How to Negotiate a Credit Card Debt Settlement

You May Be Able to Pay Only 25¢ on the $1.00 of Your Credit Card Debt

It might be possible to negotiate a credit card debt settlement instead of filing bankruptcy. Though your success will vary on a case-by-case basis, in some situations, it can at least be worth a shot.
It might be possible to negotiate a credit card debt settlement instead of filing bankruptcy. Though your success will vary on a case-by-case basis, in some situations, it can at least be worth a shot. JGI/Tom Grill/Getty Images

If you've found yourself reading this, the odds are good you want to know how to negotiate a credit card debt settlement.  Realize that you are not alone in this endeavor.  In fact, it's a common question that is frequently asked.  My goal is to give you some basic information about the process, some of the potential pitfalls, and some of the surprising consequences of credit card debt negotiation you may not even realize occur.

Before You Begin Credit Card Debt Negotiation

First, before we continue, let me congratulate you on the decision to solve a problem that is no doubt causing you significant personal stress.  It's no secret that before you can invest and build wealth for yourself and your family, you must destroy your credit card debt as it frequently is one of, if not, the most expensive debts you can incur; every penny of interest expense flowing out the door is a penny you can't use to grow your personal portfolio.  

Second, let me assure you that it is possible to live without credit card debt.  In fact, credit card debt simply isn't a problem for most American families; a secret that nobody but economists seem to want to discuss.  To be more specific, roughly 1 out of 2 American families either have no credit card debt or use a credit card for convenience and points, paying off the balance in full every single month.

 You can join their ranks.  It isn't normal to spend your life buried under this kind of burden.

Third, before you consider a credit card debt negotiation, I'm going to assume that you've attempted techniques such as the snowball and the snowflake, which can help reduce balances and free up cash flow quickly by prioritizing your repayment schedule in certain ways.

Finally, as we dive into this topic, you need to be prepared for the possibility that your credit card company may not be willing to entertain or negotiate a credit card debt settlement.  If this happens, it's time to seriously consider discussing your options with a bankruptcy attorney.  In some situations, it's far easier to rebuild your personal balance sheet after having your liabilities discharged by a judge, the sooner the better.  A common mistake I see is well-meaning individuals draining accounts like a 401(k) or Roth IRA in an attempt to save themselves from such a fate.  This can be incredibly foolish since those accounts are often beyond the reach of creditors in a bankruptcy proceeding, meaning that, if you leave them intact, it's possible you could walk out of the courthouse debt-free with your retirement funds still generating dividends, interest, and rents.

What Is a Credit Card Debt Settlement and Why Would a Credit Card Company Agree to One?

Credit card companies, many of which are owned by banks, have several priorities.  The first, of course, is to generate profit for the parent company and its shareholders (you may actually be a shareholder through the mutual funds you hold in a retirement account without even realizing it).

When it becomes evident that someone may be unable to pay his or her balance, a shift in the credit card company's priorities happens that can work to your advantage.  The bank or credit card company becomes concerned with one thing and one thing only: getting as much of the balance back from you as possible and closing or restricting your account.  Why?  This allows them to avoid charging off the entire amount on their income statement, which would cause their stock to fall, management to get lower bonuses, and perhaps even dividend payments to shareholders to be reduced.

If you declare bankruptcy, it is possible that the entire credit card balance will be wiped out because credit card debt is almost always unsecured.  This means it isn't backed by a specific asset or pile of assets that the credit card company can seize in the event of default.

 All the lender has to go on is your unsecured promise that you'll repay the obligation.  Contrast this to something like a mortgage on your home, which is secured by the real estate.  If you fail to pay that mortgage, the bank can seize the house, put it up for sale or auction, and recover some, if not all, of its funds.  

Absent some sort of unique set of circumstances, a bankruptcy filing would be the worst-case scenario for the credit card company because it stands to lose everything it has extended you.  This means they can often be convinced of privately negotiating settlements of as much as 75% of the debt balance, forgiving what you owe in the hope of getting back something.

