Dealing with debt can be really overwhelming especially if you are facing financial trouble at the same time. Times are so tough that even managing day to day expenses is becoming a lot for people. In such circumstances, it just makes sense that paying off your debt becomes out of the question sometimes. Luckily, for people drowning in debt, there are multiple debt relief options out there including debt consolidation, debt management and debt settlement.
What makes credit card debt settlement stand out is the fact that it reduces a substantial amount of your debt. Instead of paying the full amount back, you just have to pay a lump sum amount and the rest of it is forgiven. For someone who is new to the concept of settlement, this is the right place as we will discuss everything about it in detail.
Understanding Credit Card Debt Settlement
A credit card is just like any other financial instrument. It increases your purchasing power. What happens is that when you purchase something, your card issuer will pay the retailer on your behalf. After a month, your card issuer will bill you for your expenses that you’ll have to pay later on a decided date.
Now what happens when you aren’t able to pay off the bill? This is where debt settlement comes into action. In a settlement negotiation, you request your creditor to waive off a certain percentage of your outstanding balance by making a lump sum payment. It’s more like an agreement between you and your card issuer in order to deal with the piled up debt.
It’s never a good idea to just ignore your debt and do nothing about it, especially when you know you won’t be able to pay it off anytime soon. Things can take a really bad turn if you leave your debt unpaid. Most importantly, late or missed payments can wreak havoc on your credit score which is the last thing you’d want for yourself. On the other hand, if you are facing any financial emergency or have some other valid reason that explains why you can’t afford to pay off your debt then it’s best that you negotiate with your creditor as soon as possible.
How Credit Card Companies Handle Settlements?
Every credit card company would do anything to collect as much as possible of the amount they are owed. However, if it looks like a customer can’t or won’t ever be able to pay off the outstanding amount then they do agree on a settlement to at least recover some amount rather than nothing.
Here’s how they handle when a customer requests to settle credit card debt for less;
Delinquent Account
When you miss your payments for like 80 to 190 days, your account becomes delinquent and it gives the impression to the creditor that you may not be able to pay off your debt. A delinquent account means your credit score will start falling and your debt will increase due to late fees and increasing interest.
Internal Collections
Initially, your account will stay “in house”. The card issuer will do everything he can to make sure that you bring your account current. You might even be offered hardship programs.
Charged Off Status
After 180 days, your account will be marked as “charged off” which means that for account purposes, it will be written off as a loss. If this happens, you still owe the company their money and this mark will serve as a serious red flag on your credit report.
Collection Agency Or A Settlement Offer
Once your account has been “charged off”, the credit card company will try to make a settlement offer to you or they’ll simply turn over the debt to a collection agency. The collection agency will go to all lengths to collect or settle the debt with you.
The Negotiation Phase
In the negotiation phase, if you contact the creditor directly or through a settlement company, your creditor might agree to a lump sum settlement of around 40% to 60%. For this to happen, they’ll require proof of hardship and everything will be documented.
Post Settlement Reporting
After you make the payment, your account will then be marked as “settled” or “settled for less than what you owe”. In both cases, it will stay on your report for 7 years and if the creditor has forgiven more than $600 debt then it will be considered taxable.
Steps To Settle Credit Card Debt On Your Own
Negotiating credit card debt settlement can be a little overwhelming especially if you want to do it yourself. Using a third party service like a debt settlement company can really cut down your stress because these companies have years of experience and they know how to handle the process professionally. However, if you still want to do it on your own then make sure that you follow all the steps carefully;
1-Confirm The Amount You Owe
The very first thing you need to do is to confirm the total amount you owe to the company. You can easily confirm the total amount through your credit report or ask the credit card company for a debt validation letter. If you believe that the total is wrong and you’ve already paid a part of it then you have to dispute it within 30 days of receiving your debt validation letter.
2-Calculate How Much You Can Afford To Pay
It’s crucial that before the negotiation, you plan your budget. To get an accurate figure, you first need to review your monthly expenses and your income. If you don’t want the negotiation to go downhill then ensure that you are putting up a realistic offer.
