7 Ways to Pay Off Debt Already in Collections

You may feel there’s no way out if you have multiple debts in collections. That’s not the case. You still have options. None of them are perfect options: your debts won’t simply disappear. Each option has its own risks and costs — but also has its opportunities.

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7 Ways to Pay Off Debt In Collections

It may seem easy to ignore the phone calls from debt collectors, but don’t. Collection accounts will hurt your credit score, and unless you make repayment arrangements for your unpaid debts, you could face serious consequences including lawsuits and wage garnishment.

Pro tip: The first step, before you worry about how to pay off the debt, is to ask the debt collector for a debt validation letter. This will confirm that the debt is legitimately yours. While you wait for the letter to arrive, check your credit reports with all three credit bureaus — Experian, Equifax and TransUnion. And if you don’t recognize the company that’s contacting you, call your original creditor to confirm that your debt was sold. You don’t want to end up agreeing to repay a debt you don’t actually owe.

Once you’ve confirmed that the debt is yours, here are some payment methods to consider:

1. Debt Settlement Company

Debt settlement companies are for-profit businesses. They negotiate with your creditors or debt collection agencies to offer partial payments to settle your debts for less than the full total you owe. You’ll make one payment to the settlement company, and the settlement company will pay your creditors, either in one lump-sum payment or an established payment plan.

Pro tip: You may have to pay taxes to the IRS on settled debts, but you won’t have to pay this if you can prove that you’re facing financial hardship.

In exchange, you pay a fee ranging from 15% to 27% of the total enrolled debt. A settlement will reduce your debt load but may temporarily damage your credit score.

Debt settlement companies will probably ask you to stop making payments on debts while they negotiate. This can encourage a company to settle but will also lead to your debts being charged off. This will severely hurt your credit score because payment history accounts for 35% of your FICO score. Don’t worry. Your score will rebound once the settlements are paid.

Pro tip: Debt settlement works with almost all forms of unsecured debt, including credit card bills, medical bills, personal loans and some student loans. And you’ll repay less than you owe. Statistics show that debt settlement clients get out of debt while paying about 80% of the total they owe, counting the debt settlement company’s fees.

Secured types of debt, like auto loans, cannot be settled.

Choose your debt settlement company carefully. Not all companies are legitimate.

READ MORE: Best debt settlement companies

2. Debt Management Plan

Nonprofit credit counseling agencies offer debt management plans. Most of these agencies offer a free initial consultation. A credit counselor will review your situation and options and help you decide whether a debt management plan is right for you.

If you decide on a debt management plan, you will make one monthly payment to the credit counseling agency. They will distribute the money to your creditors. They will negotiate with your creditors for better terms and potentially debt relief. However, unlike with debt settlement, you will repay the full amount of your debt.

You will pay a fee to the counseling agency and may be required to close some credit cards or other accounts. Be careful when choosing a credit counseling agency: many are legit but some are scams. Do your research and check the company’s reviews and reputation.

READ MORE: Best debt consolidation companies

Pro tip: Debt Management Plans and credit counseling work primarily with credit card issuers and won’t always work if you have other unsecured debt.

3. A New Loan

Using a loan is a traditional method of debt consolidation. You borrow money, use it to pay off your other debts, and then pay off the new loan. Bad credit makes qualifying for a new loan challenging, but it’s not impossible. Some companies target bad credit borrowers, and homeowners have a few extra options that tap into their home’s equity. If you’ve got a bad credit history, you’ll probably end up paying a high interest rates and debt settlement or DMPs may be more affordable.

Here are some loan possibilities:

Debt consolidation loans are a form of personal loans. It may be difficult to get a loan at a competitive rate with bad credit, but lenders like Upstart, Navy Federal, BadCreditLoans.com and Upgrade will deal with borrowers who have compromised credit.
Home Equity Loans are secured by your home, so approval is easier and interest rates are low even with bad credit. If you own a home and have enough equity these can be a great consolidation option, but be careful: if you can’t pay you could lose your home.
A Home Equity Line of Credit or HELOC is like a home equity loan, but it’s a revolving account. You can keep drawing up to a fixed limit. You may be tempted to draw more than you need, and if you can’t pay you could lose your home.

