Credit debt settlement has consequences

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NEW YORK --- Pay a fraction of what you owe, walk away debt-free.

If the premise of credit card debt settlement sounds too good to be true, that's because it is.

Debt settlement is when a cardholder agrees to pay a portion of a balance in exchange for the remainder of the debt being forgiven. The benefit for card companies is that they salvage at least part of a debt that otherwise could go uncollected.

The practice is gaining attention, in large part because of the explosion of firms promising to whittle down credit card balances. Some claim they can lower balances by as much as 70 percent -- for a big fee, of course. The other catch is that the firms often don't deliver what they promise, and can leave you in worse financial straits. And they don't mention the black mark a debt settlement leaves on a credit report.

While debt settlement is a necessary move in some scenarios, there are alternatives and repercussions to consider. Here are some questions and answers about how it works.

Q: How do I know if I'm even eligible?

A: Explain your situation to your credit card company. You might get a settlement if you can show you're in serious financial distress.

Debt settlement is nothing new, but banks are agreeing to them more readily now to cash in on whatever they can if they suspect the borrower is unlikely to pay.

"The creditor might want to have his money now, rather than risk not getting any of it," said Gail Cunningham, a spokeswoman for the National Foundation for Credit Counseling.

These days, there's even a possibility your lender might contact you to propose a settlement. Typically, people who get settlements have missed at least a few payments.

Note that you can work out a debt settlement directly with your lender. There's no need to enlist -- or pay -- a debt settlement firm.

In May, New York Attorney General Andrew Cuomo launched a nationwide investigation into debt settlement firms -- what he called a "renegade industry" that makes promises it can't keep.

Q: How do I determine if I should pursue a settlement?

A: Sit down with a credit counselor to sort out your finances. You might find you can pay off the debt and avoid a settlement with some tweaks to your budget.

There are hundreds of nonprofit groups that offer credit counseling, and consultations are usually free. You can search for a counselor in your area on the Web sites of either the National Foundation for Credit Counseling or the Association of Independent Consumer Credit Counseling Agencies.

There might be monthly fees of about $20 for select services, such as debt management plans, but the fees can be waived if you can't afford to pay.

Q: If I do pursue debt settlement, how does it work?

A: The terms of the settlement will vary depending on the size of your debt, your financial circumstances and your credit card company.

To determine the amount of the settlement, a credit card company might ask about your income, assets and other debts. A credit report will tell them if you have other collections.

"They're going to look at everything," said Ms. Cunningham.

Lenders usually require a lump-sum payment to settle debts, but they might let you pay the amount over the course of a couple of months.

The amount of debt forgiven is noted on your credit report.

Q: What is the impact of a debt settlement on my credit profile?

A: Very damaging. A debt settlement stays on your credit report for seven years and can significantly reduce your credit score.

The lower your credit score already is, naturally, the less severe the impact.

A healthy credit report is important if you're looking to buy a home. It helps determine your mortgage rate, or whether a bank will even lend to you. You job prospects could also take a hit; companies can run credit checks on potential hires.

Some credit card companies refuse to issue new cards to people they've settled with in the past, said John Ulzheimer, president of consumer education for Credit.com.

Q: How is debt settlement different from filing for bankruptcy?

A: A debt settlement involves one account; a bankruptcy can involve many debts. Both are serious marks on a credit report, but a settlement generally isn't as big a blemish as a bankruptcy.

They also embody two different financial strategies.

With a settlement, you still need to pay a portion of your debt. You also pay taxes on any debt beyond $600 that's forgiven, Ms. Cunningham said. Taxes might be avoided if you're insolvent, meaning your debts outweigh your assets.

With the more common form of bankruptcy, you absolve yourself of all revolving debt. (Fixed forms of debt, such as mortgages, remain.)

There are costs, though. A bankruptcy lawyer can cost hundreds or even thousands of dollars. Anyone who files for bankruptcy needs to take a credit-counseling session and a budgeting class, both of which come with fees.


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