Credit Card Debt Settlement and Forgiveness: Everything You Need to Know
Unlike some other forms of debt, outstanding credit card debt can’t be forgiven, even after death. Consumers who can’t pay their monthly bills have no good options other than setting up a debt management plan through a credit counselor or, as a last resort, filing for bankruptcy. This guide covers a third option, that of engaging a company to help you settle your debts. hile this option may sound appealing, it comes with many negative consequences. It’s best to avoid debt settlement services.
Who Offers Credit Card Debt Settlement
Debt settlement programs are usually provided by for-profit companies, which negotiate with your creditors to settle your debt for less than what you owe, paid in a lump amount. You will be required to set aside a specific amount each month that will be transferred to an escrow account, managed by an independent third party, who is responsible for paying your creditors from the account on your behalf. This money will be used to pay off your eventual settlement, if there is one. The accumulated funds and any interest earned belong to you, and you can withdraw your money at any time without penalty. You also may be charged a reasonable fee for account maintenance.
Debt settlement companies can’t charge upfront fees. They can only collect fees for debts that they have renegotiated. If a company settles one of five debts, say, then it can charge only a portion of its full fee because four of the five debts remain outstanding. When it settles another, it can collect another portion of the full fee, and so on. If the fee is based on a percentage of the amount you save through the settlement, then the percentage and estimated amount it represents must be disclosed. Debt settlement companies can require you to also set aside your fees in the escrow account. Before helping you, debt settlement companies must provide the following information:
- Explanation of fees and terms of services
- How long before it will make a settlement offer to each creditor
- How much you must save before it will make an offer to your creditors
- Explanation of the consequences if it requests you to stop making payments to creditors
Risks of Credit Card Debt Settlement
Settling credit card debt may seem like an easy out, but it also comes with many risks. The failure rate is high and debt settlement is devastating to your credit, especially if you’ve kept up with payments so far. The industry is also awash with sketchy companies that provide incomplete information and promise more than they deliver. Consider these risks before taking on debt settlement.
Length of time: You typically have to save money in the escrow account for 36 months or more before all your debts are settled. For some people, it’s too challenging financially to keep up with these regular monthly deposits. Studies show that between one-half and two-thirds of people enrolled in a debt settlement program drop out within two years. Before signing up, make sure you have enough disposable income in your budget to make these monthly payments for the long term.
Unwilling creditors: Your creditors aren’t required to negotiate a settlement for your debt. Some creditors may not even work with certain debt settlement companies. That means you may not settle all of your debts and remain responsible for paying back the full amount—plus any incurred fees and interest.
Non-payment consequences: Debt settlement companies often encourage you to stop making payments to your creditors to persuade them to negotiate. But this hurts you in many ways. It damages your credit score. You accrue late fees and penalties that add to what you owe. You may also get calls from debt collectors asking for repayment. In some cases, you may be sued over the debt, and if creditors receive a court judgment, your wages could be garnished or a lien placed against your home.
Tax consequences: Any debt or portion of debt that is forgiven may be considered taxable income by the Internal Revenue Service, unless you are legally insolvent—as in when your debts exceed the value of your assets. Consult with a tax professional to see if you qualify for this exception.
Scams: The debt settlement industry is ripe with companies that deceive consumers. You should avoid a debt settlement company that does the following:
- Charges upfront fees before any settlements, which is against federal law
- Advertises a “new government program” that eliminates personal debt
- Guarantees to get rid of your unsecured debt
- Requests that you stop paying your creditors or communicating with them without explaining the risks
- Claims it can stop all debt collection calls and lawsuits
- Guarantees that your credit card debts can be paid off for pennies on the dollar
Is credit card debt forgiven after death?
Credit card debt doesn’t die when you do. Instead, the responsibility for paying it off goes to your estate, which includes your cash, real estate, insurance policies, trusts, business stakes, investments and other assets. The executor of your estate—either the person designated by your will or appointed by a court—will make payments to satisfy your debts with what is available in your estate. The executor may sell some of your possessions to cover those debts. If the estate doesn’t have enough money or can’t raise enough money, the debts remain partially or entirely unpaid.
There are some scenarios when the responsibility for repaying your credit card debt may fall to another person, such as your spouse, after your death. If you and your spouse co-signed a credit card, then your spouse is legally responsible to pay any remaining debt on that card after you pass. If your spouse is only an authorized user, he or she isn’t obligated to pay the debt. But if you live in one of the 10 states with community property laws—Alaska, Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin—then your spouse may be responsible for your credit card debt after you die, even if your spouse isn’t a joint account holder. Check with an estate lawyer to find out what state laws may apply to you and your spouse.
Alternatives to credit card debt forgiveness
There are other ways to deal with unmanageable credit card debt without resorting to debt settlement. Consider creating and following budget that aims to pay off your credit cards strategically by using the snowball or avalanche method. Look into personal loans to consolidate credit card debt at a lower interest rate. Or, tap your home equity at a low rate to pay off debt. We describe these options in greater detail here. If your debt burden is still overwhelming, speak with a non-profit credit counselor about the following two options.
Debt Management Plan: This plan, set up by a credit counselor, is designed pay down your outstanding credit card debt (and other unsecured debts) by lowering your monthly payment to affordable levels. You make one monthly payment to the credit counselor who distributes the funds to your credit card issuers on your behalf. To get a lower payment, the credit counselor typically gets the creditors to reduce your interest rate and waive or reduce finance charges, late fees, and over-the-limit fees you’ve already incurred. The total balances you owe remain the same. You make the lower payments until your debt is paid off in full.
These plans typically last 36 to 60 months and, once enrolled, you can’t use any credit cards whose repayment is included in the plan. These plans also help reduce the number of collection calls you receive and starts the process of repairing your credit history. You may be charged an initial session fee by the counselor—typically between $30 and $50—along with a monthly service fee ranging from $25 to $60. To find a reputable nonprofit credit counseling agency, contact your state consumer protection agency or use the look-up tool from the National Foundation for Credit Counseling.
Bankruptcy: Besides debt settlement, the only other way to reduce how much you owe to creditors is by filing a Chapter 13 bankruptcy. Also known as a reorganization bankruptcy, it enables you to develop a three- to five-year repayment plan to satisfy all or just a portion of your debts. You also are able to keep your property with this kind of bankruptcy. The bankruptcy and the included debts are discharged after you complete the repayment plans. This kind of bankruptcy stays on your credit report for seven years from the filing date.
If you want to discharge your credit card debt altogether, your only option is a Chapter 7 bankruptcy. But you must meet the eligibility requirements. You can only file for Chapter 7 if your income falls below your state’s median or you can prove that you don’t have enough disposable income—gross income minus necessary expenses—to pay your creditors. You must also sell nonexempt property to pay back creditors before your debts are discharged. This type of bankruptcy remains on your report for 10 years from the filing date.