Today’s world runs on credit. Student loans, car loans, mortgages, the list goes on and on. Most of you have some debt or the other. There are different ways to take care of debt other than the conventional way of making monthly payments.
One such option is Debt Settlement, where a deal is negotiated between the consumer and creditor where the former decides to make a lump sum payment to the creditor. The amount is usually much lower than the original loan amount.
Creditors usually go for this settlement because this means that they get back a sizeable chunk of their money within a much shorter time period. However, there are several advantages and disadvantages to this. You should carefully consider both sides before going in for a settlement.
The pros of settling debts
One of the first pros to the client is that he gets to pay off his debt with a much-reduced sum of money as opposed to the loan amount. This can help the client save a lot of money. Sometimes, the amount paid is less than 50 % of the original sum of money.
Secondly, the monthly payments involved in Debt Settlement are obviously much lower than what you would be paying for the original loan. And since the amount is much lesser, the time period will also be much shorter. So in the short term too, it involves saving quite an amount of money. The time is usually between 24-36 months.
Thirdly, the number of monthly payments and the time period are all very flexibly handled by the creditors. You are given the freedom to modify as and when you require to.
Lastly, it is always a better option if the client is faced with bankruptcy. Settling a debt is always a better financial decision than declaring bankruptcy. The negative effect of a bankruptcy on your credit report is higher than that of a debt settlement.
The cons of settling debts
There are also quite a few downsides to debt settlement too.
Firstly, debt settlement badly hits your credit report. Your report gets affected for the next seven years at least. It shows that the client settled his debt with his creditors for a much lower sum. This discourages future creditors who fear that they might face the same loss. Thus it is not a good option if you are planning to take a loan in the near future.
Secondly, only go in for debt settlement if you are confident that you can make all the monthly payments within the short term. Otherwise, it could leave you high and dry.
Another con that not too many people are aware of is the taxation involved. The amount that is forgiven by the creditor is added to your taxable income. If that sum is large then it can push your income tax slab up to the next higher bracket. This means you have to pay more tax for money that you haven’t even got.
If you do go in for debt settlement make sure that you have the money in hand and some to spare. The settlement will take up a huge chunk of your money because of the lump sum payments so you need to have backup finances to survive.
However, make sure you take up the services of an established debt settlement company who will do all the negotiations for you and make the process as hassle-free as possible. Beware, there are many fraudulent companies out there so always check with the Better Business Bureau.
Finding Debt Settlement Help
Debt relief and debt settlement are important topics in our unstable economy. Some refer to our current economic woes as a second Great Depression. Regardless of how people view it, Americans are struggling with their debt.
Unknown Facts About Debt
Did you know that you can work with your lenders in an effort to settle your debt? Most people have good intentions when opening credit lines or getting loans. Things happen that affect our lives. People lose jobs. People get injured. People are stuck with the decision of paying their bills or feeding their family.
You have three options to debt settlement. You can hire a company that specializes in debt settlement. They will work directly with your lenders to negotiate a settlement. You can hire an attorney to contact the company on your behalf.
The benefit of hiring an attorney is that they know the credit card and debt laws that will apply to your specific situation. You can contact your lenders directly and attempt to settle your debt.
The first thing to realize is that the settlement process takes time. This is not something that can be done within 24 hours. It does not matter if you choose to hire someone or do it yourself. Your financial history with the lender will be reviewed by more than one person before a settlement offer is issued.
The second thing to realize is that you need to have money on hand for the settlement. This shouldn’t be a conversation of, “Yes, I will settle my $10,000.00 debt for $5,000.00 if I can convince someone in my family to loan it to me.” Debt settlement should be attempted only if you have the funds available to pay.
Beating Collections
Settlement attempts are best before the account is in collections. Yes, an account that is in collections can be settled. In fact, they often are settled because a company would rather make some money than no money. If an account is in collections, it will reflect poorly on your credit.
Come up with a debt settlement strategy if you are attempting to do this on your own. Have a factual history written out about what has led you to this point.
Include all history that you have of your on-time payments, any previous pay-offs, and any other information that shows that you have been a customer of good standing for the majority of the time that you’ve had the account.
Read over the Fair Debt Collections and Practices Act. It explains when and how often a creditor can call you. Knowing your rights is very powerful in a situation that you are dealing with creditors.
When you are negotiating, don’t agree to the first amount the creditor or collection agency suggests. If your account is with a collection agency, it has fees that were charged by the collection agency. The goal is to pay less than what you owed.
Try and negotiate below that amount. The power of a lump sum of cash can be seen at this time. While some creditors will accept a payment plan, the power of cash will allow you to make a one-time payment that is lower than one that you would pay out in installments.
