There are five main objections to consumer debt settlement: damages credit, increased collection calls, possibility of lawsuits, tax consequences and the need to settle with all creditors.

You Can Still Be Sued

A debt settlement company does not make monthly payments on the debtor's accounts and they still remain in default. While the debts are still in default the creditor or its assignee can still file a lawsuit against a debtor. Most creditors and debt collectors want a lump sum payment to settle for less than the full debt. Although a debtor may make monthly payments to the debt settlement company, the amount is too small to successfully negotiate a settlement until after the debtor has made several months' worth of payments.

Damages credit

The debt settlement damages the scores in credit report. A credit report is used by creditors to judge past credit performance to see if the applicant meet their criteria for lending. Insurance companies uses a person's credit report to determine premiums and prospective employers review the credit report to establish the character of a job candidate.

Tax consequences

Another common objection to debt settlement is that debtors whose debts are partially canceled outside the bankruptcy system will need to report the canceled portion of the debt as taxable income. (IRS Publication 908)

The Internal Revenue Service considers $600 or more of forgiven debt as taxable income. The forgiving creditor must provide the taxpayer with a 1099-C tax form. This form will list the amount of forgiven debt and interest in Box 2. Taxpayers with portions of personal loans forgiven may not subtract the interest reported in Box 3 from the amount of reportable income on this form.

However, the IRS does not require taxpayers to report forgiven debt if the tax payer was insolvent at the time the creditor forgave the debt. Being insolvent means that the amount of a debtor’s debts are greater than his/her assets (how much money and property the debtor owns). However, the IRS adds that “you cannot exclude any amount of canceled debt that is more than the amount by which you are insolvent.”

For example, if a taxpayer is $10,000 in debt and owns $3,000 in assets, he/she cannot exclude more than $7,000 of forgiven debt from his/her income tax. Any forgiven debt over $7,000 that year must be reported as taxable income.