Can You Buy Your Own Debt? How Debt Settlement Works

While individuals cannot literally purchase their own debt as an asset, they can engage in debt settlement. This process involves negotiating with creditors or debt buyers to pay a reduced amount to satisfy an outstanding obligation. This article clarifies how debt ownership functions, outlines the steps for negotiating and settling debts, and explains the financial and credit reporting consequences.

Understanding Debt Ownership and Acquisition

The concept of “buying your own debt” refers to negotiating a settlement with the entity holding the debt. Initially, debt is owed to the “original creditor,” such as a bank or credit card company. If payments become severely delinquent, original creditors may sell the debt to a “debt buyer” or assign it to a “collection agency.” Debt buyers purchase these accounts for a fraction of the original value, gaining the legal right to collect the full amount. This allows the original creditor to recover some funds immediately.

Debt can be sold multiple times, with each new owner acquiring the legal right to pursue collection. The types of unsecured debt most commonly subject to negotiation and settlement include credit card debt, personal loans, and medical bills. Unsecured debt is not backed by collateral, meaning there is no physical asset, like a car or home, that the lender can seize if the borrower defaults. This characteristic often makes creditors more willing to negotiate a settlement, as they face a higher risk of not recovering any funds if the debt remains unpaid.

Negotiating and Settling Your Debt

Before contacting any debt holder, gather details about your accounts, including account numbers, the original debt amount, the current balance, and the date of your last payment. It is also important to identify the current debt holder, whether it is the original creditor or a debt buyer, as this is who you will negotiate with. Having a clear understanding of your financial situation, including how much you can realistically afford to pay, is also important before making an offer.

Once prepared, you can initiate contact with the current debt holder. You can then formulate a settlement offer, which typically involves proposing a lump sum payment that is less than the total outstanding balance. While there is no fixed percentage, initial offers often range from 25% to 30% of the total debt, though creditors may counter with demands for 50% or more. The amount a creditor will accept can depend on factors like the age of the debt and your financial hardship.

A crucial step before making any payment is to obtain a written debt settlement agreement. This document should clearly outline the agreed-upon settlement amount, the payment schedule (whether a lump sum or installments), and a confirmation that the account will be considered settled or paid in full for less than the full amount upon completion. This written agreement protects you by providing proof of the terms and preventing future disputes. Once the agreement is in place, payments can be made through secure methods, such as Automated Clearing House (ACH) transfers directly from your bank account, online payment portals, or even mobile payment apps.

Financial and Credit Reporting Outcomes

When a debt is settled for less than the full amount owed, the forgiven portion may be considered taxable income by the Internal Revenue Service (IRS). If the canceled debt is $600 or more, the creditor is generally required to issue Form 1099-C, Cancellation of Debt, to both you and the IRS. You are responsible for reporting this canceled debt as income on your federal tax return, typically on Schedule 1 of Form 1040 as other income.

Exceptions to this rule exist, such as the insolvency exclusion. If your total liabilities exceed the fair market value of your assets immediately before the debt cancellation, you may exclude some or all of the canceled debt from your taxable income. For example, if you have $50,000 in assets and $100,000 in liabilities, you are insolvent by $50,000, and up to that amount of canceled debt could be excluded. To claim this exclusion, you need to file IRS Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness.

An account settled for less than the full amount will be noted as such on your credit report. Common statuses include “settled for less than the full amount” or “paid off less than full balance.” This differs from an account marked “paid in full,” which indicates the entire original balance was repaid. While settling a debt resolves the obligation, the “settled for less” notation is considered a negative mark because it signifies that the original terms were not met. This negative information remains on your credit report for seven years from the date of the original delinquency that led to the settlement.