Credit Card Rejection and Debt Forgiveness

Most credit card companies won't provide forgiveness for all of your credit card debt. But they will occasionally accept a smaller amount to settle the balance due and forgive the rest. Or the credit card company might write off your debt. But this step doesn't eliminate the debt—it's often sold to a collector.

You can also wipe out your credit card debt by filing for bankruptcy. However, bankruptcy isn't the same as debt forgiveness.

Also, keep in mind that if you're over your limit or paying your credit card bills late, your card might be rejected when you try to use it.

Why Was My Credit Card Denied?

It's happened to many of us. You present your credit card to a merchant or restaurant waiter only to have it returned as rejected.

So, what are some reasons why a credit card could be rejected? When a merchant swipes your card, it's contacting a credit card guarantee company with a record of your credit status. The guarantee company checks for:

• Your overall credit limit. If you've exceeded your line of credit, the guarantee company probably will tell the merchant to reject your card.
• Your daily limit. Many credit card companies don't let cardholders use their card more than a certain number of times a day or spend more than a specific amount per day. These limits are meant to protect against the use of stolen cards. If you've exceeded the daily limit, the merchant will be told to reject the card.
• The amount of the particular purchase. Merchants must check with the guarantee company for approval on purchases larger than a certain dollar amount (called a "floor limit"), which varies among guarantee companies and merchants.
• Whether you're late on a payment. If you often pay late, the guarantee company might tell the merchant to reject your card.

Will Your Credit Card Get Taken Away?

If the card was reported stolen or if you're excessively delinquent in your payments, the guarantee company might tell the merchant to keep it. Some merchants receive rewards for turning in revoked cards.

Most merchants, however, refuse to confiscate cards and simply tell you your card wasn't accepted.

Offering a Settlement to Your Credit Card Company

If you're delinquent on your payments and have a lot of credit card debt, you can offer a lesser amount to settle the entire debt. The credit card company might accept it.

Taking a settlement is sometimes less risky than suing you for payment. Lawsuits cost money, and creditors know they often have little chance of collecting their entire balances through traditional methods, like garnishment.

How Settling Your Credit Card Debt Works

When a creditor agrees to settle a debt, it accepts the settlement payment and forgives the remaining balance.

Example. Jenna owes $12,000 on her credit card. She knows it will take her a long time to repay the total amount plus interest because she lost her job and can't find a new one. She has $7,000 in her bank account and offers it to the credit card company in exchange for wiping out the debt. The credit card company agrees to the settlement. Jenna pays $7,000, and in return, the credit card company forgives the remaining $5,000 balance and considers the debt satisfied.

If you settle your debt for less than you owe, the amount of the canceled debt might be taxable. Settling debts for less than you owe can increase your tax liability depending on your tax bracket and the canceled amount.

Credit Card Companies Sometimes Write Off the Debt

If you stop paying on your credit card debt and become seriously delinquent, the credit card company will likely write off the debt and consider it uncollectible. At that point, the company takes your debt off its books.

However, this write-off offers no benefit to you because a write-off isn't debt forgiveness. The credit card company registers the debt as a loss—but the debt still exists.

The Credit Card Company Might Sell Your Debt

A debt owed to the credit card company is an asset of the credit card company, like any other asset. The creditor can sell the debt to a third party, such as a collection agency, which can then try to collect the debt from you.

The third-party debt collector can file a lawsuit to collect the debt.

What Happens After a Credit Card Lawsuit

Once the collector gets a money judgment against you, it can use the judgment to garnish (take) money out of your paycheck or your bank account. If you end up in this situation, remember that certain types of income are exempt from garnishment, like Supplemental Security Income (SSI), and certain types of property are protected from collection.

The collector can also put the lien on your home and foreclose to get paid. However, while judgment lienholders generally have the right to foreclose, they usually don't. Instead, the lienor will probably just be patient and wait until you sell the property or refinance while interest accrues on the debt.

But the judgment is meaningless if the creditor can't get your income or property (that is, you're "judgment proof.")

Bankruptcy Discharge of Credit Card Debt

If you file for bankruptcy and get a discharge from the bankruptcy court, your credit card debt will likely be wiped out entirely. However, this elimination isn't debt forgiveness. The creditor has little choice, and the debt still exists.

The discharge eliminates only your obligation to repay it, which might matter if you have a cosigner or a co-borrower and that person doesn't file for bankruptcy. That person will still be responsible for the debt.

Consequences of Debt Forgiveness, Write-Offs, and Bankruptcy

Here are the main consequences of any of these possibilities:

• If the creditor writes off the debt as uncollectible, the consequences include a blemish on your credit reports for the delinquent payments and the write-off.
• Additionally, the creditor will likely sell the debt to a collector, who will aggressively pursue you for the money and might sue you.
• If the creditor settles the debt with you, it will note on your credit reports that the debt was settled for a lesser amount. This notation can have a negative impact on your credit.
• Again, the IRS and your state government might be considered taxable income, and you could have to pay taxes on it.
• If you file bankruptcy, your credit reports will reflect the bankruptcy for seven to ten years, depending on the kind of bankruptcy filed. However, debts wiped out in bankruptcy aren't considered taxable income.

Getting Help

For more information about choosing and managing credit cards, get Solve Your Money Troubles: Strategies to Get Out of Debt and Stay That Way, by Amy Loftsgordon and Cara O'Neill (Nolo).

If you need help managing your credit card debt, talk to a nonprofit agency that provides free or low-cost services, like those affiliated with the National Foundation for Credit Counseling (NFCC). Be sure to avoid debt settlement companies and learn the pros and cons of your various options, such as filing for bankruptcy or entering into a debt management plan.

Consider hiring an attorney if you need help negotiating with creditors or determining which option is best for your situation.