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Credit Card Debt – Settlement Companies or DIY?

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Almost all of us have been there at some point; credit card statements get bigger and the money to pay them is not always there.  Sometimes we’re lucky enough so that we can turn the situation around before we get in too deep over our heads.

Other times, it just gets out of control: lost job, big unexpected healthcare bill, maxed credit cards or unexpected emergencies.  We reduce our credit cards payments to pay only the minimum required, then we may get behind on bills, stress starts to increase and life soon becomes a nightmare.

Next thing you know, you’re behind 30-60-90 days on your credit card payments and you start receiving numerous calls from debt collectors. This in turn creates more pressure and stress and you are left feeling completely stuck. What can you do?

You have options

One option is to pretend there’s no problem at all and just don’t answer your phone. A better option is to face the reality of your situation and start tackling your debt. How will you deal with it when it seems so overwhelming?

Debt settlement is one solution to deal with your debt. This plan usually takes 24 to 36 months to work out but in the meantime your credit score will continue to be negatively impacted.

How debt settlement works

The way debt settlement companies work is instead of paying your minimum card payments to your card company each month, you pay the settlement company instead. Let’s say you owe $30,000 in credit card debt which means your minimum monthly payment should be around $600-$700 each month. The debt company will ask you to pay them that $700 for, say, 30 months, which will add up to $21,000, plus a $700-$1,000 initial fee.  Over those 30 months they’ll simply keep adding your money into an account until your credit score is low enough that the credit card companies will be ready to settle for 40-60% of your debt (lets say $15,000 vs. the original $30,000).

The debt company then pays $15,000 to the credit card company as a settlement in your behalf and they keep the remaining balance ($6,000) as its service fee.

Is there a better way to reduce your debt without waiting the 24 to 36 months and ruining you credit in the meantime? Yes, you can negotiate with the credit card company directly and cut out the middle man.

DIY debt settlement

Doing it yourself has it’s pros and cons. It can definitely be a pain to deal with debt collectors directly but it can save you hundreds or even thousands of dollars in the long run. Most of all, it can help you lessen the negative impact on your credit.

The first thing you will need to do is to call your credit card company or the collecting agency and tell them you’re ready to settle your debt with them. Naturally the longer you’re behind on your payments, the more chances you have of settling your debt at a reduced rate.

So, assuming you can find a few thousands dollars, say $7,000-$10,000, you can offer to settle your debt to them for that amount and they are likely to accept your offer. You can also do the same with a collection agency and offer them to settle your debt for your $7,000 to $10,000 (which is better for them than getting nothing at all).

Note: if you don’t have $7,000 but still have an ok credit you could borrow that amount on services like Lendingclub.com or Prosper.com. You will pay interest on that loan but it’ll be much lower than your credit card interest.

Important tips

When you directly deal with your credit card company or collection agency:

  • Have everything in writing before you pay anything.
  • Do not use a check from your own bank account to make a payment: use a money order or a cashier’s check instead.
  • Write on the check that “If this check is cashed that makes the account (use debt account number) settled in full”.
  • You also want the company to submit to the credit agencies that “this debt is paid in full”  (instead of “settled”).  Otherwise if it’s only marked as settled in your credit history future creditors may see you as a high risk consumer and decline you credit (or charge you higher interest rates). 
  • If you settle with a collection agency, you also want to make sure you get in writing that you are released from the original creditor. This way your creditor will not be able to come back to you in the future for the balance they did not get from the collection agency. It is a regular practice for card companies to sell the balance of your debt after you settle it. This is simply because it showed you were ready to pay some amount and they may be tempted to get more. This is why it’s important that you’re released from the original creditor (your card company).
  • Last thing (well, almost) you may owe the IRS income taxes on the balance from your settled amount as well and your initial debt. Most of the time if you owe more than your worth, the IRS will not tax your balance but in other cases they may. This is why it’s also important that your settlement document also mentions that you will not owe income taxes on the balance.
  • Get everything in writing. Yes it was number one but it’s so important that it’s the last point too.

So there you have the steps to settle your debt yourself. It isn’t fun to do but it can save you a lot of money, preserve your credit and give you a sense of empowerment over your finances.

Another similar option is to work with a consumer credit counseling service (CCCS). In that case, you pay them a fee and they pay your creditors and work with them to reduce your debt. Their fees are usually much lower than a settlement company.

What it requires from you

Overall settling your debt yourself requires the following:

  • You’re ready to do the call and the negotiations yourself with your card companies or your collectors
  • You have the money to pay your settlement upfront or you are able to get a loan to pay it.

It’s not fun and easy to do but it can be done. When you’re at that point whether you use a debt settlement company or you do it yourself is based on your own preference and financial situation.

Additional Resources:

FTC: Dealing with collections

FTC: Managing your debt (good overview)