You’ve seen the advertisements promising to reduce your credit card debt by up 60% and even 70%. As someone who’s swimming in credit card debt, the service sounds enticing. Can this really work? Unfortunately, many people looking for a debt solution realize debt settlement isn’t what was promised.
How Credit Card Debt Settlement Is Supposed to Work
You enroll in a debt settlement program. After you give them details about your credit card debt – which credit card companies you owe and how much you owe – the debt settlement company makes a settlement offer to your creditors. Settlement offers are usually between 10-60% of your total debt.
Ideally, the credit card company agrees to the debt settlement. The debt settlement company sends the money and you never have to worry about that particular credit card debt again.
How Debt Settlement Really Works
For a credit card debt settlement to be successful, there are a couple of prerequisites. First, you need to be able to pay the settlement as soon as the credit card company agrees. Second, you need to be behind on your payments (more on that later).
Depending on the size of your debt, even settling for pennies on the dollar could mean you owe thousands of dollars. If you had that kind of money available, you probably wouldn’t be using debt settlement. The debt settlement company helps you save up to make a settlement offer. Your payments are put into an account until you’ve accumulated enough to approach the credit card company with a settlement offer. The process is repeated for each credit card.
Unfortunately, your payments don’t accumulate as quickly as you’d think. That’s because the debt settlement company takes its fee from the first few payments. So, it could take a few months before your debt settlement savings starts to build.
Debt Settlement Hurts Your Credit Score
Credit card companies rarely (if ever) accept settlement offers on current accounts. Instead, the older your account, the more likely it is that your credit card company accept a settlement. If your accounts are currently all paid up, your debt settlement company will advise you to stop paying your credit cards so they become delinquent.
Each month you miss a credit card payment, it’s included on your credit report. Because your payment history is the most important factor influencing your credit score, those late payments missed payments make your credit score drop.
Missed payments aren’t the only part of debt settlement that hurts your credit score. If you manage to stick with debt settlement long enough to actually settle a debt, the account status will be listed as “Settled” on your credit report. That negative payment status indicates you didn’t fulfill your original payment agreement and will remain on your credit report for seven years.
Collection Calls Will Start
As your account becomes delinquent, you may begin receiving calls from your credit card company demanding payment. When your credit card goes six months past due, it will be charged-off and sent to a collection agency. You still owe the debt and your credit card company will continue to try to get you to pay.
You Could Be Sued
When you fall behind on your credit card payments, your creditor is within its rights to sue you for the debt. Telling your creditor that you’re working with a debt settlement company can speed up the process. A lawsuit could force you to pay the debt in full. If you can’t afford payment, the court may allow the creditor to garnish your wages.
Your Income Taxes May Increase
You may owe income taxes on a debt that’s been settled. The Internal Revenue Service (IRS) requires you to include cancelled debt as taxable income on your income tax return. If the cancelled debt as $600 or more, your credit card issuer is required to send you a Form 1099-C that lists the amount of debt that’s been cancelled. This form has also been sent to the IRS, so they’re aware that you should report this debt on your tax return.
The cancelled debt could decrease the amount of your tax refund if you’re due one. Worse, you could end up having to pay more taxes to the IRS.
Credit Card Debt Settlement May Not Work
In the end, debt settlement may not even work for you. There’s no guarantee that your creditors will accept a settlement offer. Actually, it could take up to a year or two before you have enough money in your settlement account to settle your first debt. After sending payments for months and seeing no results, a lot of people give up on debt settlement services.
Is Credit Card Debt Settlement Ever Right?
There may be some exceptional circumstances that make debt settlement right for you. For example, if your debts are unsecured, already charged off, and you can’t file Chapter 7 bankruptcy because you make too much money, debt settlement may be an alternative to Chapter 13 bankruptcy which requires to pay all or some of your debt within 5 years.
If you decide to settle your debts, it may be cheaper to work directly with your credit card company rather than hire a debt settlement firm and pay their hefty fees.
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