Tactics to handle old debt and preserve your credit scores.
Money Girl
286 MG Settle Debt or Pay in Full-What's Better for Your Credit?
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I'm Laura Adams, and you're listening to the Money Girl podcast. Many people are tempted to settle an old debt for less than they owe, but they're unsure about how it would affect their credit. Deanna asks, "I don't have a huge amount of debt, but it's killing my credit score and I want to get rid of it. Is it better to pay an old credit card debt in full or to settle it for less?" Debt settlement is the process of making a large one-time payment toward a debt in exchange for having the balance of the debt forgiven. For instance, let's say that Deanna has $6,000 in credit card debt, and she hasn't been able to make minimum payments for many months. The credit card company may approach Deanna, or she could contact them about settling the debt for $3,000 and canceling the remaining 3,000. How much you can settle a debt for is always negotiable, and the higher your balance, the bigger the discount you're likely to receive on a percentage basis. Settlement is typically an option for unsecured debts, like credit cards and medical bills that are not backed by collateral that could be seized by the creditor and sold to pay off the debt, as is the case with a car or home loan. In general, an unsecured creditor would rather get a smaller upfront payment than risk getting no payments on the account. If you have a lump sum of cash to make a debt settlement, paying less than you owe may sound like a dream come true. However, there are drawbacks to be aware of. The first downside to settling debt is that it shows up on your credit report. Anytime you pay less than you borrowed, including interest, you damage your credit history and credit scores. Negative information, like late payments or a settlement, remain in your credit file for up to seven years from the original delinquency date. Making a payment or settlement doesn't reset the clock and cause negative information to stay in your credit history any longer. If your credit scores are already in the dump because you missed payments or the account was turned over to a collection agency, taking a settlement will probably have little or no additional negative effect on your credit scores. Just remember that a settlement on your credit file looks bad to potential future lenders because it shows that you have a history of not paying back what you borrow. A second downside to settling debt is that you typically owe tax on any amount that's cancelled or forgiven. Creditors are required to report forgiven debt that totals $600 or more to the IRS, which means that you'll receive Form 1099C at the end of the year and must include the amount on your tax return. There are exceptions when you don't have to include forgiven debt in your income, including debt on a principal residence as outlined in the mortgage debt relief act, debt discharged through bankruptcy, and debt if you are insolvent, which is when your total debts exceed the fair market value of your total assets. This isn't a complete list of exemptions, so be sure to refer to IRS publication 4681 or consult with a tax accountant for more information. So Deanna wouldn't have to repay the credit card company $3,000 if she settled, but she'd still owe Uncle Sam a big chunk of it depending on her income and tax situation. The settlement saves her money, but means she might have to come out of pocket for an unexpected tax bill. If having good credit is your main priority because you want to qualify for a car or home loan in the future, paying off an old debt in full is the best option. For some, paying off debt as agreed is a matter of pride and ethics. But if your objective is simply to repay as little debt as possible, settling is the best route. Don't fall into the trap of mistakenly believing that if you don't pay an old debt, that it will just disappear. Nothing could be farther from the truth. As I mentioned, unpaid debt gets wiped off your credit report after seven years, but you still legally owe the money. Unless a debt is forgiven or discharged through bankruptcy, the creditor can attempt to collect from you forever. However, a creditor can't sue you once the statute of limitations for debt has expired. This is a legal window that varies widely by state and by the type of debt. In general, it begins from the date of your last account activity. Therefore, in some states, making a payment or settlement on an old debt can reset the clock on the statute of limitations. If you're considering settling an old credit card debt, here are three tips. Number one, get your agreement in writing. Never pay a debt settlement until you receive a signed agreement showing that your payment will satisfy the entire debt and that the creditor gives up their rate to sue you for the unpaid portion. Number two, reduce spending on the card. A card company won't view you as a customer who deserves their sympathy if your statements show that you've been splurging on spas or designer shops, cut back or stop making charges on the card several months before you request a debt settlement. In Colorado, our freedoms are everything. Gabe Evans would rip them away. Just like Lauren Beaubert, he'd ban abortion without exceptions for rape or incest and overturn the right to marry for same-sex couples. Don't let him take our freedoms. Paid for by DCCC, www.dccc.org, not authorized by any candidate or candidate's committee. H5N1 bird flu is spreading in some animals. If you work with poultry, dairy cows, wild animals, or withdraw unpasteurized milk, wear protective gear and take precautions. cdc.gov/birdflu, a message from CDC. I love learning and anything that makes learning easier. If you're a parent and your child needs some homework help, then Ixcel is a right for your family. Ixcel is an online learning program for kids covering math, language arts, science and social studies. Ixcel has interactive practice problems for topics from pre-K to 12th grade and everything is organized by grade and subject. As kids practice, they get positive feedback, awards, and explanations for wrong answers. Ixcel figures out what your kids need more help with and recommends more topics to practice. Their videos, lessons, sample problems, and learning games too. One subscription to Ixcel gets you all subjects and all grade levels. Membership started just $9.95 a month. It's no wonder Ixcel is used in 95 of the top 100 school districts. I think the positive feedback that Ixcel gives is really crucial when it comes to learning. So make an impact on your child's learning. Get Ixcel now and money girl listeners can get an exclusive 20% off Ixcel membership when they sign up today at Ixcel.com/moneygirl. Visit Ixcel.com/moneygirl to get the most effective learning program out there at the best price. And three, make a low initial offer. Start by offering to pay a dollar amount that's about 25 percent of what you owe and expect the creditor to make a higher counteroffer. If a creditor doesn't agree to a debt settlement, ask about other opportunities to save money. For instance, request that they reduce your interest rate, lower your monthly minimum payments, or allow you to temporarily stop making payments. If you have access to cash to make a debt settlement, think carefully about the best way to use it. You may need the cash for everyday living expenses or consider using it to file for bankruptcy instead if your financial situation is really dire. On the other hand, spending cash to pay off debt at a huge discount could make sense if your financial situation is starting to improve. You'll get a lot more money advice and tips when you sign out for the free Money Girl newsletter, join the Money Girl Facebook page, or follow on Twitter where my username is @laraatoms with no space. To get links to everything I've mentioned, there's a transcript of this show on the Money Girl page at quickanddirtytips.com. Just look for episode number 286 called "Settle Debt or Pay in Full What's Better for Your Credit." I'm glad you're listening to change. That's all for now, courtesy of Money Girl, your guide to a richer life. Is it time to reimagine your future? The right business skills may make a difference in your career. 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