The Truth About Credit Card Debt Settlement (Part 1)

Written by Curtis Arnold
Posted On: April 14, 2009

Editor's Note: This article is the first of a three-part series about debt settlement.

As an increasing number of people struggle to pay their bills, debt settlement companies are thriving. You can find their ads promising to settle your debts for pennies on the dollar anywhere.

If you’re drowning in debt, those ads can be pretty attractive. But are they for real? And how will settlement affect your credit rating? Debt settlement is controversial. In fact, the Federal Trade Commission held an all day conference in late 2008 to discuss the industry. Here’s a basic guide to debt settlement, with tips to help you figure out if it makes sense for you. What Is Debt Settlement? 3d_red_icons_moneyxxsmDebt settlement is also known as “debt negotiation.” It’s also sometimes referred to as debt consolidation, but that’s misleading since your debt is not consolidated in any way. Settlement programs have been around for many years, but the industry has been exploding recently as consumers find themselves deeper and deeper in to debt. With debt settlement, you negotiate to pay back a portion of what you owe, usually in a lump sum payment, to resolve a debt that you simply can’t pay back in full. While some ads may tout repayments of as little as ten cents on the dollar, a more typical settlement is somewhere around fifty percent of the amount owed. Here’s an example of how settlement can work:

Jack owes a total of $50,000 on six credit cards. His issuers have been lowering his credit limits and raising his interest rates. In addition, he is no longer earning overtime at work, so he just can’t keep up with his minimum payments. He talked with a credit counseling agency, but the monthly payment they proposed was too high and left no room in his budget for any emergencies. He also considered bankruptcy, but does not feel right about not paying back debts he incurred.

Jack works with a reputable settlement company (we’ll discuss how to find one in a moment) and stops paying on his credit cards. Instead, he starts putting that money aside into a savings account. As he starts falling further and further behind, creditors start offering to let him pay off his bills for less than the full amount. He starts to pay off some of the debts, while waiting for better offers from others. He takes any extra money that comes in – a tax refund, for example – and uses it to help eliminate another debt. Over the course of the next eighteen months he reaches settlements with all his creditors and pays a total of $28,000 (including the settlement companies’ fees) to get out of debt. This method can work well for someone who has more unsecured debt than they can afford to pay off in three to five years, but either can’t or won’t file for bankruptcy. It has its drawbacks, though. cardbenefitsFirst, creditors will not settle if you are paying your bills on time. So that means you must stop paying to even be eligible for a settlement offer. (Of course, if you’ve already started to fall behind, then you may be a prime candidate for debt negotiation.) And there may be legal or tax implications. Other the other hand, it is a process that allows consumers to pay as much as they can afford on their debts, and it allows creditors to get something, rather than nothing if the consumer files for bankruptcy. In fact, many large credit card companies that refused to settle in the past are offering very attractive settlements now in order to reduce losses. For more help deciding if debt settlement is the best option for you, check out the Consumer Recovery Network. You may also want to review Stop Debt Collectors: How to Protect Your Rights and Resolve Your Debts, by Gerri Detweiler and Mary Reed, for advice on how to deal with unfair collection tactics. On a related note, if you have been unsuccessful at negotiating a lower rate on your existing credit cards, you might want to consider shopping for a new low rate credit card. As a reminder, you can compare low credit cards on CardRatings.com!

About the author:
Curtis Arnold
Curtis Arnold, a nationally recognized consumer educator and advocate, has been educating consumers about credit cards since 1998. New! Curtis is the author of "How You Can Profit from Credit Cards: Using Credit to Improve Your Financial Life and Bottom Line" (FT Press, 2008). He is also the co-author of the upcoming Complete Idiot's Guide to Person-to-Person Lending (Alpha Books/Pengiun Group USA, April 2009), a contribitor to The Ultimate Allowance (InnerWealth Publishing, 2008) and is extensively featured in 42 RulesTM for Driving Success With Books (Super Star Press, January 2009).
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