Debt Settlement, Credit Reports and Debtor Reputation; American Financial Solutions Offers Tips for Protecting Consumers

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Paying less to get out of debt seems like a great solution. But there are real ramifications to your credit and credit score when using debt settlements to manage debt. Credit counseling agency American Financial Solutions provides the information needed to make the right decision about settling debt.

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American Financial Solutions

A settlement (on your credit report) doesn’t instill confidence that you will repay your debt

Many people dealing with unpaid debt have received letters or phone calls from collection agencies offering deals to settle accounts for less than the full balance owed. When someone settles a debt, it means they pay off a portion of what they owe to the creditor. This sounds very enticing, but that discount on debt comes at a very high cost to an individual’s credit report and reputation. Below, American Financial Solutions outlines the dangers of settling debt.

The damage done to a credit report from a debt settlement is significant. During the settlement process, many collection agencies make it sound as though, once paid, the account will show in good standing on the credit report. The reality is that the account will be marked on the credit report as settled for less than full balance. This is a derogatory mark and may cause future lenders to be leery of approving a loan application. It will also impact a credit score.

Dean KiloDavis, Loan Officer for HomeStreet Bank, says having a settlement on a credit report can result in being turned down for a loan. “A settlement doesn’t instill confidence that you will repay your debt,” says KiloDavis.

He explains it this way, “Imagine I ask you for a loan to be paid back in two weeks. Then you find out from a mutual friend they loaned me money. You are informed that I didn't pay them back when I said I would, and I paid back less than I borrowed. Would this knowledge make you comfortable giving me the loan in the amount I asked for?”

In addition to the damage to a credit report and the ability to borrow money, any type of debt forgiveness or settlement (except bankruptcy) may also result in higher taxable income. The Internal Revenue Service considers all or most settled debt or cancelled debt as taxable income, depending on the consumer’s asset-to-liability ratio (do they owe more than their assets are worth) at the time the debt was forgiven or settled. The individual will receive a 1099-C tax form from the creditor if $600 or more is forgiven. Also, while rare, creditors may sell the unpaid portion of the debt to a collection agency. The bottom line is that people may still be responsible for repaying part of the forgiven debt.

If someone is thinking about settling a debt, there are certain steps they can take to try and protect themselves. These include:

  • Deal with their creditor directly rather than using a debt settlement company.
  • Attempt to come to a settlement agreement with the original creditor, rather than waiting until the debt is sent to a third party collection agency.
  • Request that the creditor provide them with a 1099 – C form rather than sending the remaining debt to a collection agency.
  • Attempt to have any agreements with the creditor (or collection agency) in writing.

"The information on your credit report determines your ability to qualify for many things from car insurance, getting a job, and of course buying or refinancing a home," cautions KiloDavis, "but there are resources out there, like American Financial Solutions, who can get you back on track. Bad credit is not a death sentence. You can fix it, but it'll take some elbow work. Making that first call to ask for help can be scary, but when some of that weight starts lifting off your shoulders, you'll be glad you did it."

HomeStreet Bank is one of the largest community banks in the Pacific Northwest and Hawaii and has specialized in mortgage lending since 1921. They are an equal housing lender.

American Financial Solutions (AFS) is a non-profit 501(c)3 financial education and credit counseling agency that helps people find solutions for managing their money and improving their financial lives. Since 1999, AFS has helped individuals across the United States through one-on-one counseling, classes and the use of debt management plans. AFS is a member of the National Foundation for Credit Counseling (NFCC) as well as the Association for Independent Consumer Credit Counseling Agencies (AICCCA). AFS is also accredited by the Council on Accreditation (COA) and has an A+ rating by the Better Business Bureau. Find us and add us on Facebook, Twitter and Google+.

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Becky House