An option that an individual can take in settling their accounts with their creditors is by settling the debts themselves. A consumer may deal directly with their creditor and make arrangements with them. If an account has been far behind on payments from the debtor, one of the lender's action plans is to offer a certain percentage of settlement to the debtor, proposing to forgive the remaining portion of the balance. If an individual opts for this choice, they are required to make the lump sum payment for the settlement. However, if the customer negotiates their balance with a collection agency or a junk debt buyer, they would be able to create a payment plan that would prove to be more manageable for the lender. Some collection agencies allow the debtors to make payments for the settlement amount in split increments over a certain period of time. For example, if Dana's creditor, Acme Sporting Goods, has agreed to give her a 50% settlement from her $6000 debt, she needs to pay the whole lump sum of $3000 to Acme if she deals directly with them. On the other hand, if her account has been transferred to collections, she can pay the $3000 in a span of 90 days. If you will be dealing with a collection agency on the matter, be sure to clarify the terms of your agreement with them and ask for a copy of it in writing, illustrating its terms and conditions. In some states, mere verbal agreements are not considered as valid, and may be considered voided if an individual is not able to obtain the necessary paperwork.
Aside from that, an individual can also inquire directly with the collections agency if the account can be settled through them. Some agencies require certain qualifications to be met before an account is eligible for settlement; the account needs to be open for at least a year, for example, or the account should not have been enrolled in other payment arrangements prior to the settlement. If you are interested in doing this, it is best to ask the collection agency that you will be speaking with.
More people are opting to do-it-yourself debt settlement. The biggest advantage that it can offer is that debtors do not need to worry about any more expenses. Since they will be directly negotiating with the creditors or their collection agencies, they have no obligations to pay for any extra amounts on administrative and service fees. The debtor also has a greater degree of control as to where their payments would go. There is an assurance and security in knowing that the payments the debtor would be making would be going directly to their account, and not with a third party.
What happens to the remaining of the amount?
The amount that the lender agrees to forgive is considered as taxable income. If an individual has a forgiven debt amounting to $600 or greater, lenders will report the forgiven amount in their settlement agreement to the Internal Revenue Service. For instance, if Kurt was granted a $3500 settlement from an original $8000 balance on his North Park Shore Bank credit card, the remaining $4500 is deemed as income. In effect, it will be included in an individual's yearly earnings in order to determine their tax liability. His bank needs to provide him with a 1099-C form, which will illustrate all the amounts of forgiven debts.
The IRS may not require debtors to report any instances of forgiven debts if they are considered “insolvent.” When an individual is in the state of insolvency, it means that the amounts of their debts are greater than their current assets. The IRS still stresses that in spite of insolvency, the debtor still is required to report all taxable income that was earned.
Some related resources:
How does debt settlement work
How does debt settlement affect your credit report?