Working out a deal to settle a delinquent debt for a percentage of the balanced owed is one of the most commonly recommended tactics for anyone starting out on the road to getting out of debt and improving their personal financial situation. However, there are often costs associated with these deals that many consumers simply don’t consider.
No matter what type of debt situation you are attempting to resolve, almost every creditor is willing to accept some type of deal to get an outstanding balance off of their books. But savvy consumers know that you can only be sure this is a good idea after carefully considering all of the factors at play for a specific scenario.
With that in mind, let’s take a quick look at the three common costs associated with any type of debt settlement agreement.
The Upfront Cost of the Deal
The most obvious cost associated with any debt settlement agreement is the amount the creditor is willing to accept in order to clear the debt off of their books. The discount a creditor is willing to take to settle a debt can span a wide range from a few percent to almost the full balance.
Whatever agreement you are able to work out with your creditors, the agreed upon price is obviously going to be the first cost to consider when deciding whether paying off a debt in a settlement agreement is a good idea for your situation. However, there are two other costs that you might not be factoring in properly.
The Impact on Your Credit Score
While getting a great discount to settle an old debt might sound like a good idea, having a debt settlement agreement stick on your credit report is something that could haunt you for years to come.
Of course, if you already have an account in collections on your credit report, that could do just as much to ruin your future plans, so the impact here could vary significantly depending on your specific situation.
In many cases, it is possible to negotiate having the entire account completely removed from your credit report, but you need to get this in writing prior to completing the agreement and paying off the settlement amount.
The Income Tax Implications
Another factor that most people overlook until it is too late is that any discount applied to your outstanding balance is considered income according to the federal tax law. That means you are going to have to count that amount as regular income on your tax return for the year in which the agreement is completed.
Like all regular income, you will owe income taxes at your normal income tax rate on the amount of the discount, which will vary based on what income bracket you fall into. But just like winning a new car on The Price is Right, you always want to make sure that you can afford the taxes before taking the deal.
If the deal still makes sense after considering all three of these factors, then it is time to pull the trigger and get that debt off of your credit report. However, if settling a debt is going to end up costing you more than continuing to make payments on it, you might want to just keep doing what you’ve been doing.
But no matter which option is better for your situation, carefully considering all of the information available before making a decision is always going to be the best thing for you as that consumer.