Credit Card Debt Settlement

Debt is at an all-time high for Americans and many are finding themselves saddled with credit card balances that are ballooning out of control. Whether it’s because of interest charges and fees or juggling other types of debt, sometimes paying off a credit card just isn’t possible. Credit card debt settlement might be the perfect solution.

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What is credit card debt settlement?

Credit card debt settlement is when your creditors agree to accept a portion of the total outstanding debt and consider the debt paid off. What’s in it for credit card companies? Unlike a mortgage or a car loan, there’s nothing a credit card issuer can come after if you don’t pay your bill. Because of this, they would rather settle and get some of their money rather than nothing at all.

Different ways to settle credit card debt

If you’re buried under balances, you actually have several options at your disposal. Each can affect your credit score, taxes, and debt repayment structure differently, so some settlement options may be better in certain situations than others.

Lump-sum settlement

The traditional type of debt settlement that most people think of when they hear the term ‘settlement’. When approaching a lender to ask for a portion of the debt to be forgiven, they often require payment in a single lump sum. This is most likely the type of settlement agreement you’ll encounter if enrolling in a debt settlement program with a third-party company.

Workout agreement

A workout agreement is when you ask your credit card company for assistance paying off your balance. This can include waiving or reducing your monthly payment, lowering or eliminating your interest rate, and removing past late fees. Though this approach won’t get rid of a significant portion of your debt, it can make it much easier to pay it back — and while keeping your credit score intact.

The credit card(s) included in a workout agreement will be frozen so you won’t be able to make any additional purchases with them. Those cards will then be closed once the account is paid off. These closures may negatively affect credit score but not nearly as badly as a lump-sum settlement would.

Hardship plan

If you can display financial difficulty (such as from losing your job or falling seriously ill), you can negotiate a hardship plan directly with your credit card company. It may include temporary assistance similar to what’s offered in a workout agreement for a few months.

Unlike a workout agreement, your credit card(s) usually won’t be closed under a hardship plan. However, they might be temporarily frozen so that they’re unable to be used while on the modified payment arrangement.

How to settle credit card debt (5 steps)

Credit card balances and medical bills are the most common types of debt used with settlement. Unlike the processes for settling student loans or tax debt which are specialized, settling credit card debt is much more straightforward. Here’s the process in a nutshell:

1. Decide if you want to do the negotiating yourself or pay for a professional
2. Determine how much you owe, to whom, and the APR of the accounts you want to settle
3. Put money aside for a settlement offer
4. Contact the credit card company(s)
5. Get an agreement in writing

This guide to settling credit card debt will walk you through everything you need to know, from preparation to the execution process to deciding if settlement is indeed the best option for you.

Step 1: Choose your settlement approach

Settling credit card debt isn’t always guaranteed to work. Credit card companies (or collection agencies, depending on whether the debt has been charged off) must first agree to settle and take less than the full amount owed. From there, an agreement can be reached to determine a dollar amount of how much will need to be repaid.

Both of these details will require negotiating which can be done through a third-party debt settlement company or on your own. This is one of the most important decisions to make as it can affect your likelihood of success, how much money the process takes, and what the process will look like.

Option 1: Hiring a debt settlement company

If you’d prefer a hands-off approach to getting rid of your credit card debt, there are companies dedicated to settling debt. They will negotiate with credit card issuers or collections agencies on your behalf, allowing you to settle one or multiple balances.

When working with a debt settlement company, the individual will need to make monthly payments which will be set aside in escrow. They help evaluate your budget to see how much money you have available to set aside each month; this amount is often significantly less than the total monthly payment you’re making on all credit card debts.

Once these funds reach a sizable lump sum, the company will reach out to the lender to make them an offer. Experienced and likely to have standing relationships with various financial institutions, working with professionals can increase the chances of successful credit card debt negotiation.

However, they don’t provide this service for free. These are for-profit companies and will charge you. Most debt settlement company fees are around 20-25% of the total amount of your debt and they may charge additional fees for things like maintaining your funds. There are also plenty of unscrupulous players in the debt settlement landscape, so it’s important to know what to look for to avoid being scammed.

Option 2: Negotiate on your own

It’s possible for a person to contact their lender and negotiate with them directly, whether the balance is still with the original lender or charged off to a collection agency. The biggest benefit is the cost savings, which depending on how much you owe, could be thousands of dollars.

The tradeoff, however, is that you’ll have to get your hands dirty with preparation and outreach, which can be quite time-consuming. If you have multiple credit card balances, you’ll need to negotiate with each credit card company individually.

For the best odds of success, you’ll want to research the settlement policies of each individual creditor and make sure you know your rights (especially if you’re dealing with a collection agency). Then there’s the issue of talking to the right person and getting them to agree to settle. It’s not uncommon for this to require multiple attempts.

Additionally, you’ll likely still need a lump sum to be taken seriously when reaching out to a lender. Some card issuers or collection agencies may be willing to set up a payment plan, but on having at least half the total amount owed saved up before approaching them.

