One of the ways people attempt to get rid of their debt is to negotiate a debt settlement with their creditors in hopes of paying something that would satisfy the creditor but would also be something that they can afford. There are some pros and cons to this, and we’ll discuss them here.
If you find yourself unable to stay current in your debt payments, you may be able to negotiate with your creditors and try to get an agreement to either settle the debt for less than the total amount owed, or lower the interest rate, or both. To do this, you would need to call up your creditor and explain your situation. The creditor may want to know why you are unable to pay the debt according to your contract with them and what you may be able to do to resolve the debt. Two of the most common negotiated payoff agreements involve settling the debt for less than the amount owed and negotiating a new interest rate.
Depending on your ability to repay your debt, some creditors may be willing to negotiate and settle your debt for less than the amount owed. This type of agreement typically involves a onetime lump sum payment, or a short series of payments adding up to the agreed settlement amount paid out. After such a settlement, however, the creditor may still report to the credit reporting bureaus that the debt was settled for less than the amount owed. This notation may lower your credit score. But, so would an unpaid debt. You pick your poison on this. Some people decide to deal with the lower credit score and get the debt extinguished sooner. They can then start working to repair their credit score when they have the ability to stay current on their bills.
Sometimes a creditor will agree to lower your interest rate if you continue to pay off the debt. With this option, you may still pay the debt in full, but with a lower interest rate, each payment bites off more of the principal amount, and less money will be eaten up by interest. By staying current on your debt and paying it in full, your credit score may improve.
Caution: There may be IRS issues: If all or part of a debt is forgiven, like when you settle a debt for less than the amount owed, the IRS may consider the savings to be taxable “income” to you, even though you never received any money. The creditor may report that debt settlement to the IRS. If this happens, you should consult your tax professional and determine whether this type of debt forgiveness is taxable to you.