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Your Bailout: Slash your Credit Card Debt

Paul Keleher

As the credit crisis winds toward its inevitable conclusion, the number of customers unable to pay off their credit card each month is swelling. And credit card companies, facing the very real possibility of customers defaulting entirely, are now willing to come to a settlement for substantially less than the amount owed. With the credit card companies ready to deal, here’s what you need to know to get your own personal bailout.

Credit Cards are Unsecured Loans

Credit cards are a form of unsecured loans. What does this mean in layman’s terms? An unsecured loan is a loan in which a borrower is not required to use an asset as collateral in order to receive credit. In contrast, secured loans (mortgages or auto loans, for instance) use collateral that may be repossessed should the borrower default on their payments. By the nature of their business models, credit cards and other forms of unsecured loans typically offer shorter payback terms and higher interest rates.

Bailouts for the Delinquents?

With the recent rise in unemployment and wage cuts, credit card debt delinquency has significantly increased and shows little sign of slowing down. So what’s a credit card company to do? Bail you out! If you fall into the delinquency camp, there is a good chance that you may be able to negotiate an agreement with your card provider to pay off a portion of your debt in exchange for them wiping out the rest.

Increasingly, consumers are reporting that they are getting offers from their card providers to wipe out debt in exchange for payments. Few creditors are admitting to the practice. American Express and Bank of America admit to deciding on a case-by-case basis whether to accept partial payments. Other companies are keeping their lips shut, but their trade group, the American Bankers Association, acknowledges that settlements are becoming more common.

What not to do

Let’s be 100% clear. If you are NOT delinquent on your debt, it would be extremely bad practice to purposefully go into debt in the hopes to get a free ride and have your debt wiped out. There are no guarantees that any company will wipe out your debt, and the risks and costs associated with trying to pull this trick off are simply not worth it.

If you are delinquent, it would be equally as risky to go on a spending spree in the hopes that your debt will be forgotten. Be smart and ethical. Debt settlements can still show as a black mark on your credit history, and this is bad news for you. Debt settlement should be resorted to only at last option.

How to Settle your Credit Card Debt

You’ve done everything you can to get out of debt, but just can’t seem to dig out of the hole. Your only option is to settle. There is no exact science to settling debt with every credit card company, and a lot of your success will come down to your negotiation skills. This is tricky business and if you’re in doubt, you may want to consult with a lawyer or certified financial professional. Here are some suggestions if you’ve decided to go down this path based on stories that we’ve heard from others who have succeeded.

  1. Stop making payments: if you’re paying off at least a portion of your debts, why would the credit card company have any reason to settle with you? Wait at least 60 to 90 days prior to making an offer.
  2. Build enough cash to offer a settlement: at the same time you’ve stopped making payments, you’re going to have to have money on hand to make an offer. Perhaps you sell some of the luxuries that got you into this mess in the first place or get a second job.
  3. Make your first offer: explain your situation and make an offer. 25% is a good starting point. The credit card company is probably not going to accept your first offer, so it’s good to start low. You may get a counter offer at this point – but be patient in your negotiations.
  4. If you increase your offer, ask for more: ask for any black marks on your credit report to be removed in your negotiations.
  5. Get it in writing: get your agreed upon terms in writing from the credit card company.
  6. Make your payment: pay by money order and send via certified mail so that you can verify that you fulfilled your end of the agreement.
  7. Tax significance: you will get a 1099 from your credit card company and must claim the forgiven amount as income on your tax return.
  8. Learn from your mistakes: if you can’t get your credit history wiped clean, the ‘debt settled’ mark will stay on for seven years past settlement. This will result in you having difficulty getting good credit terms during this time. Learn from your mistakes so that this does not happen again.

For more of GE Miller’s writing, visit personal finance blog 20somethingfinance.com.

Here’s Mint’s credit card guide and credit card calculators to help you manage your credit.