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Credit Card Debt Settlement

If you have high credit card debt, you might be able to settle the debt for less than the full amount. But beware of the downsides to credit card debt settlement.

If you’re trying to free yourself from the burden of credit card debt, you have a number of options available. If you lack the means to pay the debt in full over a reasonable period of time but are unable or unwilling to file bankruptcy. debt settlement may be an option.

How Does Credit Card Debt Settlement Work?

Debt settlement involves making an offer to the credit card company to settle the amount you owe for a lesser amount. If the creditor accepts, you will need to pay the entire settlement amount up front, in one lump sum. (For help in crafting a settlement offer, get Nolo’s eForm Offer to Settle Debt With a Reduced Lump Sum .)

A credit card company might accept a settlement if you’re very delinquent on your payments; it is often less costly for a creditor to accept a lesser amount in settlement than it is to send the account to collections, file a lawsuit, obtain a judgment, and then try to collect on the judgment.

Example. Janet has a $10,000 credit card balance. She hasn’t paid the bill in nearly a year. She has managed to save $6,000, but she’s so behind on other bills that she can’t afford to save any more. She contacts the credit card company and offers to settle the account for $5,000. After some negotiation, Janet settles the debt for $6,000 and pays the entire amount to the creditor. The creditor writes off the remaining $4,000 balance and reports to the credit bureaus that the debt was paid in full by settlement for a lesser amount.

Pros of Credit Card Debt Settlement

Debt settlement has the following benefits:

  • You are paying less overall on your debt in a much shorter period of time. Paying the debt off immediately means paying no more interest, and settling means you’re paying even less than you currently owe.
  • Debt settlement is less harmful to your credit than bankruptcy if your credit is not already poor.

Example. Ted owes $10,000 on his credit card. He is six months behind on his payments. Ted’s six-month deliquency has hurt his credit; however, bankruptcy would cause his score to tank. If he only makes the minimum payment, with interest, it will take him 10 years to pay off, and he’ll end up paying $18,000 total over that 10 years. If he successfully settles the debt, he will be rid of the debt immediately and pay less than $10,000.

Drawbacks to Credit Card Debt Settlement

On the other hand, debt settlement also has multiple drawbacks:

Debt Settlement Is Risky

If you stop making your credit card payments in an effort to save up enough money to offer a settlement, your credit card company can sue you in collections, obtain a judgment, and garnish your wages and bank accounts. Even if you notify the creditor of your intent to settle, nothing legally stops the creditor from collecting.

Using a Debt Settlement Company Is Even Riskier

Many of these companies will advise you to default on your credit card payments and instead pay the money to them; after taking a monthly fee, they will put the rest of your payments into an account to accumulate a lump sum large enough to offer the credit card company. There are hundreds of fraudulent debt settlement companies advertising today, and it can be very easy to get pulled in by a debt settlement scam.

Debt Settlement Creates Income Tax Liability

When a credit card company forgives any amount of the debt, the IRS and your state government will perceive the debt forgiveness as income to you. The difference between you original balance and the settlement amount is taxable income, and you will have to pay taxes on it. (To learn more, see Tax Consequences When a Creditor Settles a Debt .)





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