Debt Settlement: Not All It’s Cracked Up To Be

“Not all it’s cracked up to be” is one of my favorite idioms. “Too good to be true” is another good one that also applies to debt settlement. Forgive me for speaking in generalities, but the reality is that debt settlement rarely benefits the debtor in the end. It sounds like a great idea, but the math simply doesn’t work.

For example, consider Joe who earns $50,000 a year and has $5,000 balances on two separate credit cards. Joe is having difficulty paying off these debts and his interest rate has gone up to 25 percent on each account because he paid a couple payments late. Joe contacts one lender and offers to settle his $5,000 balance for $3000 and they agree, but he doesn’t have a lump sum to pay. The lender agrees to allow him to pay the $3,000 over twelve months. For twelve months Joe makes his payment each month and at the end of the twelfth month the lender agrees that the debt is satisfied in full. But what they didn’t tell him is that the creditor will report the forgiven portion of the debt to the Internal Revenue Service as income and Joe will end up paying taxes on the forgiven portion of the debt. In addition, the other credit card continued to accrue interest, and at 25 percent interest a year Joe now owes an additional $1,250 on that card plus late fees.

There are some instances where debt settlement works. If the balance owed isn’t too high and the debtor has sufficient income to make payments or a lump sum to pay off the debt, then debt settlement might be worth the effort. However, if the debtor is struggling with making minimum payments then settlement of the debt is most likely not a viable option.