Common Objections to Debt Settlement

Damages Credit

The process of negotiating and reaching debt settlements with creditors requires the debtor to save up and set aside money into a settlement fund from which settlements are paid. However, due to the debtor’s financial hardship, the debtor is unable to make minimum payments towards credit card debts while saving up and setting aside money to payoff settlements. This inability to pay credit card bills while saving up money to payoff settlements results in the credit card company reported non-payment to credit bureaus (credit reporting agencies: Equifax, Experian and TransUnion).

Because payment history accounts for 35% of the FICO credit score calculation ([8] myFICO: What’s In Your Score), reports of non-payment to a debtor's credit file will lower the debtor’s credit score and reflect negatively on the debtor’s credit report.

The counter argument made by the debt settlement industry is that the good credit and the loose lending practices of the credit card industry enables consumers to accumulate an overwhelming amount of debt and all it takes is one financial hardship to interrupt the consumer’s ability to continue scheduled debt repayment. The other counter argument is that a consumer’s financial wellbeing is not always directly tied to their credit score and maintaining a credit score at the expense of basic needs is harmful to the consumer and the consumer’s family.

Increased Collection Calls

Another argument against debt settlement is that the failure to continue scheduled debt repayment results in increased debt collection activities that cause the debtor undue stress.

The counter argument made by the debt settlement industry is that many debtors are already being hounded by collection calls by the time they enroll in a debt settlement program. Many debt settlement companies offer assistance with alleviating collector calls and educate consumers about their rights as debtors as codified in the Fair Debt Collection Practices Act (FDCPA). Some companies actually change the phone number and address of their clients with the creditors to ensure that deal exclusively with the credit card companies.

While the FDCPA applied only to third-party debt collectors (not to creditors), some states passed legislation to supplement the FDCPA and to include creditors in their state consumer protection laws regarding debt collection.

Possibility of Lawsuits

The fear of lawsuits is often an objection to debt settlement.

The counter argument made by the debt settlement industry is that while creditors have the right to take legal action to collect on a delinquent debt and such lawsuits are filed against debtors, such lawsuits are not as common as the threats of lawsuits. Debt collection lawsuits rarely make business sense because the costs, time and other resources involved in legal action usually outweigh the return on these investments, even after receiving a judgment. Often, legal threats are made by collectors in an effort to make the debtor give that creditor account a higher pay-off priority.

Tax Consequences

Another common objection to debt settlement is that debtors whose debts are partially canceled outside the bankruptcy system will need to report the canceled portion of the debt as taxable income. (IRS Form 980)

The Internal Revenue Service considers $600 or more of forgiven debt as taxable income. The forgiving creditor must provide the taxpayer with a 1099-C tax form. This form will list the amount of forgiven debt and interest in Box 2. Taxpayers with portions of personal loans forgiven may not subtract the interest reported in Box 3 from the amount of reportable income on this form.

However, the IRS does not require taxpayers to report forgiven debt if the tax payer was insolvent at the time the creditor forgave the debt. Being insolvent means that the amount of a debtor’s debts are greater than his/her assets (how much money and property the debtor owns). However, the IRS adds that “you cannot exclude any amount of canceled debt that is more than the amount by which you are insolvent.� (IRS Publication 525)

For example, if a taxpayer is $10,000 in debt and owns $3,000 in assets, he/she cannot exclude more than $7,000 of forgiven debt from his/her income tax. Any forgiven debt over $7,000 that year must be reported as taxable income.

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