Credit card default: How it happens, what to do about it

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During unsettling economic times, consumers who have been negatively affected (through job loss or other circumstances) must prioritize how they spend their money. In these situations, credit card payments often land at the bottom of that list. And if you get to the bottom and find there is nothing left to give, those cards may just go unpaid. If enough time passes, you may then enter into the land of credit card default.

What does your priority list look like? Keeping a roof over your head, food on your table and getting to work are at the top of the list. This means paying your rent or mortgage and associated necessary utilities, like water, electricity and gas. Food on your table means buying it from the grocery store or taking advantage of food pantries (or a combination of both). Getting to your job could mean purchasing gas and a car payment.

Other necessities, like prescriptions or diapers, could also be high on your list of priorities. If you are unemployed and looking for work (or plan to in the future) your list should also include keeping your credit report clean for prospective employers who may pull credit reports as part of the hiring process.

Whatever your priorities are, it is easy to see what is important when it’s listed out and why credit card debt seems to come in last. It’s not that the debt is not important; it’s just that other things must come first. Still, it would be a big mistake to make no payment if you can pay the minimum. Credit is a powerful tool and having it at your disposal when things get back to normal is smart. Let’s take a closer look at credit card default and what it means.

How credit card default happens

As noted above, when you don’t pay your credit card bill(s) for an extended period of time your card may enter into default status. Default is different from delinquent. You become delinquent after missing a payment for 30 days. Default usually happens after six months in a row of not making at least the minimum payment due. Make no mistake, during that time you will be contacted by your creditor and they will want to know what you are going to do about it. If they are not satisfied with your response (or the lack thereof), the account will be closed and after 180 days with no payment, reported as charged off to the credit bureaus.

How credit card default affects your score

Once your account is delinquent, your credit score is going to be negatively impacted. When your account is charged off, the damage becomes more serious. Late payments are not immediately reported—for instance, if you miss your due date by a few days. It typically happens when you are at least 30 days late. But once that happens, your score is in jeopardy of starting on a downward spiral.

Every month of non-payment will result in another hit to your score as the delinquency ages and balances owed increase due to interest and fees. And an actual default will likely result in the card’s line of credit being closed, which will cause your credit utilization rate to soar to 100 percent on the account. To add insult to injury, it may be turned over to a collection agency, putting you in another category of bad for your score. (One notable exception to this rule is medical bills. They are not reported as past due until they are six months old.)

For those of you job hunting, the main worry is not your credit score, which employers generally are not interested in, but your credit report. It is still common (it used to be virtually guaranteed) for employers to pull a credit report as part of the interviewing process. A string of delinquencies or defaults could make you less competitive. My advice is to make at least the minimum payments until your search is complete to keep your credit report looking as impressive as possible.

What to do about credit card default

You have several options to handle your debt. You can continue to pay it off, try to settle the debt for less than owed or file for bankruptcy. One might argue that a fourth option exists, which is to do nothing. But ignoring the problem will not make it go away, at least not for a very long time. If you are able to evade your creditors until the statute of limitations for debt is reached, you then cannot be successfully sued in court for the debt. But remember, even in this unlikely scenario, you still owe the debt, so you have not in fact handled the debt.

And we are talking about years here; depending on where you live, the statute of limitations could range from three to 20 years. That’s a long time to dodge a creditor. In the meantime, your credit score is likely just going to get worse and worse. Let’s look at the three options and also, consider an option that is really a combination of all three.

Pay in full

Paying your debt off in full is the best way to handle a default. While the creditor would love it if you could just write a check for the entire amount, you got here for a reason, and having the cash to pay it in one fell swoop may be impossible. So a payment plan may be the only option. Fortunately, many creditors are willing to work with customers to craft a short term plan with reduced payments or lower interest charges. You just have to ask.

Debt settlement

You can also try to settle the debt by paying less than you owe. But these negotiations are not without peril. Remember, if more than $600 in debt is forgiven, you will owe taxes on the forgiven debt. As with any negotiation, be sure to get everything in writing and make sure the language clearly states that the debt will be considered paid in full. Otherwise, you may find that the creditor or collector has sold the remaining portion of the debt to another collector, which may then come after you for the balance.

For the record, I don’t recommend using debt settlement companies. They tend to be adversarial and have a terrible track record, leaving you with both the debt and a very upset creditor.

Bankruptcy

Third, bankruptcy may be in your future if you ultimately cannot take care of the debt. As part of your decision-making process, I would recommend a call to a nonprofit credit counseling agency. You will be required to have credit counseling as part of a bankruptcy filing anyway. But if you call the agency first they may be able to help you cut through the emotion and fear of dealing with debt to determine your best course of action.

Debt management plan

Finally, you may be able to combine features of all the above by using a debt management plan offered by a non-profit credit counseling agency.  If you qualify, they will get you preferred repayment terms, with concessions tailored to your budget for as long as five years. A DMP is similar to a chapter 13 bankruptcy, but without the credit score damage. Contact the National Foundation for Credit Counseling to find a member you can trust to help you find the best solution.

How to avoid defaulting on credit cards

As with anything, prevention is better than a cure. If you find yourself in a position where you feel like you cannot make your payments, reach out to your credit card company immediately. Most creditors have systems in place to reduce your payments for at least a time through a hardship program. These programs are not generally long-term, but may be enough to get you through to the other side. Communicating with your creditors early is your best hope of avoiding default.

Defaulting on your credit cards is never a good thing, but sometimes it cannot be helped. Knowing what the cost to your score will be before you take action will help you make the right decision for your situation.

Good luck!