Considering debt settlement to resolve a collection lawsuit or otherwise pay off your unpaid debts? Here are some guidelines to consider as you weigh your options.
Be realistic about debt settlement, especially if you have multiple debts
We’ve settled hundreds of debts over the years and have found that a typical range for settlement is between 40% and 80% of the full amount sought. Keep in mind that this range is for a lump-sum settlement that you pay all in one shot. Where you land in this range will depend on your negotiating skills, your overall financial picture, and whether you have any defenses to the debt. Despite what you may read elsewhere, settlements for pennies on the dollar are very rare, especially if the creditor is suing or garnishing you.
If you’re unable to afford a lump sum payment in the 40% to 80% range, most creditors will take smaller monthly payments over a couple of years. But in exchange for the flexibility of a low monthly payment, you’re going to have to pay the full balance or pretty close to it.
If you’re considering settling multiple debts rather than filing bankruptcy, be brutally honest with yourself. Do you really have the resources to pay 40% to 80% of all of your delinquent debts in a lump sum? Can you realistically afford monthly payments for all of your debts? If not, consider another solution.
When negotiating with your creditors, remember that it’s a process
If you’ve done a sober analysis of your finances and decided that you can afford to settle your debts, the next step is to reach out to your creditors and begin the negotiation process. Target a realistic settlement amount and make an opening offer somewhat lower than where you hope to land. Remember that there will likely be some back and forth during the negotiations, so you want to have room to increase your offers as the negotiation proceeds.
We’ve found the process is smoothest if you make the opening offer. A common negotiation technique is to open with approximately half of where you hope to finish at. Your goal should be to get the ball rolling and coax the creditor into making a counteroffer that is less than the full balance. You can then increase your offers slightly to nudge the creditor further down toward your target settlement. Consider sharing a little bit about your finances if you think it will help your bargaining position.
Get the agreement in writing before you make your settlement payment
Once you've reached a verbal agreement with the collector, ask them to send you confirmation of the agreement in writing. Read the agreement carefully to be sure that it actually contains the terms that you agreed to. Any reputable debt collector will be willing to confirm a payment arrangement in writing, so be wary of one who won't. Keep the settlement letter for your records in case there’s a problem later.
When the time comes to finally make the settlement payment, make sure to keep a copy of the payment. For example, if you're paying with a personal check, get a copy of the canceled check from your bank. Similarly, if you're paying with a cashier's check, make a copy of the check and send it using certified mail. Along with the settlement letter, your proof of payment may be needed in the future to prove that you settled the account.
Be sure to get the proper follow-up documents
The appropriate follow-up documents vary depending on what point in the legal process you’re at when you settle the debt:
If you settle the debt before you get sued, the collector's written confirmation of the agreement, plus your proof of payment, should be sufficient.
If you settle the account after you've been sued, but before a judgment is entered, the collector should send you (and the court if the case has been filed) a dismissal WITH prejudice. A dismissal with prejudice means that the claim is fully resolved and can't be brought against you again. Don't accept a dismissal without prejudice if you've settled the account in full because there's a possibility that you could get sued again for the same claim.
If you settle the account after you've been sued and after a judgment has been entered, the collector should send you and the court a satisfaction of judgment. And if your wages were being garnished at the time you settled the account, the debt collector should quash the garnishment.
Consider the tax consequences of any settlement
Before agreeing to any settlement, make sure you understand the tax consequences of it. In general, forgiveness of debt is considered income and you must pay taxes on it. There are exceptions to this rule, so it’s worth talking to your tax preparer to see if any of the exceptions apply to your situation. Your tax preparer may also be able to estimate the amount of taxes you will have to pay if you go through with the settlement.
Many creditors will send a 1099-C form to you and the IRS stating the amount of debt forgiven. It may be possible to get the creditor to promise not to send a 1099, but not all creditors will agree to this.
make sure your credit report gets updated after the settlement
Once you’ve made the settlement payment, it’s a good idea to check your credit report to verify that it has been updated. We recommend waiting 60-90 days after making the payment because it can take a few months for credit reports to update.
We suggest using AnnualCreditReport.com. This is the only website where you can get a free report. Make sure to download the report and save it for your records.
Once you have your credit report, make sure that the account that you settled is being reported properly:
If you’ve made all the necessary settlement payments, the account should be reported as "settled, less than full balance" or something similar.
If there was a court judgment, make sure it is being reported as "satisfied.”
If you’re still making settlement payments, it’s likely that the account is still reporting as delinquent. Check back when you've made all the payments to be sure it's been updated to settled status.
We often get asked whether it’s possible to negotiate a “pay for delete.” This means that in exchange for your settlement payment, the creditor agrees to delete the credit report trade-line altogether. In our experience, this is a rare outcome. There’s no harm in trying to negotiate it, but it probably doesn’t make sense to let the settlement fall apart if the creditor won’t agree to a deletion.
Want to talk to a lawyer about debt settlement?
Schedule a free consult with debt defense lawyer Todd Murray.
Since 2009, Todd has helped hundreds of Minnesotans resolve their unpaid debts, saving his clients millions of dollars in the process. Todd’s clients have described him as “very professional and easy to work with.” He lives in Minneapolis with his wife and four children.