You're drowning financially and need some serious help with the credit card bills. Besides bankruptcy, are there other options?
Yes. It is possible to work with your credit card issuer and negotiate a partial settlement, a workout agreement or even just a reduction in the bills for a few months. But getting the deal you need won't be a slam dunk. You face a series of phone calls and have to wrestle with details that might not seem important now, such as the impact to your credit and next year's tax bill.
"It's not easy," says Ira Rheingold, executive director of the National Association of Consumer Advocates.
There are only three key steps to renegotiating debt, but they're not simple.
Lump-sum settlement. If you have access to a chunk of money, such as from an inheritance, you can try to negotiate a settlement for less than the full amount owed. Frequently, you can break the sum into three payments.
If you had a credit limit of $3,000 but have a balance of $5,000 with interest and late fees, "you may be able to go back to the principal and get a reduction if you pay it off," says Rick McElvaney, program director for the Center for Consumer Law at the University of Houston Law Center. "It's all up to the individual creditor. In situations like this, it really matters how the deal is structured."
What you need to know: Be clear that the lump sum you agree to pay will satisfy the bill and get that confirmation in writing, says Gail Cunningham, vice president of public relations for the National Foundation for Credit Counseling.
Also understand that paying less than you owe impacts your credit score depending on how the payment is reported to the credit bureaus, says Anthony Sprauve, senior consumer credit specialist for FICO, the company that pioneered credit scoring.
For example, a charge-off (which means the company removes the entire debt from its books for accounting purposes but doesn't eliminate your obligation) -- will hurt your credit score more than a payment of less than the total debt owed, he says.
Finally, tax law considers most forgiven debt as income. If a lender forgives at least $600 worth of the principal on your debt, it must report the amount to the IRS via a 1099-C form. So, for example, a lump sum payment of $2,500 to settle a $4,500 credit card bill will mean you'll likely have to pay tax on an additional $2,000 in income next year.
Workout arrangement. Under a workout, the bank may eliminate or lower both your interest rate and minimum monthly payment, and often stops assessing punitive fees (such as late fees or over-limit charges), Cunningham says. You can also ask the company to forgive past punitive fees to further reduce your balance, which it may or may not do.
What you need to know: Your credit line will likely be cut off, so you won't be able to use your card(s). Again, the impact to your credit score will depend on how the issuer reports the arrangement or your payments to the credit bureaus, Sprauve says.
Keep in mind also that if your credit line is cut, that loss of available credit will ding your credit score because it will raise your credit utilization ratio, Cunningham says. For example, let's say you have $10,000 in available credit on various cards and you owe a total of $5,000 on them. If you then close one account with a $1,000 limit, your credit utilization ratio will increase from $5,000/$10,000 to $5,000/$9,000. "You'll still owe the same amount, but the amount of available credit has decreased," she says.
Debt management program. If you don't want to negotiate with your creditors yourself, you can opt to go through a debt management program, Cunningham says. Best bet: a nonprofit agency affiliated with the National Foundation for Credit Counseling or the Association of Independent Consumer Credit Counseling Agencies. A counselor will meet with you to talk about your specific situation and make repayment arrangements with all your creditors on your behalf, Cunningham says. The counselor will work with the lender to restructure your debt so it's affordable. Typically, the counselor can negotiate to lower your interest payments, reduce or drop fees and lower your payments, Cunningham says.
What you need to know: You will pay the entire amount owed, Cunningham says. All your credit card accounts will be included in the program and closed. While being in a debt management program by itself won't hurt your credit, shutting down accounts is likely to hurt your credit score, again because your credit utilization ratio will be lower. Still, it's a smarter, more score-friendly option than bankruptcy or debt settlement, Cunningham says.
What you need to know: Stopping payments on your debts does significant damage to your credit history, though paying a portion of what you owe is better than paying nothing. Those accounts will stay on your credit record for seven years. And again, Uncle Sam also may get a share -- you will owe taxes on any settled debt.
If you use a debt settlement firm, be aware that you do not have to pay upfront for debt settlement services. Debt settlement companies 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.&
Step 2: Examine your debt and income
Take a hard look at what exactly you owe. Ask the company for a breakdown of your bill, says Rheingold. "How much of it is garbage fees? How much did I blow, as opposed to late fees, over-limit fees, etc.?" he says. Once you separate it out, "you'll be shocked," he says.