Most of the time, creditors agree on a 50% lump sum settlement offer. Anything less than 50% means that the negotiation might fail. If you can’t afford to make the lump sum payment at once, request the creditor to break it down into a monthly plan like 12 to 24 months. It’s best if you start setting aside the lump sum amount in another account to prepare yourself if the negotiation goes through.
3-Make Sure You Have A Valid Reason With Proof
Valid reasoning that explains why you can’t afford the debt is of utmost importance in this entire process. You can’t just enter into a settlement negotiation only to save your money. This debt relief option is specifically for those who are really facing some serious financial hardship in their life. It can be anything from a medical emergency to a divorce or even loss of income. Whatever your reason is, make sure that you have proof for it because the creditor will demand one before agreeing to your terms.
4-Contact Your Creditor
The next step is to contact your creditor or the collection agency dealing with your debt. You first need to ensure how far behind you are on your payments. If it’s only been a few days, your creditor might not agree on settling your debt. You at least need to be 90 days behind your monthly payments to start a negotiation. Usually after 120 to 180 days, credit card companies mark your account as “charged off” and your debt goes into collections which is another level of stress and pain. In a nutshell, it’s important that you start a settlement negotiation with your creditor before it goes into collections.
How Much Can You Expect To Pay?
The amount you can expect to pay in a debt settlement depends on the creditor that you are dealing with. Mostly, you have to pay at least 40% to 60% of the total amount you owe but some companies can even go as low as 30% if you are facing a serious financial hardship or if you are close to filing for bankruptcy. For example, if you owe your card issuer $1000, you’ll have to pay at least $40,000 or $60,000 to settle your debt.
There are multiple factors that can affect the settlement amount including;
- How far behind you are in your payments
- The policies of your creditor
- Your financial hardship
- Lump sum vs payment plan
- The creditor you are dealing with
Alternatives To Credit Card Debt Settlement
Credit card debt settlement isn’t the only option for people who can’t afford their debt. There are multiple other alternatives out there that can come in handy to you depending on your financial situation and the amount of your debt.
1-Debt Management Plan
If you want to repay your full balance but just don’t want to deal with high interest rates then a Debt Management Plan is going to be the best option for you. For this, you need to get in touch with a non profit credit counseling agency. You make your monthly payments to the agent and they then negotiate for lower interests with your creditor. When the creditor agrees on cutting down your interest, you then pay the balance off in full within 3 to 5 years. The best part about this alternative is that it won’t affect your credit score or report at all.
2-Debt Consolidation Loan
A debt consolidation loan is best for those who have multiple debts to deal with and multiple interests on top. In short, it can help you manage your debt easily. What happens here is that you take out another personal loan and then use it to pay off the rest of your loans all at once. This leaves you with only a single debt to worry about and a single interest rate to deal with. The catch here is that in order to qualify for a debt consolidation loan, you need a fair credit score that’s more than 600.
3-Balance Transfer Credit Card
If you don’t have a huge amount of debt to worry about and have a fair credit score then the balance transfer credit card strategy can work wonders for you. All you have to do here is to move your high interest debt into a credit card that offers 0% APR. This technique can help you pay off your balance without any interest. You just have to make sure that you pay the amount back within the promotional period.
Common Mistakes And How To Avoid Them
A credit card debt settlement can reduce your debt but it’s quite common for people to make mistakes during this process which then costs them more time, money and sometimes more damage to their credit. Here’s a rundown of some of the mistakes people often make and how to avoid them;
1-Stopping The Payments Too Early
Yes, you need to be far behind your payments for at least 90 to 120 days in order to settle your debt but stopping the payments way too early without a proper plan can really do more damage than good. Late or missed payments means increasing debt, increasing interest and on top of that, it will seriously affect your credit score. To avoid this mistake, you should only stop payments when you can’t really afford the debt and when you have a proper plan to negotiate with your creditor.
