CREDIT CARD HELP: The basic fundamentals of credit cards
Preventing and handling credit card debt
8 myths about settling credit card debt
"Get out of debt today!"
When finances are tight and job prospects are dim, the promises you hear in debt settlement ads sound appealing.
But is settling your credit card debts for less than you owe really that easy? Can anyone do it? And what are the consequences? Before you decide to try debt settlement, make sure you know the difference between common myths -- and the truth:
Myth No. 1: Anyone can get their credit card balance cut in half for any reason.
The truth: Both creditors and legitimate debt settlement companies screen clients to ensure their hardship meets underwriting criteria, says Brian Tawney, co-legislative director and executive board member of the American Fair Credit Council and counsel for Clear One Advantage debt settlement company.
Debt settlement is for hardships such as a temporary job loss, divorce or medical problems, Tawney says. "Often our client's situation results from unemployment, underemployment, divorce, death, medical issues and for some, overspending," he says.
Myth No. 2: I have to pay someone to help me settle my credit card debt.
The truth: "I proved that myth is not true," says Kenny Golde, author of "The Do-It-Yourself Bailout." Golde is a filmmaker whose partner became ill and passed away while they were making a movie. By the time the film was completed and it became apparent the film wasn't selling in a timely manner, Golde was $250,000 in debt. He consulted with a bankruptcy attorney, who told him about debt settlements.
Golde had heard a lot of debt settlement companies are scams. He figured no one would work as hard on his behalf as he was prepared to. Besides, he says, "Here was a challenge, and I wanted to move forward and meet that challenge." Golde successfully negotiated his debts and saved nearly $150,000.
On the other hand, having an experienced negotiator on your side can help. So many people are trying to get their balances reduced, according to Ken Clark, certified financial planner and author of "The Complete Idiot's Guide to Getting Out of Debt," that "you call and try to negotiate a balance, and it's 'Get in line.'" The card company's attitude may be, "Yeah, you and everybody else," says Clark.
Says Tawney: "Just as you don't have to pay someone to do your plumbing and don't have to hire an accountant to do your taxes, you can also negotiate your debt yourself. But we find that many people can benefit from having someone else help."
Based on experience negotiating with creditors, debt settlement companies know what percentage of debt owed each creditor is likely to agree to, Tawney says. "We use an algorithm that considers 140 different variables and tells us the accounts that have the highest opportunity to settle at any given time. We negotiate in bulk," he says. "We can negotiate thousands of cases and get a better settlement for everyone."
Myth No. 3: I have to pay upfront for debt settlement and the debt settlement company controls my money.
The truth: Not anymore. Debt settlement companies that market their services over the phone are banned from collecting advance fees from consumers before settling or reducing the consumers' credit card or other unsecured debt, according to a Federal Trade Commission rule that took effect in October 2010. The rule also specifies that the consumers' money set aside to pay debts be maintained in an account at an insured financial institution; that the consumer owns the funds and any interest accrued; that the debt settlement company does not own, control or have any affiliation with the company administering the account; and that the provider does not exchange any referral fees with the company administering the account, the FTC says. Also, the consumer can withdraw from the debt relief service at any time without penalty and receive all unearned provider fees and savings within seven business days.
Myth No. 4: Debt settlement won't hurt my credit score.
The truth: Debt settlement can hurt your credit score almost as much as bankruptcy would.
Although asking for a settlement on your own won't hurt your credit score, succeeding in getting a settlement, or skipping payments as some settlement companies advise, definitely will. "The truth: Debt settlement can hurt your credit score almost as much as bankruptcy would.
Although asking for a settlement on your own won't hurt your credit score, succeeding in getting a settlement, or skipping payments as some settlement companies advise, definitely will. "Defaults, settlements and similar events don't affect your credit score until they are reported," says R. Glen Ayers, attorney and former bankruptcy judge. "But of course these [defaults and settlements] are usually reported."
Myth No. 5: Using a debt settlement company won't cost much.
The truth: Debt settlement companies will charge you a percentage of the enrolled debt or a percentage of the savings negotiated, Tawney says. Account maintenance fees are no longer allowed, he notes. What you pay the debt settlement company will vary, but your lower credit score means you'll pay more to borrow money and obtain credit in the future. That's because the lower your credit score, the higher the interest rates lenders will charge you. "That lower score is going to cost you a lot over the next five to seven years," Clark says.
Finally, Uncle Sam may get a cut too. The amount of debt that is forgiven by a lender is often taxable.
Myth No. 6: If I don't settle, the debt stays forever.
The truth: There is a statute of limitations for collecting the debt. Many collectors, whether the issuer or a person or entity who has purchased old credit card debt, attempt to collect debt that is often time-barred -- the statute of limitations has run out, Ayers says. This varies from state to state, but if a debtor has not made a payment on a charge account for enough years, the debt is no longer enforceable in court. At that point, any payment made is first, voluntary, and second, isn't in your interest, since it probably negates the limitations argument.
In addition to the legal obligation dying out, the credit damage will also sunset. True but negative information on your credit report -- such as a failure to pay -- drops away after seven years.
Myth No. 7: Debt settlement and bankruptcy are my only options when I can't pay.
The truth: You always have options. For example, if you lose your job and you call your credit card company, they may give you "forbearance" -- in other words, they may allow you to make smaller payments or no payments at all for a time (you'll still be charged interest, however).
If it's time to get your finances under control, a nonprofit credit counseling organization can help you look at the big picture and see all your options, from downsizing to increasing your income or managing your budget.
"Each person's situation is unique and there is not a one-size-fits-all approach," Tawney says. "Some people may be better suited for credit counseling; others for bankruptcy. Debt settlement can be a great debt resolution option for those struggling to make payments and need more than educational and budget advice- those that need a principal reduction."
Myth No. 8: When the negotiations are done, I'll be out of debt.
The truth: Some debts don't qualify for debt settlement, including student loans, taxes owed, and child support and alimony.
See related: Do-it-yourself debt settlement, Credit card debt negotiation in 3 not-so-easy steps, Debt settlement vs. bankruptcy: Which damages credit score more?
Updated April 28, 2014
CREDIT CARD HELP: The basic fundamentals of credit cards