If you negotiate a settlement with your credit card companies, the debt you no longer have to pay is known as "forgiven" debt. While it's nice to be able to settle a debt without having to pay off the full amount, the record of the debt doesn't simply vanish. Even though you didn't completely walk away from your obligation, a forgiven debt can still cause problems on your credit report.
Credit Report Notation
Even after you close accounts, they still appear on your credit report for seven years from the date of your last activity. If any of your debt is forgiven, your credit report will list the status of the account as "settled." This indicates that you did not pay the account in full and that you did not honor the terms of your original credit agreement.
Effect on Credit Score
A forgiven debt on your credit report can cause serious damage to your credit score. Settling a debt for less than you owe hurts your payment history, which makes up 35 percent of your FICO credit score and is the single largest component of your credit score. Forgiven debt hurts your score as much as a charge-off or an account included in bankruptcy, since all of these types of accounts reflect your inability to fulfill your credit obligations.
Preventing A Bad Report
The general rule of credit reporting is that you cannot remove any information that is accurate, but creditors are not required by law to make any reports at all to a credit reporting agency. You may be able to negotiate with your creditor to remove or refrain from submitting any negative credit reporting as part of your settlement arrangement. Since creditors are generally more interested in getting paid than in worrying about what your credit report looks like, some might be willing to make that compromise.
Settling your debt may result in some unexpected financial consequences. According to the Internal Revenue Service, forgiven debt is generally considered taxable income. Your creditor will send you a Form 1099-C at the end of the year listing the amount of your forgiven debt, which you must report on your tax return. The only way to avoid this taxation is to file bankruptcy or to qualify as being insolvent.
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