“Dear Paula,

In Debt have not made any payment in the last 5 years or talk to any creditors about it. I Have a bout 40 grand in debt from about 5 years ago almost all credit card debt. I have some medical bills as well. I am back on my feet and starting to make good money. I feel as I might be able to pay back these debts. Would it be wise to settle out of debt or if I can just payoff the whole debt? If the whole debt is paid off are they going to try and hit me with some unforeseen fee that I will also have to pay off before it is removed from my credit score. I feel that it may be possible to pay this off in full I just don’t know where to start or if I should.”


Hi Brandon:

Excited to hear you’re back on your feet and starting to make good money. Here are a few things to take into consideration as you make your decision about what to do with the 40k in debt that is 5 years old. You didn’t mention how much the additional medical bills add up to.

First, before you start to pay off any of those debts, I encourage you to build up a savings cushion. On the off chance you find yourself out of work again, you want to have some savings set aside to tide you through rather than getting any deeper in debt.

Next, there are a few options for you to consider. Let’s look at the different ideas you’ve had so far:

paying the creditors’ off in full. Since it’s been five years, the original creditor has probably written off the loan, and anyone you’ll be dealing with is a collection agency who has bought your debt for pennies on the dollar. So there are two options for paying the creditors off. In the first scenario, you pay them in full, the collectors are extremely happy and your accounts are marked paid in full. The original creditor is still going to be marked charged off, but with some persistent hard work on your part CAN be updated to reflect that the amount was paid in full.

In the second scenario, you (or someone on your behalf) negotiates with the collector to pay a lower percentage of each debt. Any amount above $600 that is forgiven (meaning the portion of each creditor’s debt that you don’t have to pay) can be considered taxable income – so you’d have to pay extra income tax at the end of the year on this phantom income. If you go this route, I encourage you to talk to your human resources department and have them take out extra taxes from your paychecks so you don’t wind up with a huge tax bill at the end of the year. Let’s say you negotiate 25% off the 40,000. That’s $10,000 you were “forgiven” that you could wind up paying taxes on if the creditor issues a 1099-C form to you and to the IRS. If they take 75% off, then you’re taking about possible taxes on $30,000 of phantom income. Still much less than the 30k you’d have paid out.

The creditors/collection agencies will try and convince you that they can only mark the account “settled”. They also won’t always be square with you in your agreements. Which is why when I negotiate for clients, the creditor/collection agency has to fax in a letter stating specifically that the amount being agreed on as settlement is considered payment in full and that the credit reporting agencies will be notified that this account has been satisfactorily paid in full. They also include where they want the funds wired directly. Once that letter is in my client’s hands, then and only then, do I encourage them to send payment. I would advise you to do the same if you’re negotiating yourself.

There’s a third scenario I’d like you to consider. If you truly have made no payments on the credit card or medical bills in the past 5 years, these debts (unless creditors have gotten judgments against you) will all fall off your credit reports and be uncollectable once it’s been 7 years since you’ve made a payment. Making any kind of payment now would start the clock rolling again. And if you wind up in similar circumstances, and unable to pay the debts (assuming you are paying them out over time, then the collection clock starts all over again.

Big decisions to make, and only you can decide for yourself which one is best, given all the different circumstances in your life right now. Talk with a professional who can help you objectively walk through each option given what’s going on in your life and then make the choice that makes best fiscal sense to you and that you can sleep with at night.

Peace and prosperity,
Paula Langguth Ryan

*Original article courtesy of Steve Rhode, Get Out of Debt Guy