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Credit Card Debt Settlement

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When you can’t afford to pay off everything you owe, credit card debt settlement can help you get out of debt fast. You pay back a percentage of what you owe and in return, the creditor discharges the remaining balance. This may hurt your credit score, depending on the terms of the settlement you negotiate. Even so, as long as you are aware of the impact and have a plan to recover, settlement can be beneficial. It can provide the fast exit that you need to get a clean start without your existing debt weighing you down.

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There are two basic paths to credit card debt settlement

Credit card debt settlement negotiation works in two basic ways:

  1. You can negotiate a settlement with a single creditor or collector.
  2. You can enroll in a debt settlement program to settle multiple debts.

The first path is something that you can either do on your own or work with a debt settlement attorney. It’s usually used when you have one problem account that’s gone to collections. To use the second option, you usually must go through a debt settlement company. This option is best used when you have multiple debts that are behind or already charged off.

2 Ways Credit Card Settlement Works

Option 1: How to negotiate credit card debt settlement yourself with a single creditor

This basic credit card debt settlement process can vary. In some cases, the collector or creditor may contact you with a settlement offer. Then you decide if you want to accept it or make a counteroffer. In some cases, you can make the settlement with a small series of payments, instead of a single lump sum; however, this is less common.

Option 2: How a debt settlement program works

When you have multiple debts to settle, you generally set up a debt settlement program through a debt settlement negotiation company. Using a debt settlement program generally follows this same basic process for individual negotiations. However, there are steps you take before negotiation when you enroll in a program through a debt settlement company.

  1. The settlement company creates a “set aside” account where you deposit money to generate the funds you need.
  2. They help evaluate your budget to see how much money you have available to set aside each month; this amount is usually significantly less than the total monthly payment you’re making on all credit card debts.
  3. Once you generate enough funds, they approach one of your creditors to make a settlement offer.
  4. The creditor may counteroffer, in which case your settlement team negotiates to reach a final amount that all parties can accept.
  5. Once you reach a settlement, fees can be applied.
  6. This process repeats with each creditor or collector until you reach settlements on all the debts included in your program.

This type of debt settlement works for other unsecured debts!

Credit cards aren’t the only type of debt that you can settle using the methods described on this page. This type of settlement works for almost any unsecured debt:

So, if you have more unsecured debts that just credit cards, you can roll them into the same settlement program. This gives you one solution to take care of a wider range of the debt challenges that you face.

It’s worth noting that there are also settlement programs for tax debt and private student loans. Settlement usually doesn’t work for most secured debts, like mortgages and auto loans. That’s because the lender can simply repossess the collateral (your home or car) if you don’t pay the debt.

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Pros and Cons of Credit Card Debt Settlement

Pros of Credit Card Settlement Cons of Credit Card Settlement
It usually takes less time than other solutions Settlement generates negative items on your credit report
You get out of debt for less than you owe (usually about 40-80% of the balance) These items also hurt your credit score
You’ll avoid getting sued in civil court and actions like wage garnishment Settlement will always close your accounts; you may have trouble opening new ones
It stops the constant annoyance of collection calls You could be on the hook for income taxes for the settled debt

Credit card settlement benefits by the numbers

In June 2014 the Center for Responsible Lending conducted a study to evaluate the impact of reputable debt settlement services following the implementation of new regulations by the Federal Trade Commission. Here is what they found…

When credit card debt settlement can be better than consolidation

If you have credit card debt to repay, you generally have two options:

  1. Credit card debt consolidation
  2. Debt settlement

Settlement is usually the better option when you simply want a fast exit and don’t care about credit score damage. It’s especially useful once your debts are already charged off. That typically happens after six months of nonpayment. The creditor freezes the account, moves it to charge-off status and counts it as a loss for the company. They either sell it to an outside debt collection agency or send it to their in-house collections department.

At this point, in either case, all interest charges and late fees on the account freeze. Federal law says that a creditor or collector cannot apply interest charges or additional late fees to a charged-off balance. They can only collect the amount listed when the account was charged off.

This means that there’s less benefit to consolidating the debt. The biggest advantage of credit card debt consolidation is to reduce or eliminate the interest rate applied to each debt. If no new interest charges can be applied and rates don’t matter, then consolidation offers less of an advantage.

This means that once a debt goes to collections, settlement should be on the table as a possible solution. Consider carefully if you’re willing to accept some credit damage. If you are, then you should seriously consider settlement. If you want to avoid credit damage, then you should look at other options first.

Debt Settlement Taxes and How to Avoid Them

When you settle a debt for less than the full amount that you owe, you could be subject to income taxes. Any principal that you do not pay back is considered “canceled debt.” The IRS treats canceled debt as a source of income – it’s money you took in without paying your creditors back. But that means that it is taxable.

The good news is that there is a way to avoid paying taxes on canceled debt. All you need to do is show the IRS that the debt was canceled during a period of financial hardship.

How tax filings work for canceled debt

When a debt is forgiven or canceled in a settlement, the creditor must complete a 1099-C. It will report your Cancellation of Debt Income (CODI). This happens for any debt settled that totals over $600. So, you don’t need to worry about this if the settled debt amount is less than $600.

In all other cases, you should receive a copy of the 1099-C from the creditor. They also send one to the IRS, which is why you can’t just ignore it. Instead, you need to apply for an exclusion. You can qualify for an exclusion if you can show that the debt was canceled due to insolvency. In other words, you didn’t have the money to pay!

To qualify for an exclusion, you must complete IRS form 982. It’s worth noting that this is not exactly an easy, hassle-free form to fill out. It includes a title form called the Reduction of Tax Attributes Due to Discharge of Indebtedness that is fairly exhaustive. We recommend working with a certified tax preparer or resolution service to ensure this is done correctly. If you don’t qualify for the exclusion, then you can expect to pay taxes on the settled debt on your next income tax filing!

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Debt Settlement and Your Credit Score

Q:
How does credit card debt settlement appear on your credit report?

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A:

Each time you settle a credit card debt, it creates a negative item on your credit report. This item is reported for seven years from the date of final discharge. It may be possible during the negotiation that you ask the creditor or collector to “re-age” your account following the settlement. They basically agree to update the information in your credit report to show as current in exchange for your payment.

This can remove the negative credit report information, so you’re not bogged down by settlements as you move forward. It’s one of the reasons Debt.com recommends using a professional debt settlement company. They are more likely to negotiate favorable credit terms for you if you’re worried about additional damage to your credit score.

Q:
How does a credit card settlement affect your credit score?

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A:

Credit card settlements count as part of your credit history, which is the biggest factor used to calculate credit scores. Credit history counts toward 35% of the total weight in a credit score. So, negative information like settlements can have a significant impact on a consumer’s credit score.

On the other hand, the size of the impact depends on where you start. If you have excellent credit with no prior negative information, then a settlement would have a notable impact. However, if you have bad credit already caused by a number of other negative items, the impact may be less.

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