Can Settled Debt Hurt My Credit Rating?

by Eugene Melchionne, Esq.

March 28, 2007

The secret to settling debt with your creditors is assure finality. You want to make sure that the debt never comes back. (Read: Zombie Debt Haunts the Discharged and Zombie Debt.) Can debt be settled? Absolutely. However when you negotiate to settle your debt you must make sure that the creditor reports it properly on your credit report.

Will settled debt hurt your credit score? Yes, it will. Even though you stepped up the plate and paid something on the bill to get rid of the obligation, do not be surprised if the creditor reports it on your credit reoprt as ‘delinquent’, ‘charged-off’, or ‘settled-not paid in full’. Since you paid less than what the creditor calculated that was owed, the creditor can report the settlement in a negative way. It WILL hurt your credit score.

Another side effect of the settlement will be a 1099. A what???  A 1099 is a report to the IRS that you got something for nothing. The IRS has determined that the event is taxable as income. So the bank gets a deduction for the portion that you didn’t pay and you have to pay taxes on that portion. Talk about insult to injury!

You should make sure that before you settle with a creditor that they will not put a negative entry on your credit report and they won’t be sending a 1099 to you later. Then get that assurance in writing before you send any money.  After all, you could spend all that money to pay your creditors and find out that you still owe later when you could have considered the bankruptcy option and saved the expense.

Sometimes, bankruptcy can be a viable alternative to a debt management plan by payments negotiated from a credit counseling company or debt settlements with your lenders.

“ConnecticutGene Melchionne is a bankruptcy lawyer covering the entire State of Connecticut. He can often be found on Google+ and Twitter, where he shares information about consumer protection issues and personal finance.

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Last modified: November 19, 2013