Pro tip: If you choose a consolidation loan, it is essential that you stop incurring new debt until you have paid off the consolidation loan. If you keep taking out loans or relying on credit cards, your strategy will fail.

Negotiate with the collection agencies first and try to reduce the amount you’ll pay before settling on a debt consolidation loan. If you can cut the amounts you’ll need a smaller loan that’s easier to pay.

Debt Consolidation May Not Work for Debt in Collections

Debt consolidation is typically the most straightforward fix if you’re struggling to repay your debts.

This rolls multiple debts into a new loan with a single monthly payment. Consolidation doesn’t eliminate your debts, but it simplifies the payments, makes late payments less likely, and may get you a better interest rate.

However, if your debts have already been turned over to debt collectors, you probably already have charged-off accounts on your credit report, and your FICO score has probably taken a nosedive. This will make it challenging to qualify for debt consolidation loans large enough to pay off all your debts at once, and debt consolidation may not work.

4. Bankruptcy

Nobody wants to file for bankruptcy, but it’s a legitimate option if you have no realistic way of paying your debts. Bankruptcy can discharge most of your unsecured debts: you’ll no longer have to pay them. That’s a chance at a fresh start.

Bankruptcy can discharge credit card debt, medical debt, payday loan debt, personal loans, and other unsecured debts. It will not affect alimony or child support, tax debts, some types of student loans or court-imposed fines or settlements.

In a Chapter 7 bankruptcy — the most common type — your assets can be seized and sold to pay your creditors. Many assets are exempt, and 96% of Chapter 7 cases conclude without asset seizure.

While some costs will be incurred in a bankruptcy filing, minimizing your expenses is possible. Many bankruptcy attorneys offer free initial consultations that can help you decide if bankruptcy is right for you. You can also try Upsolve, a free app to help consumers file a simple Chapter 7 bankruptcy without a lawyer.

Bankruptcy will significantly impact your credit score but give you a chance to start over again, and the impact will fade.

5. Negotiate With Your Creditors

Many creditors are willing to work with debtors who approach them in good faith and try to find a solution. There are several options.

Hardship plans: Many credit card companies offer hardship plans for debtors affected by illness, job loss, divorce, or other hardships. They may offer an extended payment option or interest rate reduction for a specific amount of time. These plans are not advertised; you will have to ask.
Extended payment plans: Many creditors will negotiate a plan that allows you to pay your debt in installments. This will help protect your credit as long as you make the payments on time.
DIY debt settlement: You will offer a reduced sum as full debt payment. They may accept if the creditor thinks the alternative is not getting paid. The debt will be reported as settled for less than the amount owed, harming your credit.

You will have to decide on your priorities. If your credit score is still reasonably good, you will want to protect it, even if it means paying more.

Pro tip: If you have multiple accounts in collections, your credit score has probably taken a beating already. In this case, your priority may be getting the collectors off your back. Settlement or bankruptcy might be a better option in this case.

Watch this video by Dave Ramsey: How Do I Negotiate Debt That’s 6 Years Behind?

6. Credit Card Balance Transfer

If you have an existing credit card that’s not in collections, see if it allows cash advances or balance transfers.

Though these advances and transfers can be expensive, the interest rates are usually lower than what you’d pay for a bad credit loan, and you since you already carry the card, you don’t have to worry about being approved for a new credit card.

If you aren’t sure whether this option is available, call your credit card company to ask whether your account qualifies for balance transfer offers.

7. Payday Alternative Loans

Nothing will derail your debt relief strategy faster than taking on new debt, especially high-interest payday loans. Many credit unions offer Payday Aternative Loans to help members avoid the payday loan trap.

These loans are generally too small for debt consolidation, but if you are caught short between paychecks, they can bridge the gap without breaking your budget.

Pro tip: All debt relief strategies have one thing in common: you must stop taking on new debt while you clear your old debts. If you keep piling on new debt, you will just make things worse. Lock up those cards and stick to your budget!

Before You Decide, Assess Your Debt

Not all methods will work for all types of debt.

After requesting a debt validation letter and reviewing your credit report, sit down and review your bank account and list all legitimate debts. Include the interest rate, the minimum monthly payment, and the date that the account became delinquent (if it is).

You need answers to these questions.

