Common Questions

How do I decide between a debt management plan or a debt settlement plan? What could go wrong with debt settlement?
While Credit Advisors' primary focus is offering debt management plans for persons who need that assistance, we have in the past arranged for settlements on individual accounts for clients that are enrolled in those plans. That being said, most clients pay their financial obligation through the organized and consistent applications of monthly payments until they reach the state of being debt free.

In the mean time there are some things you should consider regarding debt settlement.

Documentation is everything in debt settlement. Prior to any funds being paid to a creditor who is entering into a settlement arrangement, you should have the terms of the settlement in writing, on the company's letterhead, signed by an employee who has authorization to arrange settlements. The terms should include the amount of the original debt, the amount of the settlement, how the settlement is to be paid, to whom, by what date and how the settlement will be reported to the credit bureaus. Once the funds are distributed, you will have no ability to ensure the terms are kept unless you have it all in writing in advance. Some settlement companies cannot provide you with this information because they perform their settlements in a "batch" and lack documentation on an account by account basis. Settlements in your favor can generate a tax liability as the creditor is required to report all amounts forgiven (over a certain amount) to the IRS as income. So if you had a debt of $10,000 with a credit card and settled the debt for $6,000 the credit card company would send in a form 1099 to the IRS showing the $4,000 that was forgiven as income for you. This would create an increase in your tax liability. This is an area where you should consult a tax advisor as an increase of $10,000 to $15,000 in income could cause your overall tax liability to increase to a rate that would make settlements ill-advised.

Some creditors will not even discuss settlement arrangements on any account that has not yet reached a charge-off status (I9, R9 or O9). On a scale of 1 to 9 with 1 being positive and 9 being negative, you might have to have negative credit to even begin negotiations for settlement. These ratings can remain a part of your credit file for up to 7 years from the date of last activity, depending on your location. Your employment, living situation and other obligations may make the fall out of a settlement not be worth the money written off.

You should consider your housing plans in the near future. Some (not all) mortgage underwriters will require you to go back and pay any amounts settled before they will approve an application for a mortgage. At the very least, they will want documentation of the arrangements and proof the terms were kept.

You should consider your employment plans in the near future. If you are employed in a field that requires bonding, licensure, or security clearances, settlements can be a potential problem. Another area where having the correct documentation can be everything.

Settling the accounts now will still require you to monitor these accounts in the future. You will have to ensure that they are correctly reported to the credit bureaus according to the terms negotiated. This is the largest problem with settlements. The vast majority of reporting to credit bureaus is done through automated methods. Those automated methods are created to swiftly and accurately transmit information in a standard format on the vast majority of the accounts from a particular creditor. Accounts upon which settlement arrangements are made would probably make up less than a tenth of 1% of all outstanding accounts held by a creditor. They are by no means the standard format. Credit reports are notorious for containing errors, mostly because tracking every credit transaction for every adult in the country is a daunting task. You may be required to send documentation to the credit bureaus to update the information on the settled accounts several times during the life of those accounts on your credit file. Again, documentation is everything.

With the recent growth of the third party debt buyer industry, keeping complete documentation will only become more and more important. Third party debt purchasers will buy blocks of old debts from creditors for cents on the dollar and then turn around and try to collect the debts. Some of the debts will still be valid, but some may have been included in bankruptcy, settled or have expired statute of limitations. When you are contacted by a collector in 10 years, you will need the documentation still. Never get rid of the documentation on settled accounts.

You will be able to obtain a credit card after settling your debts. The true question is under what terms will you be able to obtain the credit card? You may have to start over with a secured card or with cards that carry unfavorable account conditions for interest and fees. Over time and with conservative use you will be able to obtain credit cards with better terms, but in the short term you must consider the higher cost of obtaining new credit against the savings achieved through settlement.

While I do not believe settlements are right for everyone, you may determine it is the best option for you after careful review of your current finances, housing, employment, familial and future credit needs. If you would like to have someone review your current situation, please contact one of our certified credit counselors at 800-766-3328.
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