2-Falling For Shady Settlement Companies
There are some really good and reliable debt settlement companies out there but unfortunately some of them are just waiting out there to scam you at the first chance they get. A shady settlement company will always ask you for a huge upfront fee. As per the FTC, no debt relief company is allowed to charge any fee upfront. To avoid getting scammed, it’s best to work with a non profit credit counselor or to just find FTC compliant companies that can be reliable and trustworthy.
3-Not Saving Enough For A Lump Sum
Before the negotiation, you need to have a settlement savings plan. You can’t just offer your creditor a lump sum settlement that you don’t even have. This is the very first thing you need to prepare because if after the negotiation, you still aren’t able to pay the decided amount, it can increase your debt and cause unimaginable damage to your financial life.
4-Not Considering Any Tax Consequences
A debt settlement is a legal process and before getting into it, you should know all its pros and cons. One of the most important things people often forget and neglect is that sometimes the forgiven amount is considered taxable by the IRS. Especially if your creditor is forgiving more than 60% of your debt then it sure is taxable.
5-Underestimating The Impact On The Credit Score
A poor credit score causes multiple hurdles in your financial life. People often underestimate the damage that debt settlement does to their credit score and report. For those who don’t know, a settled account will stay on your report for 7 years. However, it’s still less damaging than bankruptcy so you should only consider it when it’s your last resort.
Case Studies Of Successful Credit Card Settlements
1-Case Study #1: Ava — $15,000 Settled for $6,000
- Background:
Ava lost her job an year ago and was unemployed since then
She had three credit cards with a total of $15000 debt
She had no income or means to pay off the debt and was going to consider bankruptcy.
What She Did:
- She stopped her payments and started saving $500 every month
- After around 6 months, Ava managed to save $3000
- She contacted the creditors, one settled for 40%, the second one settled for 60% and the third one agreed on 55%.
Final Result
- She paid a total of $6000 and the rest of the $9000 was forgiven.
- Initially her credit score dropped but she started working on improving it and within a year she was debt free.
Case Study #2: Frank — $9,800 Settled with Collection Agency for $3,200
Background:
- Frank had a total debt of $9800 and it went into collections because he wasn’t able to make the monthly payments for the past 7 months.
- Frank recently started a new job and started saving to make a lump sum payment for the settlement.
What He Did:
- He contacted the collection agency and offered a lump sum of $3000 but the agency declined the offer.
- After a month, the agency contacted Frank with a counter offer of $3500 but he was just able to pay them $3200 which is why the agency agreed.
- He got all the settlement details in writing before making any payments.
Final Result:
- Frank paid a total of $3200 and the rest of the $6600 was forgiven.
- The credit report shows “settled” but there’s no further collection activity that he has to worry about.
The Final Word
Debt settlement can work wonders for people dealing with a significant amount of debt but what you must know about this process is that it will take some time. It’s no magic and you don’t just become debt free in a night. It can take you months and sometimes years before your creditor agrees on your terms. You just have to negotiate the right way, make a realistic offer, have the lump sum prepared and most importantly, you need to stay consistent with your efforts. There are high chances that your card issuer will reject your initial offers but that’s where you need to stay firm and keep making counter offers till you both reach an agreement.
FAQs
Q1. Is Debt Settlement Better Than Bankruptcy?
Even though debt settlement will take longer and will impact your credit score, it still is a better option than filing for bankruptcy. Banktrucpy can do more damage to your credit report and it can serve as a red flag on your credit forever.
Q2. Can I Negotiate With My Creditor If My Debt Isn’t Past Due?
Yes, you can but there are high chances that your creditor won’t agree on settling your debt until you are far behind your payments. A delinquent account can reduce your credit score but it can also pressurize your creditor to take the lump sum from you rather than getting nothing.
Q3. Will A Debt Settlement Company Erase My Debt?
No debt settlement company can eliminate your debt completely. You’ll always have to pay a lump sum settlement or follow a payment plan. A debt settlement means reduced debt, it doesn’t mean that you won’t have to pay anything at all.
Looking for the right debt settlement company that can reduce your credit card debt in a hassle-free manner? Try Mountains Debt Relief and you sure will be impressed with what we have to offer!