Definition
Debt settlement is a debt relief strategy where you negotiate with creditors to accept a lump-sum payment that's less than the full amount you owe to consider the debt satisfied. This typically happens when accounts are severely delinquent or in collections, and the creditor believes that accepting a partial payment is better than receiving nothing. Debt settlement can be arranged directly with creditors or through third-party debt settlement companies. While it can reduce your total debt burden, it typically has serious negative consequences for your credit score and may have tax implications, as forgiven debt over $600 is generally considered taxable income.
Frequently Asked Questions
How does debt settlement affect my credit score?
Debt settlement typically has a significant negative impact on your credit score because accounts settled for less than the full amount are reported as 'settled' rather than 'paid in full.' Additionally, to be in a position to settle, accounts are usually already delinquent, which has already damaged your credit.
What's the difference between debt settlement and debt consolidation?
Debt settlement involves negotiating to pay less than the full amount owed to resolve a debt. Debt consolidation combines multiple debts into a single loan or payment plan, but you still pay the full amount owed, typically with a lower interest rate or monthly payment.
Are there tax consequences to debt settlement?
Yes, the IRS generally considers forgiven debt of $600 or more as taxable income. After settling a debt, you may receive a Form 1099-C (Cancellation of Debt) from the creditor, and you'll need to report this as income on your tax return unless you qualify for an exclusion, such as insolvency.
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