Borrowers who are heavily in debt and find themselves unable to repay their full credit card balances will often look up debt settlement information (or debt settlement and debt negotiation information) as an alternative to bankruptcy.

How Debt Settlement Works

In debt settlement, the credit card company or collection agency will settle for a reduce balance, usually thirty-five to fifty percent of the original debt. When the settlement is approved by the creditor, the borrower will need to repay all of the reduced debt at once, or in many cases will have to set up a repayment plan, much like a debt management plan, to repay the reduced credit.

The Costs of Debt Settlement

Although borrowers can negotiate their own debt settlement, most will choose to enlist the professional assistance of a company that specializes in this area. The costs of using a specialty company range from up-front fees to monthly payments of fees to back-end commissions on the approved reduced amount. The preferred compensation is a percentage of the reduced amount which only gets paid once the creditors have agreed to the reduced amount.

Debt Management

Insofar as debt management is concerned, debt settlement is not a recommended debt management tactic. The reasons are abundant, namely that borrowers will suffer from reduced credit scores and settlement will only address credit card balances, not student loans, car loans or mortgages. With only credit cards eligible, borrowers are usually only addressing part of their debt problems, not the whole picture.

Tax Consequences

Borrowers will find in the available debt settlement information that there tax consequence to debt settlement outside of Chapter 7 and Chapter 13. Specifically, creditors will issue 1099-C for the reduce amount of debt. This amount is to be treated as taxable income, something that many advisors forget to tell you.

Debt settlement information is rather abundant, particularly now with the economic situation facing most of us. In some cases, debt settlement might make sense, particularly if a borrower’s debt load consists entirely or almost entirely of credit card debt. However, as a debt management technique, settlement should be avoided and other options explored.