Step 2: Decide which card balances to settle

Whether you choose to use a debt settlement program through a company or settle the debt on your own, you’ll need to decide which credit card balance(s) you want to try and negotiate. Remember, settling a credit card balance will result in that card being closed. If you want to leave a card or two open in case of a financial emergency, you shouldn’t consider it for settlement (instead, use consolidation or a debt management plan).

A few other things to consider when deciding which debts to include:

• The age of the account: The older it is, the more likely the credit card company will agree to settle. But keep in mind that closing your more established accounts will hurt your credit age, a lesser factor used to determine credit score.
• Who owns your debt: Know if the credit card company charged off your debt to a collection agency. This could hurt or help your odds, depending on the policy of each.
• How much you owe: Large balances over $10,000 are the best candidates for debt settlement. A credit card company or collection agency may not be willing to settle for smaller amounts. If your debt has gone to collections, verify exactly how much you are said to owe with debt validation.

If you’re not sure where to start, map out all your credit card balances, noting who they’re owed to, how delinquent you are on payments, and by how much.

Step 3: Put money aside for payment

If you are working with a debt settlement company, they will help you determine how much you can afford to set aside each month while still making the minimum payments to your accounts.

If you’re not working with a professional, you’ll need to be disciplined and contribute to a settlement payment on your own. Creating a separate bank account can be helpful in setting aside money that you don’t want to accidentally spend.

Step 4: Negotiate with the credit card company

Once you’ve accumulated enough funds to approach the credit card company it’s time to negotiate. Simply asking for your debt to be forgiven isn’t going to be enough. You’ll need to explain your financial situation and have a good reason to settle.

You’ll also want to be clear about what you want. In addition to having the debt settled for a fraction of the full amount, you want to negotiate items that can lessen the damage to your credit:

• Negotiating to list a credit account status as paid in full.
• Negotiating to re-age an account to remove delinquent payments.
• Using pay for delete to remove a debt collection account from your credit report.

Read the step-by-step guide for DIY debt settlement negotiation »

Step 5: Get agreements in writing

Once you’ve reached an agreement with the credit card company or collection agency, it’s important to get everything in writing and have both parties sign the agreement. Verbal agreements won’t protect you if your account is accidentally charged off and sent to collections. A written agreement will help you dispute any erroneous charges on your credit report down the line.

Items you’ll want to be sure are included:

• Debt validation notice
• The agreed settlement amount
• Payment date/schedule
• Promise that the debt will be considered ‘paid in full’
• Agreement to stop future collection efforts
• Conditions that would breach the agreement

Free debt settlement letter template »

Pros and cons of credit card debt settlement

Settlement allows a person to only pay back a percentage of what they owe; in return, the creditor discharges the remaining balance. The idea of paying less than you owe makes it a highly attractive option. Plus, settlement can get rid of credit card debt quickly and cost significantly less than other debt relief options. But is settling credit card debt really the best way to deal with those pesky bills?

Benefits of credit card debt settlement

The primary benefits of this approach are that it’s faster and cheaper than other debt solutions.
With debt settlement, you might only pay between 10% and 50% of the total amount owed (the average consumer can save 30% according to the American Fair Credit Council [1]).

Settling can help you avoid late fees and the trap of minimum payments, and lower your risk of going into default. If you’re drowning in a considerable amount of credit card debt, settling can provide a clean slate without being as damaging as declaring bankruptcy.

Drawbacks of credit card debt settlement

There are a few caveats to getting rid of credit card debt through settlement. One is that this option only works if you can get card issuers or collection agencies to agree to let you settle (more on that later). This dependency on their cooperation means that credit card debt settlement is great – if you can get it. If you are able to pursue this avenue, then there are several drawbacks to consider:

Credit damage: Settlement often requires paying a large lump sum upfront (another potential drawback of this approach). Until you’ve put enough money aside to make an offer to the credit card issuer or collection agency, you’ll continue to rack up late fees and missed payment remarks on your credit report. Those don’t go away even after the debt’s marked as ‘settled’ (which itself is another negative remark that will ding your credit and stay on your report for 7 years).

Closed credit accounts: Any credit accounts included in settlement will automatically be closed once the agreed-upon settlement amount is paid. This will both hurt your credit score and leave you with few credit cards to use for financial emergencies. If your credit is severely damaged, either before or because of settling, getting a new credit card could be extremely difficult and leave you stranded without a financial safety net.

Loss of future buying power: If you have important purchases coming up in the next few years such as buying a house, a new car, or starting a business, the credit score consequences of settling your credit card debt could put those in jeopardy. You’ll need to weigh if fast debt relief is worth the long-term impact it will have on your finances.

Tax consequences: Lastly, the amount of your balance that you don’t end up paying could come back to bite you by being treated as taxable income. If this ends up being the case, the credit card company you settle with will send you a 1099-C tax form.

