Credit Card Debt Settlement

If you have high credit card debt, you might be able to settle the debt for less than the full amount. But beware of the downsides to credit card debt settlement.

By , J.D. · Wayne State University Law School

If you're trying to free yourself from the burden of credit card debt, you have several options. If you lack the means to pay the debt in full over a reasonable amount of time but are unable or unwilling to file bankruptcy, debt settlement might be an option.

Debt settlement involves making an offer to the credit card company to pay off the amount you owe for a lesser amount. If the creditor accepts, you'll need to pay the entire settlement amount upfront in one lump sum.

You can handle the debt settlement negotiations on your own or hire a debt settlement lawyer to help you. You should, however, avoid debt settlement companies.

How Credit Card Debt Settlement Works

To get the ball rolling, you (or your attorney) should contact the creditor and offer to settle the debt. A credit card company might accept a settlement if you're very delinquent on your payments.

It's often less costly for a creditor to accept a lesser amount in settlement than sending the account to collections, filing a lawsuit, or obtaining a judgment and then trying to collect on the judgment.

Example. Jacey has a $10,000 credit card balance. She hasn't paid the bill in nearly a year. She has managed to save $6,000, but she's so behind on other bills that she can't afford to save any more money. She contacts the credit card company and offers to settle the account for $5,000. After some negotiation, Jacey settled the debt for $6,000 and paid the entire amount to the creditor. The creditor writes off the remaining $4,000 balance and reports to the credit bureaus that the debt was paid in full by settlement for a lesser amount.

For help crafting a settlement offer, get Nolo's eForm Offer to Settle Debt With a Reduced Lump Sum Payment.

Pros of Credit Card Debt Settlement

Debt settlement has the following benefits:

  • You're paying less overall on your debt in a much shorter time. Paying the debt off immediately means paying no more interest, and settling means you're paying even less than you currently owe.
  • Debt settlement is less harmful to your credit than bankruptcy if your credit isn't already poor.

Example. Thomas owes $10,000 on his credit card. He's six months behind on his payments. Thomas' six-month delinquency has hurt his credit; however, bankruptcy would cause his score further damage. If he only makes the minimum payment, with interest, it will take him ten years to pay off the debt, and he'll end up paying $18,000 total over that ten years. If he successfully settles the debt, he will be rid of the debt immediately and pay less than $10,000.

Drawbacks to Credit Card Debt Settlement

On the other hand, debt settlement also has multiple drawbacks.

Debt Settlement Is Risky

If you stop making your credit card payments to save enough money to offer a settlement, your credit card company can sue you, obtain a judgment, and garnish your wages and bank accounts. Even if you notify the creditor of your intent to settle, nothing legally stops the creditor from collecting.

Using a Debt Settlement Company Is Even Riskier

Many debt settlement companies will advise you to default on your credit card payments and instead pay the money to them. After taking a monthly fee, they'll put the rest of your payments into an account to accumulate a lump sum large enough to offer the credit card company.

Hundreds of fraudulent debt settlement companies exist, and it can be very easy to get pulled in by a debt settlement scam. The for-profit companies that offer debt settlement services often provide little or no help after you've agreed to pay them. And you might get sued.

Example. Josie owes $20,000 on her credit card and feels she'll never get it paid off. Her monthly payment is $500. She hears an ad for a debt settlement company called ABC Debt Settlement on the radio and signs up. ABC requires Josie to pay the $500 she would normally pay to the credit card company to ABC instead. ABC takes a $120 fee and puts the remaining $380 in an account, promising to negotiate with Josie's credit card company when she accumulates $13,000. Although ABC notifies the credit card company of this arrangement, six months into the program, the credit card company sues Josie for defaulting on her payments and obtains a judgment against her for $20,000 plus interest. The credit card company then garnishes her wages, taking 25% out of every paycheck to satisfy the debt.

Even if a debt settlement company assists you, you'll be paying a lot for services you could do yourself or would be better off paying an attorney.

Debt Settlement Might Create Income Tax Liability

When a credit card company forgives a debt, the IRS and your state government might perceive the debt forgiveness as income to you. If the difference between your original balance and the settlement amount is considered taxable income, you'll have to pay taxes on it unless you qualify for an exception or exclusion.

Example. Claire owes $12,000 on a credit card and successfully negotiates with the credit card company to settle the debt for $8,000. She pays $8,000 to the credit card company, which forgives the debt and reports it to the credit reporting bureaus as "paid in full." The credit card company reports the settlement to the IRS, which notifies Claire that she must pay taxes on $4,000, the amount the credit card company forgave. To the IRS, the settlement was equal to the credit card company giving Claire $4,000.

Getting Help

You might be able to work out settlements with your credit card companies without getting assistance. But if you need help handling the negotiations, consider hiring a debt settlement lawyer.

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