Staying On Top Of Agreements
It is very important that you get the agreement in writing. Do not give them your bank account information. Make sure that the writing stipulates that this is a pay-off and that you will no longer owe them once you send them the money.
Send the money in the form of a cashier’s check. Make a copy of the cashier’s check and send it via certified mail. This will give you proof that the debt was paid.
This does not mean that the account will not appear on your credit report. This is particularly true if the account was in collections. When you negotiate, ask that after the account is paid that they list that the account was paid and closed on your credit report. If they agree, get it in writing.
Debt settlement is possible, but it can often be stressful. It is vitally important that you manage your credit score and your finances. Consult with an attorney about debt relief options if you cannot get your lenders to agree to settle.
Is Debt Settlement Right For Me?
Debt settlement is an option for those who are behind on paying their debts. It’s an alternative to bankruptcy and may allow you to reduce the overall amount you owe. Some people handle negotiating a debt settlement for themselves, while others choose to hire a company to handle the negotiations for them.
Debt settlement works in this way:
You offer to pay less than you owe in exchange for the rest of the debt to be forgiven. It is possible to negotiate down to 20 or 30 percent less than the original amount you owe. It is important to remember that debt settlement only works on debt without collateral, like credit cards or personal loans.
Debt settlement does affect your credit score negatively since the debt will be listed as settled, but it’s better than having an unpaid or overdue debt on your credit history. And it can certainly be a better option than bankruptcy.
Debt settlement can help you clear your debt much quicker than paying it off, and allows you to pay something towards your debt, which can alleviate your concerns if you feel bad because you haven’t been able to meet your obligations.
But debt settlement does have a dark side
It will have a negative effect on your credit since the debt won’t be listed as paid in full. You’ll also only be able to address one debt at a time, which means you could still have to deal with debt collectors. The one-at-a-time process means it will take much longer to rid yourself of your debts than you’d probably like.
Negotiating your debt settlement on your own is possible. You’ll need to first develop a list of your current delinquent debts. Try to save as much as 50 percent of the total amount of each debt, and call the lender and offer the amount as a settlement in full.
You will want to request that the lender send you a written settlement agreement, and wait to receive it before you send in payment, just so you are protected both at the time of settlement and in the future.
Bear in mind that there are alternatives to settlement. You can set up a debt payment plan, in which you list your debts in order, smallest to largest, or highest interest rate to lowest. Then you can pay a little extra each month until the debt is repaid. You can also make payments as you save up to pay off the debt in full.
Some people turn to bankruptcy when they feel they’re in over their heads, seeing it as an easy out. However, it is crucial to remember that bankruptcy can severely affect your credit score and will make it much more difficult for you to borrow money in the future.
The Unintended Tax Consequences Of Debt Settlement
Forgiven Debt = Taxes
If you are settling a debt for less than the full amount owed, it is important to know that you will most likely have to pay taxes on the forgiven debt. The IRS normally considers forgiven debt of $600 or more as taxable income. Since most people are not aware of this tax rule, this ugly tax often rears its head at the worst possible time!
When you settle a debt for less than the full balance owed, the lender will most likely report the amount of the forfeited debt to the IRS. In addition, the lender should then mail you a Form 1099-C, Cancellation of Debt.
Many people who receive this form do not know what it is and throw it away – this is a huge mistake! If you had some type of debt relief assistance in the past year, the lender should have mailed you this form.
The form will show the original amount of the debt as well as the amount that was excused. It is very important that you report this on your tax return to avoid a future IRS audit.
Special Exceptions
Although debt cancellation is usually taxable, there are certain instances when this is not the case. One example of a forgiven debt is not taxable is the Mortgage Debt Relief Act of 2007.
This act cancels a portion of a homeowner’s financial obligation on their primary residence when the home is sold in a short sale and relieves the homeowner from having to pay debt forgiveness taxes.
For example, if the amount of the original mortgage loan was $850,000 and the home is sold in a short sale for $500,000, the $350,000 of forgiven debt is not taxable. This popular legislation was recently in the news when it was extended due to the “fiscal cliff” negotiations.
Home-equity credit lines also fall under the provisions of the Mortgage Debt Relief Act provided it can be shown that the funds were used for home improvements. However, it is important to remember to keep all receipts and records and to carefully document any improvements.
Careful record keeping is important because, if a home-equity line of credit is used for purposes other than documented home improvements, the amount of any canceled debt is taxable.
1099-C: Still an Unfortunate Reality
Taxes must be paid on debt that is forgiven on other large ticket items such as a rental property, second homes, car loans, business properties, and credit cards.
