Personal Debt Settlement: Risks, Benefits & What to Expect

Going through the process of personal debt settlement is not something that most people want to deal with. However, when you have a large amount of debt, it does present you with a viable option to eliminate it. Here are some of the risks and benefits of personal debt settlement. 

Benefits

• Eliminate the debt- One of the biggest benefits of this process is that you will be able to eliminate the debt. Getting rid of a large debt load from your credit file can be a huge advantage to you. When you try to get a loan with too much debt, your debt-to-income ratio will be too high. This will result in higher interest rates or not being approved for the loan. If you need to borrow again in the future, eliminating the amount of debt that you have can help quite a bit.

• Save money- When you settle a debt properly, you will be able to save quite a bit of money. Many creditors will settle a debt for much less than what the original bill was. It is not uncommon to be able to settle your debt for less than half of what it originally was. When you do this, it means that you got free goods and services that you never have to pay for.

• Save time- When you have debt with high interest, it can take a long time to pay off in the normal way. For example, if you have credit cards and only make the minimum payment, it might take you over 20 years to pay off. When you settle your debt, you will be finished with it immediately. This allows you to move on to other things in your life quicker. You could start investing that money every month instead of applying it to debt payments. 

Risks

• Credit damage- When you go through the debt settlement process, it will often hurt your credit severely. You just racked up a large debt and then did not pay off the entire amount that you owed. From the company's perspective, you did not live up to your end of the bargain. This means that you were not a very good credit risk. They will then report this to the credit bureaus so that other creditors can avoid making the same mistake again.

• Tax liability- One of the big problems with settling debt in this manner is that it creates tax issues. When you cancel out part of your debt, the IRS looks at this as income. The company that canceled the debt will report the amount to the IRS and they will send you a 1099-C tax form. Therefore, you have to report it on your income taxes at the end of the year as income. If the amount was substantial, this could create a big problem for you at tax time. You never actually received any money, but you will be expected to pay taxes on it.