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WalletPrep worksheet · Debt

Is debt settlement worth it?

Name ____________________ Date __________

Key ideas

  1. Settlement usually starts with missed payments. Creditors rarely settle with someone who is current. Months of missed payments add late fees, interest and damage to your credit.
  2. No fees before a debt is settled. Under FTC rules, a debt settlement company can't collect fees until it actually settles a debt. Upfront fees are a scam sign.
  3. Forgiven debt can be taxable income. If $600 or more is forgiven, expect a Form 1099-C. You may owe tax unless you were insolvent or another exclusion applies.

Vocabulary

Canceled debt
Debt a lender forgives or settles for less. The IRS generally treats the forgiven amount as taxable income.
Debt settlement
A deal where a creditor accepts less than the full balance, usually after months of missed payments.
Debt management plan
A repayment plan set up by a credit counseling agency, where you make one monthly deposit and the agency pays your unsecured debts, often at lower rates.
Charge-off
When a lender stops expecting payment on a debt and writes it off as a loss, usually after about 6 months of missed payments. You still owe it.
Collections
When an unpaid debt is handed or sold to a debt collector after missed payments. It can hurt your credit score.
Statute of limitations
The deadline, set by each state, for a creditor or collector to sue you over a debt.

Work it out

Sam has $10,000 of credit card debt at 24% APR. He joins a program, stops paying for a year, then settles for half. Assume a fee of 20% of the debt.

  1. Debt enrolled
  2. Interest in 12 months unpaid
  3. Balance at settlement
  4. Settlement payment (50%)
  5. Company fee (20% of $10,000)
  6. Tax on $6,341 forgiven at 12%
  7. Sam's total cost
  8. Plan at 8% APR, $400/mo, 28 months

Check yourself

  1. A collector agrees to settle a $4,000 balance for $2,500. How much debt is forgiven?

    • A. $2,500
    • B. $4,000
    • C. $1,500
    • D. $6,500

  2. When can a debt settlement company collect its fee?

    • A. After it settles a debt with one of your creditors
    • B. When you sign up
    • C. Monthly from the start of the program

  3. Which option lets you repay the full balance at a lower rate while staying current?

    • A. Debt settlement
    • B. A debt management plan
    • C. Stopping payments
    • D. A payday loan

Your turn

List each debt with its balance, APR and how far behind it is. Then book a free session with a nonprofit credit counseling agency and ask what a debt management plan payment would be.

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Answer key

Is debt settlement worth it?

Work it out

  1. Debt enrolled$10,000
  2. Interest in 12 months unpaid$2,682
  3. Balance at settlement= $12,682
  4. Settlement payment (50%)$6,341
  5. Company fee (20% of $10,000)$2,000
  6. Tax on $6,341 forgiven at 12%$761
  7. Sam's total cost= $9,102
  8. Plan at 8% APR, $400/mo, 28 months$10,976
  1. At 24% APR, interest is 2% a month. After 12 months unpaid, $10,000 grows to $12,682, before any late fees.
  2. Half of $12,682 is $6,341. Add the $2,000 fee and 12% tax on the $6,341 forgiven ($761): $9,102.
  3. A debt management plan at an assumed 8% APR, $400 a month, costs $10,976 over 28 months, and Sam's on-time payment record stays intact.

Check yourself

  1. C. $1,500 $4,000 − $2,500 = $1,500 forgiven. Since it is $600 or more, expect a Form 1099-C, and it may count as taxable income.
  2. A. After it settles a debt with one of your creditors FTC rules ban fees before a debt is settled. The company can charge part of its fee each time it settles one account.
  3. B. A debt management plan A debt management plan from a nonprofit credit counselor often lowers interest rates, and you keep making on-time payments.