Once you realize there is little to no chance you will be able to repay your credit card debt, a credit card debt settlement is probably going to require initiating several phone calls to your credit card company, and perhaps even a few written letters.  

How Does a Credit Card Debt Negotiation Work?

If you have already missed several payments and realize it is not mathematically likely you'll be able to repay your credit card debt, it's possible that your credit score has been hit already.  If you want to try and work out a deal privately with the credit card company before pushing the nuclear button (bankruptcy), the process begins when you call or write to them.  This is probably going to be a frustrating experience that will require long conversations with multiple people over days or weeks.

Ordinarily, you are going to want to explain that 1) you are considering bankruptcy but don't want to have to file, and 2) you are hoping to work out a credit card debt negotiation so that you can make sure the credit card company gets some of its money back even if it's not the full amount, which is better than nothing.

If the credit card company is willing to entertain the idea of a debt settlement, the odds are high that they will want one of the following arrangements.

  1. A Lump-Sum Credit Card Debt Settlement - This is probably the easiest to negotiate as a lot of businesses will be willing to walk away with a pile of cash, cutting their losses.  If you've received a bonus at work, an inheritance, or are willing to raid your savings, you offer a one-time payment in exchange for forgiveness of the entire remaining balance.  The best you can probably hope for is 25¢ on the dollar - e.g., if you owe $5,000, paying $1,250.  Even then, that isn't going to be a common situation.  Some companies may want 40¢ on the dollar, while others may want even more.
  2. A Repayment Plan Based Upon Your Income and Expenses - The second best option, the credit card company might be willing to freeze your current debt balance and work out some sort of structured repayment schedule at a lower interest rate.  This way, over a period of several years, you can pay off the balance without worrying about 15%, 20%, or higher interest costs.
  3. A Temporary Forbearance Agreement - Mostly common in things like student loan debt, a forbearance arrangement can be used successfully in a negotiated credit card debt settlement.  Essentially, this means that your account balance will be frozen, the interest rate capped at a pre-agreed upon rate with no late fees or penalties, and no payments will be due for a specified period of time.  This will give you sufficient breathing room to gather the funds to repay your balance in full without falling further and further behind due to the tyranny of compounding

Major Disadvantages to a Credit Card Debt Settlement

Very few things in life come without a downside and a negotiated credit card debt settlement is no exception.  Keep in mind that:

  • The moment you inform your credit card company that you have financial issues, your access to your credit card is almost assuredly going to be cut off, the account frozen, and future charges denied.
  • Any forgiven credit card debt balances are going to be treated as taxable income for the purposes of Federal, state, and local income taxes.  For example, if your combined all-in effective tax rate is 25% and you have $10,000 in credit card debt forgiven, your tax bill is going to be $2,500 higher than it otherwise would have been for the tax year in which the forgiveness took place.  If the total debt forgiven is $600 or more, the lender is going to give you a Form 1099-C, Cancellation of Debt to use in your personal tax filing.  Do not try to avoid claiming this as the IRS is going to be notified of it by the lender.
  • Depending upon the specifics of how it plays out, negotiating a credit card debt settlement can result in significantly lower credit scores.  This can temporarily lower your access to capital from other borrowing sources as you are now seen as a bigger risk.  Other lenders may charge you higher interest rates to compensate for your heightened default probability.  In some states, your insurance costs for things like automobile insurance might rise.  Of course, the length and severity of these outcomes will be far worse with a bankruptcy filing so it can still be worth it to go through with the settlement.  However, be aware it's not all cupcakes and rainbows.

The bottom line is that a credit card debt settlement agreement can be an effective way for you to avoid bankruptcy court, the credit card company to recover some of its money, and both parties to begin rebuilding the damage done to their respective balance sheet and income statement from the debacle.  Likely, the biggest thing stopping you from considering it, if you are truly desperate to get in control of your finances, is pride.  It’s not worth it.  Consider sucking it up, taking the temporary pain, and beginning to get your financial life back on track.