Is Credit Card Settlement Bad?

If you're having difficulty making credit card payments, the promise of drastically reducing your payments through debt settlement may be alluring. However, debt settlement can do serious damage to your credit rating. Unless delinquency has already severely damaged your credit score, and you are on the road to bankruptcy, another option may be preferable.

Definition

Credit card settlement, or debt settlement, is an arrangement in which a company works on your behalf to get creditors to reduce the amount of money you owe them. Usually, creditors agree to debt settlement only if they believe you are a candidate for bankruptcy. Debt settlement means they will receive at least some of what you owe, whereas with bankruptcy they may receive nothing.

Eligibility

If you are delinquent on your credit card payments, and have already damaged your credit score to the point where you are seriously considering bankruptcy, you may be a good candidate for debt settlement. If you are still making minimum payments on time each month, your creditors are unlikely to consider debt settlement as an option.

Effects

Here's how debt settlement usually works: The settlement company collects a deposit from you, along with a monthly payment, which it holds for three to six months. During that period, you make no payments to your credit card company while the debt settlement company works to negotiate the settlement amount. Your creditors will report this delinquency to the credit bureaus, which will negatively affect your credit score. If you have been delinquent for some time, the negative impact will not be dramatic. If the delinquency is new, however, the additional delinquency will have a very harsh impact on your score.

Alternative

Instead of debt settlement, many financial advisers recommend credit counseling. Credit counselors work with your creditors to lower your interest rates, monthly payments or both. You pay the counseling company one lump sum each month, and it uses the money to pay your creditors. The Federal Trade Commission provides recommendations for choosing a credit counseling service on its website (see Resources). The FTC warns that even if a company calls itself a "nonprofit" credit counseling service, they may still charge high fees. Therefore, it's important to protect yourself by researching all the terms of such agreements before signing any papers.

Warning

Although some debt settlement companies are legitimate, consumers must also be aware of the abundance of fraudulent firms, which often charge exorbitant fees to perform debt settlement actions. As of October 27, 2010, a new rule by the Federal Trade Commission mandates that companies offering debt settlement services can no longer ask for an upfront fee before settling a consumer's debt. Before working with a debt settlement company, it's important to ask for their success rate, an estimate of how much money you'll need to save, and the name of the financial institution that will hold your account. According to the FTC ruling, your account must be with a non-affiliated, insured financial institution.