Little Ways Debt Reduction Costs More Than You Think

If your bills are piling up, and you’re getting further and further behind on payments, you may have considered debt reduction as a means to ease the burden. While debt reduction could help you lower your monthly debt payment, there are some consequences to consider.

- Taxes
You might not even realize that a debt settlement will impact your tax bill, but it will. If you’ve had more than $600 owed to creditors forgiven, the IRS will consider the amount forgiven to be taxable income. If you have large amounts of debt, this could mean big trouble. For example, let’s assume you currently hold $15,000 in credit card debt. You work with your credit card companies to reduce that debt to $9,000. The $6,000 that your creditors have forgiven from your debt will be added to your income for the year. This will mean a definite increase in the income taxes you must pay, and could even push you into a higher tax bracket, making your tax bill even more significant.

- Lawsuits
When creditors work with you to reduce the debt owed to them, they usually expect you to pay in full immediately, not in monthly payments. What does this mean if you can’t pay them in full right away? Your account is going to remain in default, and the credit card company has the right to sue you for the balance.

- Credit Score
Even though your creditor is agreeing to the reduction in your debt, they will report the fact that the debt has been settled for less than the amount owed. This will cause a drop in your credit score. There is a positive: once the creditor reports that the reduced amount has been paid in full, your credit score will start to go back up.

Before you decide to try to work with your credit card company to reduce your debt, weigh the negatives outlined above against the positives. If you could pay the full amount owed by cutting back on expenses or taking on more hours at work, it would be beneficial to do so and avoid the negative consequences of a debt reduction. When looking into a debt reduction, consider the following:

- Can I truly not afford to make my current payments?
- Is a debt reduction worth the damage to my credit score?
- Do I need to make a credit purchase in the near future, which would be affected by my reduced credit score?