Debt Settlement and Your Credit

It’s best to go into debt settlement with the understanding that it will cause some damage to your credit — here’s how:

1. Settling credit card debt for less than you owe will always result in a negative item on your credit report. It will result in a negative “settled in full” remark that hurts credit history, the single most important factor that affects credit score, and shows other lenders that you had previously had debt you were unable to pay off entirely. These remarks will remain for seven years from the date the account originally became delinquent, similar to bankruptcy. If you work with a debt settlement company, all accounts will appear in your credit report as paid as agreed. These remarks hurt payment history, the single most important factor that affects credit score, and show other lenders that you had previously had debt you were unable to pay off entirely.
2. Until enough money has been accrued to approach a credit card company and offer to settle, overdue or overdrawn accounts will continue to generate negative credit remarks every month. This also damages credit history.
3. All accounts included in the program are closed after payment is accepted. This hurts multiple factors used to calculate credit score: age of credit, credit mix, and available credit.

How much will credit card debt settlement hurt my score?

The impact will depend on where your credit health is starting from. If you have excellent credit with no prior negative information, a settlement would cause a major blow to your score. If you have bad credit already, your score isn’t going to take as much of a hit.

Ways to minimize credit damage

Re-age: It may be possible during the negotiation that you ask the creditor 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.

Pay-for-delete: If the account is in collections, you can attempt to negotiate pay-for-delete, in which the collector instructs credit bureaus to remove the collection account from your credit report.

Either of these options can remove some, if not all negative credit report information. However, be aware that creditors and collectors are required by law to report accurate information about consumer credit use. Even if the creditor or collector initially agrees to remove a collection account or re-age it, the negative information could reappear later.

Other credit card debt relief options

Settlement is best thought of as a second-to-last resort debt relief option for someone in dire financial straits. It’s not as damaging as bankruptcy in terms of your credit score and financial reputation — but it’s pretty close.

Another reason why you might not want to pursue settlement as ‘Plan A’ is the inherent risk of going the debt settlement route, which is that it doesn’t always pan out. It is well within the rights of credit card companies and collection agencies to reject your settlement offer. Then what?

Fortunately, there are other ways of getting rid of stubborn credit card debt, and under circumstances, might be a better method than settlement.

Debt settlement vs consolidation

A simple way to differentiate between the two is that debt settlement reduces how much is owed, while debt consolidation reduces how many are owed.

With debt consolidation, balances from multiple credit cards or loans are combined into one using what’s called a consolidation loan. Instead of making individual payments to multiple account balances and different lenders, a person only needs to make one monthly payment (similar to how credit card balance transfers work).

Consolidation doesn’t change the amount that’s owed, you’re still expected to pay off everything you borrowed. However, consolidation loans usually have much lower interest rates than credit cards which makes them easier to pay off and can save money in the long run.

Another advantage of consolidation over debt settlement is that unlike with settlement, credit cards are not automatically closed once they are paid off. This is good news for two important credit card factors (credit utilization rate and average age of credit) plus, you can retain access to money for emergency purchases.

Debt settlement vs debt management programs (DMP)

If you need help paying off your credit card debt, a DMP or debt management program can help you take control of your balance while also improving your credit score. You’ll be paying off 100% of your debt owed, but with the elimination of fees and APR charges, you could save as much as 50% of your total debt.

Unlike consolidation which uses a loan to pay off other account balances, debt management programs rely on credit counseling agencies negotiating an agreement with your credit card company(s) to stop your balances from growing. This process takes longer than settlement but causes significantly less credit damage. In fact, those enrolled in a DMP may find that their credit score improves before their debt is paid off.

Note that both debt settlement and DMPs result in any credit cards included in the program being closed after they’ve been paid or settled. However, debt management programs may be able to retroactively erase negative credit score remarks, which far outweighs the impact of closing a few credit cards.

Debt settlement vs bankruptcy

Debt settlement and bankruptcy are highly similar in that they allow a person to resolve their debt without paying the entire balance. They’re also similar in that they can cause major credit score damage. Settlement might drop a person’s credit score by 60 and 100 points. Bankruptcy, however, can do so by 100 to 200 points, if not more.

One key difference between debt settlement and bankruptcy is how it’s achieved. Bankruptcy requires going to court to prove eligibility. And while it’s possible to file without an attorney (known as filing pro se’), there can be legal consequences for pursuing bankruptcy incorrectly so consulting a bankruptcy lawyer is always strongly recommended. Debt settlement is less cumbersome in this regard, as an individual can easily represent themselves in negotiations.

The biggest differences are between settlement and Chapter 7 bankruptcy, also known as liquidation bankruptcy. This type of bankruptcy allows a person to get out of debt for almost nothing out of pocket and is also the fastest debt relief option, taking as little as 6 months or less. Settlement achieves similar results but takes between 1 and 4 years.