Debt negotiation — negotiating the portion of the debt you owe that you will pay to a lender — can seem simple enough. After all, who wouldn’t like to pay less than what they owe? However, negotiating a debt settlement isn’t without consequences. Does debt negotiation ruin your credit? It may not “ruin” your credit, but it could possibly impact your credit score. What’s more, it may not look good to lenders who closely examine your credit report.

How Settled Debt Looks on Your Credit Report

The euphemism for settled debt on your credit report is usually “settled for less than full balance,” “paid other than agreed” or something similar. This can lower your credit score, because you paid less than you owed and it also suggests you may have taken on credit obligations you were unable to repay.

Even if it doesn’t impact your credit score directly, settled debt can still cause problems. For example, when you buy a house, there’s a rigorous investigation into your credit history encompassing far more than just your credit score. The bank is determining your creditworthiness based in part on your credit report, and any negative items in the report could impact their decision on whether or not to lend to you.

Paying less than what you borrowed is usually better than paying nothing at all. But it’s not as good as paying what you owe. Always aim to fulfill your debt obligations as agreed.

Settled Debt isn’t Free Money

If you do settle a debt for an amount less than you borrowed, the experience doesn’t necessarily end there. The amount that you borrowed, but did not pay back, may be considered “income” by the IRS. Over a certain amount (determined by the IRS), the lender which was not paid back in full may be required to file a Form 1099-C form with the IRS and send you a copy in the mail. Depending on your unique circumstances, you may end up owing taxes to the IRS on the amount that was forgiven. You’d want to talk to a tax professional about that.

Discuss Financial Hardship With a Creditor Early

The best thing you can do is to pay your obligations on time and in full every month. If you find yourself experiencing financial difficulty, reach out to your creditor to explain your situation honestly and see if you can work out a payment plan to repay the amount in full. Perhaps your creditor will spread out your payments, lower fees or interest, or provide other assistance.

If your debts go into collections, work with the collection agency to pay back what you owe in order to potentially benefit your long-term credit health.

Sometimes, debt settlement companies may contact you attempting to solicit you. They may request that you stop making payments to your lender for months at a time while the company promises to negotiate with the lenders, but there is no guarantee that a lender will negotiate with the company and, even if they do, as mentioned earlier, it may not reflect well on your credit history.

Debt settlement negotiation might seem attractive if you’re swimming in debt, but the consequences that come with debt settlement need to be carefully considered before you make a decision.

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