Out Debt Validation Letter is the best way to respond to a collection letter. Many debt collectors will simply give up after receiving it.
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