Settling credit card debt

If you’ve maxed out your credit cards and are getting deeper into debt, you’re probably feeling anxious, wondering how you’ll ever pay off the cards. If you take a second to slow down, there are ways to get out of the red without spending a whole lot of green.

Debt settlement companies

Debt settlement programs typically are offered by for-profit companies and involve the company negotiating with your creditors to allow you to pay a “settlement” to resolve your debt. The settlement is another word for a lump sum less than the full amount you owe. To make that lump sum payment, the program asks that you set aside a specific monthly amount in savings. Debt settlement companies usually request that you transfer this monthly amount into an escrow-like account to accumulate enough savings to pay off a settlement. Further, these programs often encourage or instruct clients to stop making monthly payments to their creditors.

Debt settlement has risks

Although a debt settlement company may be able to settle one or more of your debts, consider the risks associated with these programs before you sign up:

  • These programs often require that you deposit money in a special savings account for 36 months or more before all your debts will be settled. Many people have trouble making these payments long enough to get all (or even some) of their debts settled and eventually drop out of the program. Before you sign up for a debt settlement program, review your budget carefully to ensure you can set aside the required monthly amounts for the full length of the program.

  • Your creditors have no obligation to agree to negotiate a settlement of the amount you owe. So, there is a chance that your debt settlement company will be unable to settle some of your debts, even if you set aside the monthly amounts the program requires. Debt settlement companies also often try to negotiate smaller debts first, leaving interest and fees on large debts to grow.

  • Because debt settlement programs often encourage you to stop sending payments directly to your creditors, that action may negatively impact your credit report and have other consequences. For example, your debts may continue to accrue late fees and penalties that can put you further in the hole. You also may get calls from your creditors or debt collectors requesting repayment. You could even be sued for repayment. In some instances, when creditors win a lawsuit, they have the right to garnish your wages or put a lien on your home.

Beware of debt settlement scams

Some companies offering debt settlement programs may engage in deception and fail to deliver on their promises, such as “guarantees” to settle all your credit card debts for 30 to 60 percent of the amount you owe. Other companies may try to collect their fees from you before settling any of your debts, a practice prohibited under the Federal Trade Commission’s Telemarketing Sales Rule. Some companies fail to explain the risks associated with their programs: for example, that many (or most) consumers drop out without settling their debts, that consumers’ credit reports may suffer, or that debt collectors may continue to call you.

Avoid doing business with any company that promises to settle your debt if the company:

  • Charges any fees before it settles your debts

  • Touts a “new government program” to bail out personal credit card debt

  • Guarantees it can make your unsecured debt go away

  • Tells you to stop communicating with your creditors but doesn’t explain the serious consequences

  • Tells you it can stop all debt collection calls and lawsuits

  • Guarantees that your unsecured debts can be paid off for pennies on the dollar

Researching debt settlement companies

Before you enroll in a debt settlement program, do your homework. You’re making a big decision that involves spending a lot of your money — money that could go toward paying down your debt. 

  • Check out the company with your state Attorney General and local consumer protection agency. They can tell you if any consumer complaints are on file about the firm you’re considering doing business with. 

  • Ask your state Attorney General if the company must be licensed to work in your state and, if so, whether it is.

  • Enter the name of the company name with the word “complaints” into an online search engine. Read what others have said about the companies you’re considering, including news about any lawsuits with state or federal regulators for engaging in deceptive or unfair practices.

Fees

If you do business with a debt settlement company, you may have to put money in a dedicated bank account, which an independent third party will administer. The funds are yours, and you are entitled to the interest that accrues. The account administrator may charge you a reasonable fee for account maintenance and is responsible for transferring funds from your account to pay your creditors and the debt settlement company when settlements occur.

A company can charge you only a portion of its full fee for each debt it settles. For example, if you owe money to five creditors. The company successfully negotiates a settlement with one of your creditors. The company can charge you only a portion of its full fee because it still needs to negotiate with four other creditors successfully. Each time the debt settlement company successfully settles a debt with one of your creditors, the company can charge you another portion of its full fee. If the company’s fees are based on a percentage of the amount you save through the settlement, it must tell you both the percentage it charges and the estimated dollar amount it represents. This may be called a “contingency” fee.

Disclosure requirements

Before you sign up for the service, the debt relief company must give you information about the program:

  • The price and terms: The company must explain its fees and any conditions on its services.

  • Results: The company must tell you how long it will take to get results — how many months or years before it will make an offer to each creditor for a settlement.

  • Offers: The company must tell you how much money or the percentage of each outstanding debt you must save before it will make an offer to each creditor on your behalf.

