How to negotiate a settlement with a debt collector

When you're facing a debt collection lawsuit, you usually have three options to get it resolved: (1) negotiate a settlement; (2) answer the lawsuit and challenge the case; and (3) file bankruptcy. If you decide to try to negotiate a settlement of the lawsuit, here a five tips to get the best possible deal.

If possible, negotiate a settlement in a lump sum

The best way to get a good deal from a debt collector is to offer a lump sum settlement. Debt collectors usually have blanket authority to settle debts for between 40% and 80% of the full balance if you pay the settlement in a one-time payment. If you're unable to afford a lump sum payment, the debt collector usually has the authority to agree to smaller monthly payments, often over a couple of years. But in exchange for the flexibility of a low monthly payment, you're probably going to have to pay the full account balance.

The last day of a month is the best day to get a great deal

Debt collectors have monthly goals that they must meet and there are significant consequences if they don't meet those goals. If a collector is short of their goal on the last day of the month, they may be willing to accept a lower settlement amount than they normally would. To take advantage of this, however, you'll probably have to make the settlement payment that day. So plan accordingly.

Insist that the debt collector confirms any agreement in writing, before sending them any money

Once you've reached a verbal agreement with the collector, ask them to send you confirmation of the agreement in writing before turning over your money. 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 a record of your payment

If you're paying with a personal check, get a copy of the canceled check from your bank. If you're paying with a money order or cashier's check, make a copy of the check and either note the date that you mailed it or, better yet, use certified mail. If you pay in cash or make the payment in person, be sure to get a receipt. Along with the collector's written confirmation, 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 are 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.

Why did a debt collector send me a 1099-C?

Some consumers are surprised to receive a 1099 from a lender or debt collector they dealt with in the last year, counting income to the consumer for debt forgiveness. The amount on Form 1099-C states the income "derived" from the forgiveness or settlement (for less than the full value) of a debt. Because the lender wrote off a debt (or a portion of a debt) it believed it was owed, it has the right (but not necessarily the obligation) to charge the income to you. Here are some exceptions:

  • A lender can't send a 1099-C for debt discharged in bankruptcy. If a debt was discharged in bankruptcy, the lender can't issue a 1099-C for debt forgiveness. However, let's say a debt was settled in January of 2010, and then you filed bankruptcy in February--then the debt forgiveness would be income.

  • You were "insolvent" when the debt was forgiven. The insolvency exception is a powerful tool for many people. If, on the day before the debt was settled or forgiven, all your assets (including your retirement accounts) were less than your total debts (including your mortgage)--then you don't have to count a 1099-C as income. File IRS Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness

  • The debt is disputed and the lender can't prove you owed it. If you don't owe the debt and the lender can't prove it's legit. you may be able to contest a 1099-C. Contact a tax attorney for help.