Settling debts for half of what's owed isn't easy

Banks won't accept a partial payment just because you ask

To Her Credit columnist Sally Herigstad
Sally Herigstad is a certified public accountant and the author of "Help! I Can't Pay My Bills: Surviving a Financial Crisis" (St. Martin's Press, 2006). She writes "To Her Credit," a weekly reader Q&A column about issues involving women, credit and debt, for, and also wrote for MSN Money, and, and has guested on Martha Stewart Radio and other programs.

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Question Dear Sally,
My husband and I have about $14,000 in credit card and miscellaneous debt. My in-laws are going to give us $7,000 to use to pay it off.

I plan to begin with the account with the highest balance and work down to the card with the lowest amount owed, calling each creditor and inquiring what they will settle for.

How do I go about this? I'm hoping to settle with each one at one-half or less than what we owe. How do I begin the conversations when I call? And should I mail them a check or let them take it out of our account electronically? What do I need in writing from them? Should I have them send me an invoice with the agreed-upon amount to be paid? What are your suggestions for paying all of this debt off with half the money we owe, and how will it look on our credit report? I truly appreciate your time!  -- Melissa


Dear Melissa,
You'll need to start the conversation with your creditors with a lot more information than you've given me about why you should have halve the amount owed on your credit cards and other debts. Banks are not in the business of paying merchants 100 percent of the cost of goods and services and then getting paid 50 percent by their customers.

The only reason a bank would settle for half of what you owe is if you can convince them their only other option is to get paid back less -- or possibly nothing. This may be true if you and your husband have been unemployed for a long time, for example, or if one of you has a catastrophic illness. If some kind of crisis in your life has made it impossible for you to continue to make payments on your debt, you have my condolences. You should try to settle your debt as best you can and not feel guilty about doing so.

On the other hand, if you just gradually slid into debt by spending more than you make over a period of time, debt settlement is not a good idea.

First, debt settlement, like bankruptcy, doesn't usually solve the underlying problem. If you spent more than you make, you need a workable budget, one in which your income exceeds your expenses -- including occasional "life happens" emergencies. You could get rid of all your debt tomorrow, but without good financial habits and a budget, that debt may start creeping back sooner than you think.

Second, $14,000 is not an impossible amount for most people in their working years to pay off through hard work and careful spending. If you can possibly pay off the remaining $7,000, you should.

If you're not behind on your payments, the banks will not be motivated to accept less than the full amount. This presents a practical and ethical dilemma if you're struggling to keep up, but haven't actually missed payments. Some people purposely stop paying so that creditors are more interested in negotiating. I can't recommend stopping payment when you can afford to pay, however.

I don't know how concerned you are about your credit scores at this point, but the damage done by missed payments is considerable. Late payments stay on your credit reports for seven years.

If you decide you still want to settle your debts and have a convincing, honest reason the banks should accept less than the full amount owed, here's what you should do:

  • Call each creditor and ask for the department that handles debt settlement arrangements. It may be called something else. Make sure you're talking to the right person. It's probably not the first person who answers the phone, so be patient.
  • Write down the name and phone number of the person you talk to. Explain your situation, including the reason they should accept less than 100 percent of the amount you owe. Ask what they suggest or you can make your own offer. Either way, you don't have to take the first offer made.
  • Keep notes of your conversations and correspondence with each creditor.
  • When you agree on a settlement amount, be sure to get it in writing before you send money. It can be a letter or other written documentation that states when the account is expected to be paid, how much forgiven debt will be reported to the Internal Revenue Service, and how it will be reported to the credit bureaus. Paying by check or electronic payment will come out the same in the end.

Settling debts for less than you owe will look lousy on your credit reports. Potential future creditors will know your previous creditors were not paid in full, and the effect may be almost as damaging as bankruptcy. They will either refuse to give you credit or may charge you higher interest rates to make up for the risk they are taking by extending credit to you.

You should also plan on receiving a Form 1099-C from any creditors that accept less than the full amount as payment. The Internal Revenue Service considers most forgiven consumer debt to be taxable income, unless you meet an exception.

See related: 8 myths about debt settlement, 1099-C frequently asked questions

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Updated: 01-18-2018