  • Non-payment: If the company asks you to stop making payments to your creditors — or if the program relies on you to not make payments — it must tell you about the possible negative consequences of your action, including damage to your credit report and credit score; that your creditors may sue you or continue with the collections process; and that your credit card companies may charge you additional fees and interest, which will increase the amount you owe.

The debt relief company also must tell you that:

  • Funds are yours and you are entitled to the interest earned.

  • The account administrator is not affiliated with the debt relief provider and doesn’t get referral fees.

  • You may withdraw your money at any time without penalty.

Tax consequences

Any savings you get from debt relief services can be considered income and taxable depending on your financial condition. Credit card companies and others may report settled debt to the Internal Revenue Service (IRS). The IRS considers that savings to be income unless you are “insolvent.” Insolvency is when your total debts exceed your total assets’ fair market value, and it can be complex to determine. Talk to a tax professional if you are unsure whether you qualify for this exception.

Other debt relief options

Working with a debt settlement company is just one option for dealing with your debt. You also could:

  • Negotiate directly with your credit card company.

  • Work with a credit counselor.

  • Consider bankruptcy.

Talk with your credit card company, even if you have been turned down before. Remember that you can do it for free rather than pay a company to talk to your creditor on your behalf. You can find the telephone number on your card or your statement. Be persistent and polite. Keep good records of your debts so that you can explain your situation when you reach the credit card company. Remember that you aim to work out a modified payment plan that reduces your payments to a level you can manage.

If you don’t pay on your debt for 180 days, your creditor will write your debt off as a loss; your credit score will take a big hit, and you still will owe the debt. Creditors often are willing to negotiate with you even after they write your debt off as a loss.

Contact a credit counselor. Reputable credit counseling organizations can advise you on managing your money and debts, help you develop a budget, and offer free educational materials and workshops. Their counselors are certified and trained in consumer credit, money and debt management, and budgeting. Counselors discuss your entire financial situation with you and help you develop a personalized plan to solve your money problems. An initial counseling session typically lasts an hour, with an offer of follow-up sessions.

Most reputable credit counselors are non-profits and offer services through local offices, online, or on the phone. If possible, find an organization that offers in-person counseling. Here are some good places to start:

  • Universities

  • Military base

  • Credit unions

  • Housing authorities

  • Branches of the U.S. Cooperative Extension Service

  • Your financial institution

  • Local consumer protection agency

  • Referrals from friends and family

Credit card issuers must include a toll-free number on their statements, providing cardholders information about finding non-profit counseling organizations. The U.S. Trustee Program, the organization within the U.S. Department of Justice that supervises bankruptcy cases and trustees, also maintains a list of government-approved organizations. 

If a credit counseling organization says it’s government-approved, check the U.S. Trustee’s list of approved organizations to be sure. Your financial institution, local consumer protection agency, and friends and family also may be good sources of information and referrals.

But be aware that “non-profit” status doesn’t guarantee that services are free, affordable, or even legitimate. Some credit counseling organizations charge high fees, which they may hide, or urge their clients to make “voluntary” contributions that can cause more debt.

Bankruptcy. Declaring bankruptcy has serious consequences, including lowering your credit score, but credit counselors and other experts say that in some cases, it may make the most sense. 

Personal bankruptcy is generally considered the debt management option of last resort because the results are long-lasting and far-reaching. People who follow the bankruptcy rules receive a discharge—a court order that says they don’t have to repay certain debts. However, bankruptcy information (both the date of your filing and the later date of discharge) stays on your credit report for 10 years and can make it difficult to obtain credit, buy a home, get life insurance, or sometimes get a job. Still, bankruptcy is a legal procedure that offers a fresh start for people with financial difficulty and can’t satisfy their debts.

There are two primary types of personal bankruptcy: Chapter 13 and Chapter 7. Each must be filed in the federal bankruptcy court.

Filing for bankruptcy under Chapter 13 allows people with a steady income to keep property, like a mortgaged house or a car, that they might otherwise lose through the Chapter 7 bankruptcy process. 

In Chapter 13, the court approves a repayment plan that allows you to pay off your debts over three to five years without surrendering any property. After you have made all the payments under the plan, your debts are discharged. As part of the Chapter 13 process, you must pay a lawyer, and you must get credit counseling from a government-approved organization within six months before you file for bankruptcy relief.

You must get credit counseling from a government-approved organization within six months before filing for bankruptcy relief. You can find a state-by-state list of government-approved organizations at the U.S. Trustee Program. 

Before you file a Chapter 7 bankruptcy case, you must satisfy a “means test.” This test requires you to confirm that your income does not exceed a certain amount. The amount varies by state and is publicized by the U.S. Trustee Program.

Filing fees are several hundred dollars. Attorney fees are extra and vary.

Source: The Federal Trade Commission (FTC)