Editorial Policy

Debt settlement offer keeps debt collectors away

Erica Sandberg

January 26, 2016

QHi Erica,

If I was to work out something with the credit card company so that I pay less than I'm supposed to — $90 instead of $600 I owe now — will my credit be damaged further? This is the card issuer's idea, not mine, so my credit would be OK, right? I can't use the credit card now because I owe too much, the issuer says. Anyway, I want things to be better, not worse. — Gabby

ADear Gabby,

Paying your credit card debt can only improve your credit rating — and it needs the jolt. I can assure you that at this stage, your credit scores have flat-lined.

To build a good credit rating, you need to have good information reported about you. That data comes from your actions. The credit card issuer has been sending information about your activity to the three credit reporting agencies (TransUnion, Experian and Equifax) since it approved you for the account. All would have been fine with your creditor had you sent at least the minimum payments by the due date. Credit scores — such as the FICO score or the VantageScore — rate your credit performance on many factors, with a long, positive payment pattern and low debt-to-credit-limit ratio being paramount. Because your account is many months late, those scores of yours are surely low.

It's great news that the credit card issuer is willing to work with you. If you agree and adhere to the plan, you will be safe from problems worse than a rotten rating. Most creditors will sell an account that hasn't been paid in about six months to a third-party collection agency. These companies can be very aggressive (understandably — their business is persuading people who have had a history of not meeting their financial obligations to pay). Or the issuer will sue you for the amount owed, and the result of that is usually a judgment against you. The judgment will appear on your credit report, further damaging it. You'll owe more than today's balance, too, because court costs and legal fees will be added to the balance. A collection agency also can also sue you for the debt they hold.

A plan to get you back on track by not having to come up with all the back payments is paying less than what you owe — also referred to as debt settlement. However, before taking the offer, make sure you can afford the arrangement. Review your cash flow, and if you discover that $90 is too high, ask to pay in two installments. Never make a promise that you can't fulfill, as you probably won't get a second chance.

Be aware that this deal won't erase the past. Right now, you have a delinquent account that is showing up on your credit reports. Any skipped payments you made in the past will continue to show up on your credit report for seven years. If you start to pay on schedule again, your credit score will eventually improve, because the credit issuer will send that positive information to the credit reporting agencies and it will be calculated into your scores.

Know also that if you accept this deal, you will be on the hook to the IRS for the forgiven amount of $510. The issuer will mail you a 1099-C form showing the amount of debt that was not paid, which should then be reported as income on your next tax return. The tax hit should be minimal because the amount is so small, but don't neglect to report that come tax time.

Odds are your issuer will cancel the card after you accept the deal. However, you can try to reopen it when your debt is paid and you have proven yourself to be responsible. If your request is denied, you can try with a different company, but apply only for a credit card you qualify for based on your credit score and income. Then use the card to not just to revive your scores and build your credit, but for your own financial health.

SEE ALSO: 8 tips to deal with debt collectors like a pro.

Got a question for Erica? Send her an email.

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