Legal debt settlement aspects and consequences |
By David Pilley on February 7, 2011
.jpg.aspx?width=75&height=75) Debt settlement is not for everyone. If you are a month behind on payments to any of your unsecured debts, don’t even consider this route. Creditors like to see you in financial trouble before considering a settlement. In other words, creditors will not even consider the option until you’re way behind, a few months behind, on payments. With that in mind, here are some legal issues you need to be aware of when getting a settlement.
First and foremost, your credit score will drop. Once you receive a settlement, the debt listed on your credit report will be marked as “settled.” Other lenders will see this as a warning sign and, until it is updated to “paid in full,” all three of your credit scores should be low.
Next, there are tax consequences. With a settlement, you pay just a portion of what you originally owed. The rest is “forgiven debt,” but it is not forgotten. If any amount of forgiven debt exceeds $600, it must be reported to the IRS as “taxable income.” Your creditor will supply you with a 1099 form, and you will have to fill it out and report it with the rest of your taxes. However, you might not have to pay taxes on it if you were financially insolvent at the time of the settlement. As long as the amount of forgiven debt is less than the amount you are insolvent by, you will not be taxed.
If you are looking at the help of a debt settlement company, you need to watch out for scams. If you can’t make a lump-sum payment, settlement companies will set up a “trust” account where funds will accumulate for the settlement process. If this account is not insured by the Federal Deposit Insurance Corporation (FDIC), you cannot trust the company. Some of these companies will also charge fees for their services, and some states do not allow “for-profit” debt management. If the debt settlement company is asking for fees, do some research to see if they are doing business illegally.
Finally, there is still a possibility you could be sued. Your creditor has the right to sell the debt to a collection agency. Not only will you be getting phone calls from the agency on a daily basis, you could be taken to court, where you may be ordered to pay the full amount or have some of your property liquidated to make up the debt. This judgment would complete the loop by bringing you back to the first part: your credit score will drop.
These are the major aspects of legal debt settlement. A settlement might not be right for you, so consider these outcomes before pursuing this option.
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