Part 3 of the 4-Part
Debt Settlement Series
Long-term debt settlement carries significant risks. That’s why we only work with clients who have the financial ability to settle or make payment plans on their debts relatively quickly. It’s important that you fully understand the potential downsides of trying to settle over a long period of time.
When you’re already struggling financially, you can’t afford to take on unnecessary risk. Making an informed decision is critical.
Please take the time to read this series carefully. It covers important information that most debt settlement companies often don’t explain.
This is Part 3 of a 4-part series. If you haven’t read Part 1 yet, we recommend starting there first.
In a typical long-term debt settlement program, the money that would normally go to your creditors is instead set aside until one account can be settled. Until that happens, those creditors are not being paid. The only time an account is financially addressed is when it is actually settled.
Debt collectors pay close attention to previously settled accounts on your credit report. Once they see that you’ve already settled some debts, they often become less willing to negotiate on the remaining ones.
There is a reason for that. In Jared’s collection experience, about 1 in 5 accounts were voluntarily paid. When a collector sees a settlement on your credit report, they no longer view you as someone who might ignore the debt. They view you as extremely collectable. The more collectable you appear, the less negotiable they become.
As you settle accounts one by one, your “collectability” increases in their eyes because you're financially committed and you now owe on fewer accounts. This typically leads to less favorable settlement offers. In some cases, collectors may even accelerate collection efforts — including filing lawsuits — to pressure you for the full balance.
Settling debts one by one over a long period of time can actually increase your chances of failure and cost you a lot of money.
A 2020 study commissioned by the debt-settlement industry found that 22% of enrolled consumers settled all of their accounts within 48 months.
Many people who enroll do not finish.
Let’s look into the future for a moment and use a typical 48-month debt settlement plan as an example. Suppose you settle some of the accounts and stop halfway through. In this case, that is about 24 months in.
That means you haven’t made any payments to the remaining creditors for at least 24 months. Those accounts will usually be charged off, and you will be in very dangerous territory. From a credit standpoint, you won’t fully begin to recover until every delinquent account is resolved. So at this point, you have received very little benefit toward rebuilding your credit.
If a collector sues and wins, the remaining balances may also be higher because of interest, attorney fees, and court costs. And the problem is no longer just a larger balance. A judgment can often be enforced through a lien on property, a levy on a bank account, or wage garnishment.
All of the money you spent on your first settlements and program fees is potentially wasted if the remaining accounts are not resolved. That gets much harder once those debts are placed with collection attorneys, because those accounts are often much less negotiable.
Some people face one or more lawsuits and eventually file for bankruptcy. If that happens, the money spent on the partial settlements was wasted — and so was the time. If you had filed Chapter 7 to begin with, you would already be 24 months into the recovery process, and that same money you spent on the settlements could have been used to rebuild your financial security after bankruptcy instead.
The main reason this happens is that most people aren’t financially able to settle all of their accounts fast enough.
That is why we only offer it when it can be done relatively quickly.
If you are not yet behind on your accounts, it’s important to first consider whether falling behind is even necessary to solve your problem. You’ve worked extremely hard to build your credit, and debt settlement will damage it.
If you are already behind on your accounts (or about to be), expect your credit to suffer until you settle and make the final payment on your last account. Full recovery generally begins once that final payment is made. From that point, it typically takes about 2 years to meaningfully rebuild your credit.
When a debt is settled, it usually reports as “Settlement Accepted” or “Paid in Full for Less Than the Full Balance.” While this is better than an unpaid charge-off, it is not as favorable as “Paid in Full.” For this reason, it can be wise to exclude smaller balances from your debt settlement strategy — the difference in credit reporting is often not worth the savings you would achieve on those accounts.
About 24–48 months to finish, then about 2 years to rebuild.
About 6 months to finish, then about 2 years to rebuild. Some finish sooner. Some take longer.
About 4 months to discharge, then about 2 years to rebuild.
It generally takes about 2 years to meaningfully rebuild your credit after settling and paying your last delinquent account. In contrast, most people who file Chapter 7 bankruptcy are able to reestablish their credit within about 2 years of discharging as well — often years faster than recovering from a long-term debt settlement program. Jared is a big fan of Chapter 7, when compared to a long-term debt settlement approach.
Before your accounts charge off, interest, late fees, and over-limit fees can continue to accumulate. Once an account charges off, interest and fees generally stop. However, if you are sued and lose, the court may award attorney fees, court costs, and post-judgment interest.
Settling or entering into a payment plan quickly can reduce this risk.
When you settle a debt for less than the full balance, your creditor may issue a 1099-C for the forgiven amount. This forgiven debt is generally considered taxable income unless you qualify for the insolvency exclusion.
Insolvency is a net-worth test. You add up the fair market value of your assets, add up your liabilities, and subtract. If your debts are greater than your assets, you may be able to exclude some or all of the forgiven amount. That exclusion is claimed on IRS Form 982. For additional reference, see IRS Publication 4681.
Settling accounts one by one can shrink the insolvency exclusion and make the resolution much more expensive. Each forgiven account lowers your liabilities before the next one is settled. Settling them close together is more likely to preserve the negative net worth, so more of the forgiven amount can be excluded. This timing is often overlooked. Most settlement companies talk about the 1099-C. Few talk about how settling one account at a time can use up the exclusion before the later accounts are forgiven. Our job is to resolve the debts for the least cost we can, and to flag that exposure before you hire us.
For this reason, we assess your potential tax exposure during the consultation. We’ll review your potential tax liability in a cursory way and ask you to speak with a tax professional before deciding to hire us. The last thing we want you to do is blindly transfer your debt problem to the IRS.
And lastly, if you are still current on your accounts and do not qualify for the insolvency exclusion, settling may not make sense once you do the math. In those situations, a credit counseling approach can make more sense.
If you want to settle, there are a host of reasons to settle quickly or to make payment arrangements to regain control and settle simultaneously later. These include minimizing your exposure to lawsuits, post-judgment interest, attorney fees, court costs, higher settlement costs, and taxes. Our approach also increases your visibility into your overall spend, is likely to speed up your credit recovery, and gives you a clearer path to finishing.