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Advice on Whether you Should Settle or Enter CCCS Program

I was told that it was better to use credit counseling instead of a debt settlement program. Is this true?

I was told that it was better to pay off the balance at the credit counseling instead of directly to the collection agency because it would show up as a bad debt on the credit report whereas if it is paid off to the counseling program, it will be better for the credit report.However, if it is paid directly to the collection agency, they will settle for less money. What is the truth? Will it really make a difference of how it appears on the credit report?

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Bill's Answer
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Highlights

  • Compare how consumer credit counseling and debt settlement affect your credit rating.
  • Understand that some creditors view enrollment in a CCCS program as equivalent to filing for bankruptcy, for as long as you are enrolled.

Credit scoring models are much to complex a calculation for me to predict the specific impact of any action on an individual consumer’s credit rating. I can provide you with some general guidance based on my past experience; however, since I do not know all the details of your financial circumstances, I cannot tell you how your decision to either settle this debt or enter it into Consumer Credit Counseling Service (CCCS) will impact your credit score. To read more about credit, credit reports, and credit scoring, I encourage you to visit the Bills.com credit resources page.

The first option you mention in your question are the services offered by consumer credit counseling service (CCCS) companies, which attempt to negotiate lower interest rates and monthly payments for consumers. If you enrolled in a CCCS program, you would pay the CCCS firm a single monthly payment, which would be disbursed to your creditors based on a pre-determined repayment schedule. As long as the CCCS provider pays your creditors on time each month, and the payment is large enough to cover the minimum payments, then a CCCS plan should not hurt your credit score. However, some CCCS programs do not make payments timely, or make payments which are too small, resulting in delinquencies on their members’ credit reports. If you are interested in enrolling with a CCCS firm, you should discuss these issues in detail with the firm before making your final decision. Also, although CCCS does not necessarily damage your credit score, some lenders consider enrollment in a CCCS program similar to filing Chapter 13 bankruptcy, so they may not extend you credit despite a positive credit score. To find out more about Credit Counseling, visit the Bills.com website.

You also mention that the collection agency managing this debt has expressed an interest in settling the account with you for less than the balance owed. One important issue to remember about settling a debt is that most creditors will require that the agreed upon settlement amount be paid in a single lump sum payment (or within a few months, at most); many consumers are unable to raise the funds needed to consummate a settlement agreement in the time required. However, if you have access to the funds needed to settle your account, debt settlement may be your best choice.

Keep in mind that when a financial entity forgives more than $600 in debt, the creditor is required to issue a 1099-C. When you receive a 1099-C, you may be required to declare the forgiven amount as income and pay taxes on it. It can be possible to avoid declaring the forgiven debt as income, if you are eligible to use the IRS Form 982. I recommend that anyone who has a forgiveness of debt issue to hire a tax professional to prepare the return that uses the Form 982. That way, the form is filled out properly and the tax pro can determine if you meet the IRS test for insolvency that is required to avoid declaring the forgiven debt as income.

If this account is already delinquent, which I assume it is since the creditor is offering you a reduced balance settlement, the credit impact of resolving the account should be roughly the same regardless of whether you choose to settle the account or pay off the full balance through CCCS. Settling the account will likely result in an account status of “settled as agreed” or “settled for less than full balance” appearing on your credit report. These statuses are not generally as good as a “paid in full” status, but the difference is negligible, especially on an account that is already delinquent. The key thing that will help your credit report is resolving the delinquent debt so it will report a $0 balance on your credit reports; how the account was resolved is not nearly as important, especially if the settlement will save you a significant amount of money.

As I said, the difference in how settlement and consumer credit counseling will affect your credit rating should be minima, if your account are already severely delinquent; the most important thing is that your account reflects a $0 balance, regardless of how the debt was repaid. In my opinion, the best approach available in these circumstances would be for you to settle this delinquent debt, and then open one or two new credit lines to begin rebuilding a positive payment history on your credit report. Use your new cards regularly, but make sure that you pay them off each month to avoid paying interest at the high rates charged by many credit card issuers. Taking these steps should provide you with the benefits and savings of a settlement while allowing you to continue building a positive credit rating.

I wish you the best of luck in resolving this debt.

I hope that the information I have provided helps you Find. Learn. Save.

Best,

Bill

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2 Comments

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  • LB
    Feb, 2011
    Lisa
    Sandy, UT
    I think that it is of the utmost importance that it is mentioned that if you decide to settle on debts, that you WILL be issued a 1099 form from the IRS because the difference becomes something like "earned income" and you pay taxes on it. You end up paying something like a third of the amount that was written off and the credit bureau will list it as "settled for less than the full balance" and sometimes list it also as "Charged off". I have been in the credit card industry for years and have seen what happens. CCCS is your best bet because they will get your interest rate very low.
    0 Votes

    • BA
      Feb, 2011
      Bill
      Your point about potential tax obligations for forgiven debt is sound. I have edited the posting, to include information about debt forgiveness. However, it is not the case that simply receiving a 1099-C means that the recipient will owe taxes on the forgiven amount.

      A person can avoid declaring the forgiven debt as income, if he or she is eligible to use the IRS Form 982. I recommend that anyone who has a forgiveness of debt issue to hire a tax professional to prepare the return that uses the Form 982. That way, the form is filled out properly and the tax pro can determine if you meet the IRS test for insolvency that is required to avoid declaring the forgiven debt as income. Even if one were required to pay taxes on a forgiven debt, paying taxes on a debt is a LOT cheaper than paying back all the debt (not to mention the interest that would have continued to accumulate). To illustrate, would you rather pay back the taxes you would owe on $10,000 income or pay back the entire $10,000?

      Lastly, if interest rate reduction is a person's most important goal, then CCCS is the way to go. However, if getting out of debt fastest or at the lowest overall costs is the primary goal, then debt settlement and bankruptcy are better than CCCS. Each person's should evaluate the pros and cons of each option, in order to make an informed decision.
      0 Votes

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