What Happens if You Can’t Save Up the Settlement Amount?
Settling a debt for less than you owe can be a great way to resolve what you owe and move on financially. But what happens if you agree to settle a debt, but then can’t save up enough money to make the lump-sum settlement payment? Unfortunately, rejecting a settlement after agreeing to it can leave you in a tough spot.
The Debt Settlement Process
First, let’s review what debt settlement is. Debt settlement involves negotiating with a creditor or debt collector to pay a lump-sum that is less than the full amount you owe in exchange for the account being considered “paid in full.” For example, if you owe $10,000 on a credit card, the creditor may agree to let you pay $4,000 as a full settlement of the debt. Some key things to know:
- You typically need to have fallen behind on payments to be eligible for settlement. Creditors are more willing to settle if they haven’t been receiving regular payments.
- Settlements often range from 30% to 60% of the total owed, but can sometimes be higher or lower depending on your specific situation.
- The lump-sum is usually due in one payment within a set timeframe, such as 30-90 days from when the settlement offer was made.
- Settling a debt has risks, including damage to your credit score and potential tax liabilities.
Now let’s look at what can happen if you aren’t able to save up the settlement amount within the required timeframe.
Your Credit Score Will Still Take a Hit
One big downside of debt settlement is the damage it causes to your credit score. When you stop making payments on a debt, that account will likely become delinquent and hurt your credit. Even if you then settle that account for less than you owe, your credit report will still show that adverse history. Settling a debt also leads to a separate notation on your credit report indicating it was settled for less than owed, which also hurts your score.
So if you agree to settle a debt but end up defaulting on the settlement, your credit score is still going to suffer a blow. The delinquency, settlement notation, and potential additional collection activity will all negatively impact your credit. Your score can remain damaged for years even if you aren’t able to go through with the settlement.
You May Owe Taxes on the Forgiven Debt
Here’s another consequence to be aware of – the forgiven debt from a settlement may be considered taxable income by the IRS. If a $10,000 credit card balance is settled for $4,000, the $6,000 in forgiven debt may be subject to income tax.
There are some exceptions such as if you are insolvent at the time of the settlement, but not being able to pay the settlement amount could make you ineligible for these exceptions. Make sure you understand the possible tax implications before agreeing to settle a debt.
The Creditor Can Resume Collection Efforts
When you agree to a settlement, the creditor usually agrees to suspend collections while you come up with the settlement amount. But if you ultimately default on the settlement, they are no longer bound by that agreement. The creditor or debt collector can resume their efforts to collect on the full original amount you owed.
This means you could face collection calls, letters, lawsuits or even wage garnishment if they obtain a judgment against you. The protections offered by the settlement agreement disappear once you fail to honor your end of the bargain.
Your Credit Score Will Still Take a Hit
One big downside of debt settlement is the damage it causes to your credit score. When you stop making payments on a debt, that account will likely become delinquent and hurt your credit. Even if you then settle that account for less than you owe, your credit report will still show that adverse history. Settling a debt also leads to a separate notation on your credit report indicating it was settled for less than owed, which also hurts your score.
So if you agree to settle a debt but end up defaulting on the settlement, your credit score is still going to suffer a blow. The delinquency, settlement notation, and potential additional collection activity will all negatively impact your credit. Your score can remain damaged for years even if you aren’t able to go through with the settlement.
You Have Fewer Options to Resolve the Debt
Once you default on a settlement, creditors will be less trusting of any new proposed payment plans or settlements. After all, you failed to honor the previous agreement. This makes it much harder to negotiate a new settlement or alternative payment arrangement.
Your only real options at that point are to try to come up with a lump-sum settlement amount, file for bankruptcy protection, or face continued collection efforts:
- You can try gathering funds from any means possible to make the original settlement payment. This may involve borrowing money, liquidating assets, or getting help from friends/family.
- Bankruptcy stops collections and can discharge remaining debts, but has serious long-term consequences. You would need to weigh the pros and cons carefully.
- If you can’t settle or file for bankruptcy, the creditor can continue trying to collect through calls, lawsuits, wage garnishment, etc. This can be very stressful financially and personally.
The bottom line is that defaulting on a settlement leaves you with very limited options. Creditors will be much less willing to negotiate again. Your credit score suffers regardless. And you still owe the debt, which the creditor can vigorously pursue.
That’s why it’s absolutely critical to only agree to debt settlement terms if you’re 100% confident you can have the full amount saved up in time. Explore all your options for borrowing funds or cutting expenses before the settlement payment is due.
Debt settlement can be a helpful solution, but carries risks even in the best cases. And if you can’t ultimately make the payment, the consequences can be quite severe.