How to settle credit card debt

Credit card debt settlement happens when a lender agrees to settle a borrower’s debt for less than the full amount. It can sometimes be an option when a borrower falls behind with their credit card payments.

But is debt settlement a good way to manage credit card debt? Here are some things to consider.

What you’ll learn:

• In a credit card debt settlement, cardholders pay a portion of the debt they owe, and their credit card issuer forgives the rest.

• Credit card debt settlement may involve fees and may negatively affect credit scores. 

• Cardholders might be able to negotiate themselves or through a third-party debt settlement company. 

• Ways to manage debt include balance transfer credit cards and debt consolidation loans.

A credit card debt settlement is a strategy used to eliminate credit card debt by negotiating with creditors to pay less than the full balance, typically between 25% and 80%. While it can help borrowers who can’t afford full repayment, it may harm their credit scores.

Settling debt can be explored independently or with the help of an attorney or a nonprofit credit counselor.

Debt settlement is often associated with programs offered by third-party debt settlement companies. The Consumer Financial Protection Bureau (CFPB) defines debt settlement companies as “for-profit companies that charge a credit card debt settlement fee for their services.”

They’re different from credit counselors, and the CFPB warns that working with debt settlement companies can be risky. These companies may charge high fees. And they might encourage clients to stop paying credit card bills altogether, which could mean late fees, interest charges, derogatory credit marks and more. And creditors may not always be willing to work with debt settlement companies.

As the CFPB cautions, debt settlement companies “may well leave you deeper in debt than you were when you started.”

If you’re considering debt settlement, here are some things you might want to think about:

Credit card debt settlement can have some positive effects:

• Reduces your overall debt: Credit card debt settlement can help relieve any immediate obligations and reduce what you owe. 

• Helps you avoid bankruptcy: Debt settlement may negatively affect your finances, but generally not as severely as bankruptcy. That’s why, for some, it may be a more acceptable option.

• Ends collection calls: After a debt settlement is completed, creditors typically end further collection attempts.

Negotiating a settlement can come with a number of negatives.

• It may affect your credit. Experian says that settlement and payment information likely will be reported to it as settled or paid in full for less than the full balance. Settled accounts can stay on your credit reports for seven years.

• You may not get the result you want. Lenders aren’t legally required to negotiate with borrowers over how much they owe. And even if your lender will negotiate, you may not get as much of your debt forgiven as you’d like. 

• There may be tax consequences to a debt settlement. If some or all of your debt is forgiven, it may be treated as taxable income by the government. That means you could owe income taxes on that amount. 

• Settling debt may result in account closure and loss of access to the credit card. If your account hasn’t already been charged off, it could be permanently closed once you accept a settlement offer. And if that’s the case, you won’t be able to reopen the account or use the card again.

The CFPB advises considering all your credit card debt relief options before committing to debt settlement. Alternatives include:

A DMP is a structured debt repayment program typically arranged through a nonprofit credit counseling agency. It helps borrowers repay unsecured debts, such as credit cards, within three to five years by consolidating payments and negotiating lower interest rates or waived fees.

You can get a list of government-approved credit counseling agencies by calling the National Foundation for Credit Counseling (NFCC) at 800-388-2227 or visiting this list of counseling services from the U.S. Department of Justice (DOJ).

With a credit card balance transfer, you transfer credit card debt from one or more accounts to a new card issuer to consolidate debt and simplify payments. Some credit cards offer introductory or promotional interest rates for balance transfers. Be sure you know when the promotional rate will expire and the standard rate will apply.

Debt consolidation loans let you consolidate your debt into a single loan. They usually come with fixed repayment terms that specify how much you’ll owe each month with a clear timeline for debt repayment. A longer loan term might mean smaller monthly payments but more interest. A shorter loan term might mean less interest but larger monthly payments. There may be fees involved, and teaser rates may only be temporary.

Bankruptcy is a legal process that can help individuals eliminate or restructure debts they may not be able to repay. It’s generally considered a last-resort option.

Filing for bankruptcy could impact credit and personal finances. Because bankruptcy laws differ from district to district, it can also be complicated.

Credit card settlement can help you manage debt by reducing the amount you owe. But there can be drawbacks. It might help to ask your credit card issuer what options are available to you. You can also speak with a qualified financial expert before making any major decisions.

If you decide a credit card settlement isn’t right for you, there are alternatives. If you’re considering a balance transfer, start by exploring balance transfer credit cards from Capital One.