Everyone makes mistakes. But when it comes to your credit report, what you may consider a minor mistake can be reported on your credit report for years. 1 So if you’re working on repairing your credit, you might jump at the chance to settle debts for pennies on the dollar. But like most things that sound too good to be true, debt settlement may not be all it’s cracked up to be.
Before you agree to a debt settlement, know the perils as well as the perks.
Paying Some of the Debt Isn’t the Same As Paying All
What happens when you pay a collection agency for debt? They’re going to report the debt paid per the terms of your settlement, not the original terms. This means the debt may be reported as settled for less than the amount originally owed.
Forgiven Debt Is Taxable Income
What’s more, forgiven debt isn’t just a form of “free money.” The IRS considers it taxable income and expects you to report it along with the rest of your earnings. 3 Especially for people who had a significant sum forgiven as part of a debt settlement, that might not just be extra money you have to come up with in April. It might bump you into a higher tax bracket, causing you to owe more on the income you actually earned.
The bottom line? Evaluate the perils and perks of debt settlement. It’s the best course of action.