However, the IRS offers various tax settlement plans as well as other tax relief options such as bankruptcy or insolvency when a taxpayer does not have the means to pay the taxes on the amount of the forgiven debt. Remember, if you receive a 1099-C in the mail, this is a tax bill related to forgiven debt. Do not throw it away!
Don’t Settle For Harassment From Debt Collectors
There are few things worse than having to put up with the tactics used by debt collectors. You don’t know aggression until you start receiving notice that you’ve been put into collections and they want their money yesterday. But what many people may not realize is that they have certain rights when it comes to debt collection.
Mainly, these collection agencies are not allowed to terrorize you. You have rights thanks to the Fair Debt Collection Practices Act. This amendment has been protecting consumers since 1977.
Seek Out Legal Representation For Self Protection
However, don’t think that debt collectors won’t try to get past the provisions of the Act on technicalities or walk right up to the line without crossing it. If you suspect that the agency that is contacting you is running afoul of the law, you may have reason to seek out legal representation and take the debt collectors to court.
So, what exactly does the FDCPA prohibit? The following is a partial list. It is not meant to act as legal advice; rather it is for those who may find it to be of interest. Contact a lawyer for the professional legal advice you’re seeking.
A good chunk of the provisions deal with collection calls, arguably the most obnoxious aspect of the entire ordeal. Most people are familiar with getting unwanted calls.
Even if you’ve never been in debt, you’ve no doubt had your dinner interrupted by telemarketers and the like. The FDCPA puts some restrictions on these calls and if you notice that the collectors are ignoring these provisions, you may want to take legal action.
For one thing, they can’t call you continuously. If they call, you have the right to hang up. If they keep calling, that runs afoul of the FDCPA. If they call outside the hours of 8 am to 9 pm they are also breaking the law. Calling too early or too late is considered harassment.
Outstanding Debt
Keep in mind that you can also ask for proof that you even owe a debt. They have to prove that you have an outstanding debt otherwise they can’t call you. You also have a right to send written notice saying you no longer want to be communicated with regarding your debt.
There are exceptions in this scenario, and the debt collectors can contact you again through litigation if you refuse to pay. They cannot contact you at work if your employer has spoken to the collection agency and told them that they are not to do so.
If the harassment piles up and you still can’t get the collection calls to stop, it’s at this point that you’ll want to think about retaining an attorney.
First of all, if it becomes known that you’ve retained an attorney, debt collection agencies can no longer contact you.
Second, your attorney can advise you as to the best course of action. You don’t know whether or not you have a case until you get a real legal opinion.
By all means, read up about the FDCPA and do your research. But if you truly feel like you’re being harassed, it may be time to get the help of a professional.
Mortgage Term Deep Dive – Debt to Income Ratios
One of the more confusing terms you are likely to encounter when purchasing a home is the debt to income ratios. Most lenders prefer to keep these ratios within specific limits in order to ensure that you will pay your mortgage in a timely manner as well as meet your other obligations.
While some loan programs, such as those offered by the Federal Housing Administration (FHA), allow for higher ratios, most traditional lenders cap the ratios at specific ceilings.
You may hear a lender refer to the numbers 28/36 as their preferred debt to income. What is not always evident from this information is how the lender arrives at these ratios and what they mean.
Since lenders use these ratios to determine how much money you can afford to pay for a mortgage, it is important to dig deeper into their meaning and understand how they are calculated.
Gross income vs. expenses
The first ratio which is shown above like 28, is called a front end ratio. This number is somewhat misleading however since it is based on gross income, not on net after-tax income.
When calculating the “front end ratio” lenders take gross income and then divide that number by total housing expenses. Total housing expenses include mortgage payments, tax payments, and insurance payments.
The second ratio, 36, is called the back end ratio. This number is also based on gross income and includes housing payments, non-homeowners insurance payments and other debts including credit cards, car loans, student loans, etc.
While many traditional lenders prefer this number to not exceed 36 percent, there are cases where a lender may be willing to exceed that ratio, especially if some of the debt is not considered long-term debt. For example, a car loan with less than 12 months left on the note may not be included.
When things go wrong
Even when a borrower meets the debt to income ratios established by a lender, this does not always mean that they will be able to make all of their payments without problems.
Because these ratios fail to include payroll taxes, there is a possibility that a borrower may be in over their head even if their ratios appear to be in line with expectations.
Remember that debt to income ratios are intended to be a measure of how financially secure a borrower is. Before signing a mortgage, make sure that your debt to income ratios are within the standards allowed by the lender.
While lenders may not consider your income on an after-tax basis, it may not hurt to do some checking of your own and see what your ratios are based on actual take-home pay versus pre-tax pay.