On disability, facing interest rate creep

Dear To Her Credit,

A relative with only a very low disability income and numerous medical bills has a credit card with an interest rate that has caused the minimum payment to become more than she can afford to pay.

A while back, the credit card company had given her a lower hardship rate. However, over the last year the credit card company changed hands a couple of times and both times the interest rate increased.

She has tried to request a lower rate with the current company, hoping to get the minimum payments back to a reasonable amount, but the company won’t budge. Does she have any recourse?  — Jean

Dear Jean,
Your relative may have recourse if she got something in writing from the former owner of the credit card account. According to Chicago attorney John R. O’Brien, if she did and the agreement specified that the interest payable would be locked in at a certain rate, the rate should be binding upon any later purchaser of her account. O’Brien says: “However, if there is nothing in writing, or if the lower rate only applied to her then-existing balance, and she has charged new purchases since then, the new account owner may have the right to raise the rate on the new purchases.”

As a person on disability income, she may be able to quit paying this bill altogether. As much as she may hate to default on a debt, doing so would free up more money for medical bills and other necessities.

Stopping payments altogether may be a good option if her sole source of income is Social Security disability, as opposed to disability insurance from a private insurer, and she does not own real estate, according to O’Brien. “The credit card company cannot garnish the disability payments, so any judgment they get against her by filing suit will not be collectible.” She may not want to try this option if she intends to apply for a mortgage or other credit in the future, because defaulting on a debt won’t do her credit score any favors.

Settling with the credit card company is another option. The usual procedure is to stop paying and instead put the amount of each payment, along with any other money a person can get together, into savings. Keep adding to this fund until you have enough money to try to settle. Before the credit card company sues, they may offer her the option to settle her debt for substantially less than her current balance. “If she has a $5,000 balance and hasn’t paid for over a year, they may agree to take 30 percent to 40 percent in a lump sum ($1,500-$2,000) to close out the account,” says O’Brien.

If she settles the account, or if she stops paying and the bank eventually writes it off, she will receive an IRS Form 1099-C from the lender for the amount forgiven or written off. The IRS considers this to be income, which she must report on her tax return. That may not be that bad. If she has very low income, she may owe little or no tax for the year. And if she is insolvent (she has more debts than assets) when the debt was settled or forgiven, she may qualify for an exception to paying tax on the settled or written off amount.

Of course, there’s always the option of filing for bankruptcy if your relative has debts she cannot hope to pay. Even if she doesn’t file for bankruptcy, she may be able to use it as a threat to persuade the company that they should reduce her interest rate to the previously agreed level or to settle for less than the amount owed.

See related:Don’t settle a debt for more than you can pay