You're likely overwhelmed if you're maxing out your cards and getting deeper into debt. Will you ever be able to repay your debt? You’ve received offers from companies promising to settle your debt for “pennies on the dollar.” This is called credit card debt settlement, and there are pros and cons to using this option.
Credit card settlement allows you to pay off your credit card loan for a lower amount than you owe. You can make a debt go away with less than the total amount. Before jumping into the credit card debt settlement process, consider the following facts and make sure you understand 100% what you’re getting into.
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Debt settlement companies are for-profit companies offering to negotiate with creditors for a lower “settlement” amount of your original loan. The settlement amount is a lump sum payment, typically 48% of what you originally owed.
To save that lump sum amount, they require you to send money every month to a set-aside fund which will be used to settle the debt. This process usually lasts 36 months before you can reach the required lump sum.
Setting aside a monthly amount can be challenging when you’re already trying to pay off your debts, so these companies usually advise you to stop making payments to the creditor. This is risky because it can bury you deeper in debt due to penalties, fines, and accrued interest. Reputable debt settlement companies should help review your monthly budget and find ways to make the monthly set-aside payments without sacrificing payments to your creditors.
Most debt settlement companies don’t disclose the fact that many of their customers fail to make the monthly payments and drop out of the program. These companies negotiate smaller debts first, leaving more enormous debts to keep accruing interest.
Settlement of credit card debt is reflected as "settled in full" rather than "paid in full." This notation will remain on your credit report for seven years. Since your credit history is the most important factor in calculating your credit score, this notation will damage your credit score with every debt you settle.
However, your credit score is already damaged if your debt goes into collections. Settling your debts won’t further damage your score. But a credit card settlement will drag down a fair or good credit score.
The Federal Trade Commission (FTC), which enforces credit card settlement law, has banned debt settlement companies from charging advance fees before settling or reducing their clients' debts. This means you don’t have to pay any fees, such as an administration fee, to a debt settlement company until they’ve successfully negotiated a debt settlement for you.
If they charge any advance fees, there must be a money-back guarantee. Otherwise, you’re dealing with a debt settlement scam.
Debt settlement companies collect a percentage of the settled amount as their professional fees. Depending on how much you owe, this could be in the thousands.
Unpaid debts have a maximum statute of 10 years. After this period, collectors can’t collect the debt anymore, and if they keep harassing you, you can already send a cease and desist letter, which they’ll honor.
The closer the age of your debt to the statute of limitations, the more likely collectors will settle for any amount they can collect. When this happens, credit card settlement is no longer an ideal solution. Just simply wait for the statute of limitation to expire.
The IRS considers any savings you get from settling your debt as income and can be subject to income tax. This depends on your financial condition (i.e., if you’re insolvent), then they won’t tax you. It’s best to consult with a tax professional to know your options.
Now that you know how a credit card settlement work and the facts about it, you may want to reconsider other debt-relief options first. Others, like debt management, direct negotiations with your creditors, and credit counseling, can help you get out of a mountain of debt.
Credit cards can be beneficial to our finances when used wisely. Use credit cards only in line with what you can afford to maximize their benefits and prevent stressful debt situations.
Check out the Processing Card’s blog section for more articles about managing your credit cards.
Florence Carpenter is passionate about ensuring that the process of opening merchant accounts is as straightforward as possible. She graduated from the University of Michigan with a bachelor’s degree in Marketing.
