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Thursday, April 18, 2024

11 (Need-to-Know) Credit Card Debt Settlement Facts

Credit Card Debt Settlement Facts
Mike Randall

Written by: Mike Randall

Mike Randall
Mike Randall

Mike Randall is an expert in the areas of credit scores and credit cards, having written on those topics for national publications for more than a decade. He graduated from California State University with a degree in English literature, and he has an extensive background in personal finance studies. Aside from credit cards and scores, Mike enjoys writing about changes in the subprime market and how they directly impact financial decisions.

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Edited by: Lillian Guevara-Castro

Lillian Guevara-Castro
Lillian Guevara-Castro

Lillian Guevara-Castro brings more than 30 years of editing and journalism experience to the CardRates team. She has written and edited for major news organizations, including The Atlanta Journal-Constitution and the New York Times, and she previously served as an adjunct journalism instructor at the University of Florida. Today, Lillian edits all CardRates content for clarity, accuracy, and reader engagement.

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Advertiser Disclosure

If the burden of overwhelming credit card debt has you feeling like there’s nowhere to turn, consider a solution that works for many people just like you: Credit card debt settlement.

But debt settlement isn’t for everyone – here are 11 credit card debt settlement facts that can help you decide if it’s the correct solution to your financial woes:

11. Debt Settlement Companies Are For-Profit Enterprises

That means they make their money from people like you, who they are purporting to help. That’s not to say they are necessarily dishonest, but the fees they charge and the terms they negotiate can be less than favorable in the long run.

The fees paid to a debt settlement company will be worthless if your credit issuer sends your account to collections.

The fees you pay will be worthless if your credit card issuer sends your account to collections.

An example of how debt settlement companies work can be illustrated in this way: You may be advised to stop paying on your credit card debt and to instead send the amount you would be paying to the settlement company. From there, they’ll take a portion as their fee and put the rest into an escrow-type account to build your lump sum payment. The fee they charge means less is being put aside than if you were simply saving the money yourself.

In addition, the credit card company may decide at any time to charge off your account and send it to collection; in which case, the fees paid to the settlement company are worthless.

10. Credit Card Companies Don’t Like Debt Settlement Plans

Debt settlement is something credit card companies are hesitant to do mainly because they lose money.

Your credit card company is under no obligation to negotiate or offer you a settlement for less than what you owe. It’s up to you to convince them this is in their best interest and to offer a payment that will satisfy their business needs.

Be prepared for a long and often frustrating process of back-and-forth negotiations — all while you are withholding any payment from them. This will help them take your threats of zero payment seriously enough to consider settling

9. Debt Settlement Usually Means a Lump-Sum Payment

Credit card debt settlement is a way to pay your creditors part of what you owe based on the terms you negotiate with them. This is usually a lump-sum settlement that satisfies the outstanding debt and closes the account you have with the creditor.

Debt Settlement Usually Means a Lump-Sum Payment

Debt settlement means coming up with a cash lump sum to repay the portion of debt agreed to.

Why would a creditor agree to do this? Primarily because receiving a partial payment is preferable to nothing at all, which leads us to our next fact…

8. You Need to Have Cash on Hand Before You Negotiate

One of your only bargaining tools in offering to pay less than what you owe is to offer a lump-sum payment in return for settling your debt obligation. That means you must have the cash available or ready access to it before you start negotiating. Offering more than you have available to pay only puts you in a position where you won’t be able to meet your agreement.

However, don’t offer everything you have available initially either. If you’re trying to settle a $10,000 outstanding balance and have $7,000 on hand, consider starting at $5,000 and moving up from there.

7. You Will Need to Build Your Case

In considering a debt settlement case, banks and credit card companies look at the hardship factors leading to your inability to pay. Legitimate criteria for debt settlement consideration include things like job loss, substantial medical debt, death of the primary earner, etc.

You Will Need to Build Your Case

The courts will look at financial hardships such as a job loss as to why you are unable to repay your outstanding debts.

Be prepared to state your case and explain your inability to pay the entire amount you owe.

6. Your Debt Will Not Be Cut in Half

In spite of the wild promises made by debt settlement companies, paying 50 percent or less of what you owe is almost unheard of.

A more likely outcome is a reduction of between 15 and 30 percent of your outstanding balance. In rare instances, a credit card company may be convinced to take less than that, but it will require excellent negotiating skills on your part.

5. Your Credit Scores Will Be Negatively Impacted

You may think paying off your debt will improve your score, and oftentimes debt settlement companies will tell you that doing so will improve your debt-to-credit ratio. However, in order to qualify for debt settlement, you generally need to be behind on payments, and the delinquency will be reported to the credit bureaus and appear on your credit report for seven years. On-time payments is the most heavily weighted factor when calculating your credit score.

Your Credit Score Will be Negatively Impacted

Late payments will be reported to the credit bureaus and will remain on your credit report for seven years.

The remaining balance of the agreed upon settlement will also appear on your credit report as a negative mark, as will any debts that go into collections.

4. You Need to Settle Before Your Account Goes to Collection

As hard as it is to negotiate with your credit card company, you’ll want to exhaust every opportunity with them before your debt goes to collection. Continue the dialogue and the negotiation process. As long as your creditor thinks there’s still a chance they’ll get paid, they’ll try to work with you.

Once the debt has gone to collection, much of the damage has been done to your credit and your position of power is greatly reduced.

3. You are Liable for Income Taxes on the Amount Discharged

Another thing to consider is both the federal government and most state governments consider any amount written off by a creditor to be taxable income to you. That means $3,000 written off is an instant tax obligation and may even bump you into a higher tax bracket.

 You are Liable for Income Taxes on the Amount Discharged

The written off portion of your debt is a taxable income to you, meaning it could bump you into the next tax bracket.

Consider talking to your accountant prior to making any settlement decision.

2. Not all Debt is Eligible for Settlement

While debt settlement can be a viable option for credit card debt, understand that not all debt qualifies for debt settlement. Examples of debts ineligible include: student loans, alimony, a mortgage and auto loans.

1. You Will Need the Settlement Terms in Writing

If you’ve reached a settlement deal with a creditor, ask for the details in writing before making a payment or committing to the terms.

After all of the back and forth, you want to make sure the details are what you think they are. Making a payment over the phone before you see the details may in fact be committing you to something other than what you understood.

You Will Need the Settlement Terms in Writing

Protect yourself — request the agreed upon terms of the settlement in writing.

Knowing these facts about debt settlement can help you to arrive at the best solution to a difficult debt situation. If you find yourself in a position of extreme financial hardship and are unable to continue paying your credit card debt, a settlement agreement can be your way out — if you handle it wisely and know the facts. Good luck!

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