Examine your income and other fixed expenses, and determine realistically how much you can pay. "Know what you can afford," McElvaney says. "Don't overextend yourself. You should eat and pay your mortgage before you pay your credit card bills."
Don't forget to build in some wiggle room. People who do make budgets often make them too tight with no room for expenses that pop up less frequently than weekly or monthly. "You have a senior in high school and you have to rent a cap and gown, pay for senior pictures and a senior ring," Cunningham says. "You knew in one corner of your mind that this was coming. You have to have a contingency area in your budget for these expenses."
Step 3: Start making calls
Now that you know what you can pay, it's time to ask for help. Be ready: this will likely be a marathon, not a sprint. Expect to make multiple phone calls and talk to a string of people, who may contradict each other. Keep in mind too that after your initial contact, the card company can (and probably will) freeze your credit limit.
Although you may hear that creditors won't work with you until you are already behind on payments, the responsible thing to do is seek help as soon as you realize you're in a financial crunch -- whether it's short-term or long-term, Cunningham says. If it's a short-term problem such as a temporary medical crisis, try calling the creditor yourself, explain your situation, and ask for forbearance. If it's a long-term problem such as a divorce or death of the primary breadwinner, then you likely need debt management or debt settlement help from the experts, she says.
If you're calling your creditors yourself, be prepared to call repeatedly. "It's not easy to get the right person to get a settlement on your own that takes care of all the problems," says Rheingold.
Customer service representatives who answer the phone likely will not have the authority to grant what you need, even if they won't admit it. State that you need the department that handles settlement arrangements, or workout arrangements. Every card and bank is set up differently, with different policies, department names and special programs. Some department names to try: in-house help program, workout program or loss mitigation.
"Ask for a credit manager," says McElvaney. "Someone with the authority to make this deal."
Once you get that person on the line, get the person's name, ID number (if there is one) and telephone number with extension. Then explain what you need. When you finish the call, jot down a brief summary of the conversation with the date and time. Keep all of this in a notebook with whatever correspondence you get from the company.
"Be upfront," says Cunningham. Tell them, "'You know I want to pay you. What can we do?'"
You may have to keep this telephone campaign going for several months. If you're missing payments, that will damage your credit. With many card banks, the unpaid debt typically moves to a company delinquency department after 90 days, Cunningham says.
No deal after six months? At that point, the company often removes unpaid debt from its books and sells it for cents on the dollar -- a "charge-off," Cunningham says. But that doesn't get you off the hook. The entity that bought the debt can still try to collect payment from you until the statue of limitations (which varies from state to state) runs out, she says. Further, a charge-off is a more serious ding to your credit score than making partial payment, she says.
Be ready to haggle
With any type of agreement, don't be afraid to haggle. "I want the consumer to say loud and clear that they need to negotiate," says Cunningham. "Don't accept the first offer. You don't do that when you buy a car. You don't do that when you buy a house. Why do that here?"
Sum up the situation. Explain that your financial picture has changed, but you still want to honor your commitment. Either ask what the collector or creditor can offer, or propose your own plan. You may hear yes, no or be referred to another department.
Dare you mention the B-word -- bankruptcy? Yes, says Rheingold. "If it's something you're considering, it's something you should say to them."
Your goal, as far as your credit: that any workout payments you make will be reported as current, complete and timely.
This part of the negotiation can sometimes get really frustrating. "A lot of the creditors refuse to deal with that issue," McElvaney says. "They just will do what they want to do."
Get it in writing
At last: You've cut a deal. But you're not quite done. Banks merge, people change jobs and the rep that noted your account or made promises over the phone could be long gone when you find out your satisfied account has been sold to a third party or incorrectly reported to the credit bureaus.
Your protection: an agreement that puts everything in writing, Cunningham says. That includes the fact that the account was (or will be) paid and when, the amount that will be reported for taxes and what the bank or card company will tell the credit bureaus.
"The worst thing people can do is wait too long too reach out for help," Cunningham says. "We're well-intentioned and think our ship will come in. When that ship doesn't materialize, we've dug a financial hole from which we cannot recover."