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Thinking of Settling a Debt, It May be More Damaging Than You Think

I received a call last week from a woman in a panic because she had settled a broken lease and was now being sued for the remainder of the debt. With many people feeling the financial pinch now, it is easy for to be convinced to settle debts.  After all, they probably don’t owe the entire amount that is being demanded any way, right? Well, sort of.

In a typical rent or lease agreement, credit card agreement, car lease agreement etc, there are stipulations about the fees and penalties that will be assessed if you do not follow the agreement. If those fees are outlined (and in compliance with your states laws), then yes, you owe the entire amount.

At this point, the settlement (only paying part of what you owe) seems like a good idea. However, it may not be. Settlements are one of the most damaging things you can do to your credit. They are second, for the most part, only to bankruptcy or court judgments.  

When you except a settlement, you are essentially saying, “I admit I owe you the money, however, I can only pay back this much.” Any other creditor, who sees that information on your credit report, will be hesitant to loan you money, rent you an apartment or even turn on utilities without a large deposit.

The other down sides of settling are:

  1. The unpaid portion of the debt may be sent to another collection agency or reported to the IRS as taxable income. The latter is what happened to the woman who called me. She was being sued over the unpaid amount. The creditor won the case and her wages were garnished.  

  2. If the eliminated portion is reported as unearned taxable income, you may be responsible for paying taxes on that amount.

  3. The damage to your credit report.

If you are thinking about settling a debt, contact a credit counselor today. You may have other, more beneficial options. And, even if settling the debt is the answer for you, a credit counselor can provide you advice on the best method to use, what to watch out for and what you should get in writing.

Call the number at the top of your screen now to get more information and help from a certified credit counselor.

Published Nov 21, 2012.