How low can you go with debt payment?

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Dear Debt Adviser,
This is regarding when negotiations take place in paying off creditors when they accept pennies on the dollar just so they’ll receive something on the account. Can people who are able to make the regular debt payments do that? Will any of creditors accept an offer for let’s say $3,000 to close that $5,000 account? Yes, part of me thinks it’s a stupid question, but I also think — these days anything’s possible.
— Andrea

Dear Andrea,
I agree, it feels stupid, but heck, stranger things have happened! So, for all of my readers who didn’t ask but wanted to, here’s the reality you won’t hear on those radio commercials for debt settlement. Debt collectors are experts at locating assets and sources of income and using all of the collection tools at their disposal. These include letters, phone calls, court actions (liens, summons, wage garnishment, bank account levies), repossessions and more. They get paid well for getting blood from a stone. There is no government program to bail out credit card debtors and while you have the right to ask for a settlement (you could ask for a cheeseburger while you’re at it), they have no obligation to give you anything but a hard time unless they want to.

Debt settlers are filling the airwaves with nonsensical commercials that have confused many and mislead others. It has gotten so bad that the Federal Trade Commission is implementing new restrictions on debt settlers in October to try to rein in abuses. But, you can try to settle a debt for less than you owe on your own. However, there are some consequences that I’d like you to consider before giving in to the temptation to settle.

First, your creditor is quite unlikely to settle for “something” as opposed to the full amount of what you owe until or unless your account is seriously past due (typically, more than 180 days without payment). An account that is more than 180 days late is a large negative on your credit history. Keep in mind that potential lenders viewing your credit history are interested in how well you have managed credit in the past because it is a fairly good indicator of how you will manage it in the future. Even one account on your credit report that is more than 90 days late will be a huge red flag to a lender. And, unless you bring the account current by making up those past due payments that negative notation will remain on your credit report for seven years.

One other consequence to your credit when settling a debt is that it is marked on your credit report as settled for less than was owed. This type of account is definitely not going to be received well by a potential lender. Would you lend a couple of thousand dollars to a friend knowing that the last time your friend borrowed money he or she only repaid less than half of what was borrowed?

You may be thinking that the hit to your credit would be worth it because you won’t need access to credit anytime in the near future. The trouble with planning for the future is that you don’t know what will happen. You may find that you will need credit in the next year for something that you had no way to predict would occur. Plus, don’t forget that credit reports are used by employers for promotion and hiring decisions, by insurance companies and by landlords. The list of noncredit users seems to continue to grow.

Lastly, forgiven debt (unpaid credit balances from a settlement) is considered income by the IRS. Any amount greater than $600 forgiven by a creditor will result in a 1099 tax form that must be added to your total income for tax purposes. And if you think it’s hard to settle a debt with a collector, they are pussycats compared to the IRS who can also take your future tax refunds and bar you from government help such as subsidized student loans.

The bottom line is that although many things are possible today, there is still no free lunch. If you can afford to make the payments, just do it.

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