Americans have more than $4 trillion in outstanding revolving debt, according to the Federal Reserve. Although making on-time monthly credit card payments and only charging what you can afford to repay is the best practice, unexpected circumstances could result in a ballooning balance you can’t pay back and lead you to consider settling credit card debt at a lower amount.
Credit card settlement is an available option, if you’re unable to repay the entire debt you owe. Although it can feel like a lifeline, there are pros and cons to this approach. Here’s what you should know about credit card debt settlement and how it works.
What is credit card debt settlement?
Credit card debt settlement involves negotiating a reduced debt amount with your creditor or a third-party debt collector that purchased your outstanding debt from your original creditor.
If you owe $10,000, for example, your creditor may accept a settlement of $7,000 instead of the full amount. The creditor will write-off the remaining $3,000 and inform the credit bureaus that the account has been settled. Typically, settling with credit card companies means you’ll need to pay the settlement amount within a short period, often with a lump-sum payment.
Assuming your account is already severely delinquent and the creditor thinks there’s a high risk that you may not pay any amount, the prospect of getting a lower settlement from you might be a favorable option to compared to no payment at all.
How to settle credit card debt
What some credit card users don’t know is that you can negotiate with credit card companies, directly, to reach a debt settlement agreement. You also have the option of working with a debt settlement company or debt lawyer about your options and let them negotiate with your creditors on your behalf.
Before reaching out to a creditor to negotiate a credit card settlement, request a “debt validation letter” from the creditor or debt collector to prove that the debt is yours and that you, in fact, owe it.
After you’ve confirmed the accuracy of the debt and that it is legally still active under the statute of limitations, request a copy of your credit report from all three credit bureaus (Experian, Equifax, and TransUnion), to ensure that the information is accurate.
Contact your creditor to communicate your desire to settle the debt. Explain any extenuating circumstances that prevent you from repaying the total amount. For example, if you’re now on permanent disability and can no longer work. Communication is key when it comes to settling with credit card companies.
Third-party debt settlement companies
For-profit debt settlement companies may also market their services. However, this route can be costly. These companies typically advise you to stop making payments to encourage your creditor to be open to settling. It may then ask you to make monthly payments toward an account that it manages. Once the account reaches the settlement amount, the debt settlement company will pay your creditor in one lump sum.
Stopping your monthly payments, however, results in your credit card account balance increasing thanks to missed payments, late penalties and interest charged. Plus, you’ll still pay high fees to the debt settlement company itself. Your credit score will also suffer.
It’s important to be wary of scams, such as debt settlement companies that make grand promises and charge you upfront fees. The Fair Debt Collection Practices Act (FDCPA), has strict rules in place regarding debt practices. So, do your due diligence to make sure a debt settlement company is legitimate.
Pros and cons of credit card debt settlement
- It can lower your debt obligation. Credit card settlement may result in less money paid to retire your debt in full.
- You’ll repay your debt faster. Since settlements often require you to pay the full settlement in a small window of time, you’ll pay off the account sooner.
- It’s an option instead of bankruptcy. Although a settled debt still appears on your credit report and negatively affects your score, it’s less damaging to your credit compared to filing bankruptcy.
- It affects your credit score. Settled accounts are marked as such on your credit report and will affect your score for seven years.
- You may face high fees. If you choose to go through a debt settlement program, you’ll potentially pay more money overall.
- Debt settlement scams. If a settlement company demands payment before beginning its negotiation and reaching a settlement with your creditor, this is a red flag.
- Your creditors may refuse to settle. There’s no guarantee that your creditors will agree to a reduced pay-in-full amount.
- It may result in a tax liability. The IRS may consider the forgiven debt amount as income that you’ll have to pay taxes on.
Alternatives to credit card debt settlement
If you’re struggling with your credit card debt, there are resources that can help you figure out your next best step. Consider seeking help from a credit counseling nonprofit, like the National Foundation for Credit Counseling. A credit counselor helps you come up with a debt management plan and acts as your advocate to arrange a reduced monthly payment to repay your credit card debt.
Another alternative is to wait for the debt’s statute of limitations to expire. If your account is considered a “time-barred debt” or “zombie debt,” a creditor or collector can’t take you to court to collect. The number of years before the statute of limitations ends depends on your state laws and the state law that’s cited in your credit card agreement.
If you decide to take this approach, keep in mind that collectors can still reach out to you to collect the debt, and your credit score will be negatively affected until the account expires from your credit report.
The bottom line
When pursuing a credit card debt settlement, it’s important to know your consumer rights under the Fair Debt Collection Practices Act (FDCPA). Getting rid of debt is rarely a simple exercise, but there are options.