Advertiser Disclosure

What Does It Mean to ‘Settle’ Your Credit Card Debt?

Credit Card Basics, Credit Cards
With so many websites offering free financial tools, it can be hard to know whom to trust. At NerdWallet, we spend literally 1,000s of hours researching partner offers and following strict editorial integrity to match you with the perfect choice. We even share how we make money so you can enjoy our expert advice and researched recommendations with total clarity and confidence.
What Does It Mean to 'Settle' Your Credit Card Debt?

If you get into trouble with debt, you may find yourself needing to arrange a debt settlement. While it is far from an ideal situation, debt settlement can at least give you a clean slate for the future, although it comes at risk to your credit score, and with tax implications.

Why are you at the debt settlement stage?

To understand debt settlement, you should understand how you ended up here. You may have lost your job, had to care for a family member, or were just irresponsible with your spending or credit habits. You have probably missed several payments on credit cards and other forms of credit. Your credit score has suffered.

You have reached a point where some, if not all, of your accounts have gone into collections. You realize you will never be able to pay the debts off. You are probably ready for debt settlement, rather than bankruptcy.

» MORE: How to pay off debt

Are you in collections?

You may or may not still be in your creditors’ internal collections system at this point. If the credit card company is still contacting you, and not an external collections company, then you have some leverage. The credit card company does not want to have to outsource the debt collection to an agency or sell it off for pennies on the dollar.

If it outsources, it will only get about 60% of whatever gets collected. This collector will either be “working the debt” on contingency (he gets 25%-40% of what he collects from you).

That’s better for the company than the outright sale of the debt, which may only fetch them 10 cents per dollar. The collector hopes to collect more than that from you and make a profit.

Negotiate for yourself

The first step is to determine the total amount you can afford to pay on all accounts. Then you can either try and negotiate the settlement yourself or contact a debt settlement agency to do the work.

If you negotiate the deal yourself, you can either go one-on-one with each creditor, or play them off against one another. If you go one-on-one, tell them you know how debt settlement works, and ask what discount will make the whole debt go away. Get offers from everyone and see if you can manage it.

If not, keep returning until you get something that works. If you don’t get there, hire a debt settlement company.

You can also try a conference call. Get all your creditors onto one call and say, “OK, you all know I’m in trouble. I have X dollars to pay everyone. You now must decide among yourselves how that money gets dispersed. Go.” It may work or it may not. It’s worth a try, however.

You have some leverage because your credit score has already gotten mauled — they can’t really threaten you with much at this point, and they know it. Alas, the settled accounts will stay on your credit report for up to seven years.

Downsides

There’s a downside to this process that you must account for when doing your math. Any debt that gets settled becomes taxable income. So, if you have $20,000 in debt, and your debt settlement deal is to pay $8,000, the IRS will consider the $12,000 difference to be taxable income.

The downside to using a debt settlement company is that they may or may not be transparent as to how much of the settlement is going to the creditors and how much to them. Insist on transparency and fees. You’ll also be put on a monthly payment plan with the debt settlement company, which forwards your payments to the creditors, minus their fee.


Debt settlement image via Shutterstock.