Letting your credit card accounts go into default, instead of filing for bankruptcy, is a risky move: Your credit score will take a serious hit, you'll be harassed by collection agencies and you may get sued. However, you may also be able to negotiate paying your debt on your own schedule and for less than you owe. And if you don't own or earn much, a creditor may never be able to collect on its lawsuit.
Bankruptcy
The two primary types of consumer bankruptcy are Chapter 7 and Chapter 13. In a Chapter 7 bankruptcy, the court liquidates any of your assets that are not exempt from liquidation under your state's laws. The court distributes the proceeds (if any) to your creditors, and discharges the balance of your debts. Under Chapter 13 bankruptcy, you get to keep your assets, but you must work out a plan to repay creditors over three to five years. At the end of the repayment period, the court discharges any remaining balance.
Credit Card Default
If you don't make the minimum payments on your credit cards for six months, your accounts go into default. The credit card companies will "charge-off" your cards as bad debt. The credit card company writes the debt off as a tax loss, and, if the debt is over $600, may send you, and the IRS, a 1099-C form reporting the charged-off amount. You are then responsible for paying taxes on the debt, as it is counted as income.
Collection Activity
Once your credit cards are charged offed, you will probably start hearing from collection agencies. While dealing with bill collectors is unpleasant, there are some advantages to working with them. Bill collectors may be willing to settle your debt for less than you owe. If you are inclined to do so, negotiating can save you both money and a great deal of hassle.
You also have the right to stop all contact from third-party debt collectors. Under the Fair Debt Collection Practices Act (FDCPA), you can send a letter to a collection agency asking it to cease all contact. After that, its representatives can only contact you one more times to inform you of their plans for your case, which may include filing a lawsuit. The collector may also sell your account to another collection agency, which can begin the cycle of calls and letters all over again.
Court Judgments
If your credit card balances are large enough, the credit card company or a collection agency may sue you to recover the balance. After a creditor wins its lawsuit, it has the right to collect the judgment from you. In some states, a creditor can garnish your wages, take money from your bank account, get a lien on your home, or force you to liquidate assets to pay the debt.
If you don't have any assets, your state does not allow wage garnishment. Or if your income is entirely from garnishment-exempt sources such as Social Security or a pension, the threat of a judgment may not be such a big deal. If you tell your creditors from the outset that you don't have anything of value, they may not even bother with a lawsuit.
Credit Considerations
Both bankruptcy and defaulting on credit cards have dire implications for your credit. Charged-off and collection-agency accounts can appear on your credit report for up to seven years. Bankruptcies appear on credit reports for 10 years. Although it may seem that a bankruptcy has greater impact on your credit, this isn't always the case: Credit bureaus report unpaid judgments for a minimum of seven years, or until the statute of limitations on collecting judgments runs out. In some states, this means that an unpaid judgment can remain on your credit for decades. Paid judgments drop off your report after seven years.
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