Are any of these debts near or past the statute of limitations in your state? If they are, you may not need to pay them and they will age off your credit report soon
Can you negotiate a hardship plan or extended payment plan that will make it easier for you to pay?
Can you settle any of the debts for less than the original amount?
Can you use any of the debt consolidation options discussed above?

Pro tip: Once you’ve answered those questions, prioritize your debts and choose a repayment strategy.

What to Do if Debt Collectors Are Harassing You

The Fair Debt Collection Practices Act (FDCPA) limits what debt collectors can say and do. New rules under Regulation F have expanded these limits. Many collectors violate these rules, particularly rules restricting phone calls, but you can stand up for yourself if you know your rights.

If you believe that a debt collector is breaking the law, you can report them to the Federal Trade Commission (FTC), the Consumer Financial Protection Bureau (CFPB), and your state’s attorney general’s office or financial regulator. If they persist, you can take legal action.

Be aware of these rights:

A debt collector cannot use abusive or obscene language
A debt collector cannot threaten you with debt or imprisonment
Debt collectors cannot impersonate an attorney or any law enforcement or government official
Collectors can use phone, email, and text messaging, but you can specify what methods they can use to reach you
You can tell a collector to cease all contact. Be careful: this could give them an incentive to sue you
Collectors cannot call you at inconvenient hours or at work, if you tell them not to.
Collectors can only call you once a week per debt
Collectors cannot sue you for a debt if the statute of limitations has expired. Be careful about making payments or admitting liability for old debts. You could restart the statute of limitations

You can learn more about your rights and the debt collection process from the Federal Trade Commission (FTC).

If a debt collector breaks the law, you can report them to the FTC, the CFPB, and your state’s attorney general’s office or financial regulator. If they persist, you can sue them.

To learn more about the Fair Debt Collection Practices Act, check out this video:

The Bottom Line

Debts are stressful, and having multiple debts in collections is even more stressful. If you face your situation head-on, review your debts carefully, and look at your options for consolidating debt in collections, you can get those collectors off your back and pay off your debts!

FAQs

What is Unsecured Debt?

Unsecured debts are debts that are not secured by collateral. Credit card debt, medical debt, most personal loans, and payday loans are all unsecured debts. Mortgages and car loans are secured debts because they are secured by an asset that the lender can seize if you don’t pay.
Unsecured debts have a higher risk for the lender, so they usually have higher interest rates and stricter qualification standards.

Will I Go to Jail For Not Paying my Debts in Collections?

You cannot be arrested or imprisoned for failure to pay a debt. A debt collector is not allowed to threaten you with arrest or jail time. If a collector makes this threat, stop talking to them and complain to the FTC and CFPB.
Debt collectors can sue you. If they do, you can be jailed for contempt of court if you fail to follow court instructions or appear for hearings. If you are sued you must follow all court instructions and appear when the court orders you to appear.

What is the FTC and What Does it Do?

The Federal Trade Commission (FTC) is an independent government agency tasked with preventing unfair, deceptive, and non-competitive business practices. The agency regulates a broad range of business activities, including fraud and deceptive advertising.
The Consumer Financial Protection Bureau (CFPB) provides similar functions focused exclusively on the financial industry, including lenders and debt collectors.

Do I have to Pay Federal Income Tax on Settled Debts?

When you settle a debt for less than the full amount you owe, the creditor may issue you a Form 1099-C, which reports the forgiven debt as income. This could potentially be considered taxable income by the IRS. However, there are certain circumstances under which you might be able to exclude canceled debt from your taxable income. Two of the exceptions are:
Insolvency: If you were insolvent (your total debts exceeded your total assets) immediately before the debt was canceled, you may be able to exclude the canceled debt from your taxable income.
Bankruptcy: If the debt was discharged as part of a bankruptcy proceeding, it might not be considered taxable income.

What is NMLS and What Does it Mean for Debt Collection?
NMLS stands for Nationwide Multistate Licensing System & Registry. It’s a multi-state licensing system for non-depository financial service providers, including debt collectors. Many states require collectors to hold an NMLS license. Learn more about NMLS here.

NMLS stands for Nationwide Multistate Licensing System & Registry. It’s a multi-state licensing system for non-depository financial service providers, including debt collectors. Many states require collectors to hold an NMLS license. Learn more about NMLS here.

Got Debt In Collections? 7 Ways to Pay It Off