Roadmap Roadmap

Debt Settlement tutorial

Settling with Original Creditors

First, let's reinforce this point: if you are current on your payments, no original creditor will consider settling for less than the full amount of your balance. They don't care if you're struggling financially, they don't care if you're trying to do the "right thing", because they're making money.

So if you stop making payments, for the first few months you'll get threatening phone calls and increasingly unfriendly letters. Don't worry too much about it. Almost every original creditor threatens to sue; a much lower percentage will actually go through with filing a lawsuit. (And if they do file, you can still attempt to settle before the case goes to trial.)

That's why the first time you should considering settling with the original creditor is right before the account is charged off, at around the 4th or 5th month of non-payment. At that point, time is working against the original creditor since they usually write off the debt after six months of non-payment.

Keep in mind that an original creditor who writes off a debt doesn't take a total loss on the account. As part of the process of writing off the account, the original creditor will in most cases sell the account to a debt collector for some percentage of the amount of debt (usually between 10 to 15% of what you owe). That money goes in the credit card company's pocket. Then the credit card company is likely to have insurance on its accounts, let's call that maybe 5 to 10%. The remainder of the "loss" can be taken as a tax deduction—if the company is in the 30% bracket, that's another 20% or so. So instead of losing 100% of the amount you owe, the credit card company is recovering anywhere between 30 to 50% of your account automatically.

Obviously your settlement must be equal to or greater than what they will get by writing off your debt, otherwise, why would they settle?

Of course you will have no idea what money the credit card company stands to recover, so you'll have to negotiate. If you want to settle, start low. For instance, you could say:

"I have four credit cards and I only have enough money to settle with one or two of you. Will you take 20% of the balance as payment in-full?"

Then see if they take it. The odds are slim, but like most things, you never know unless you ask. Then raise the amount until you reach the maximum for which you would want to settle the account.

If the credit card company does offer a settlement you can afford—and you feel comfortable making—ask for a few other provisions before you finalize the agreement:

  • Require a signed contract from the creditor stating the terms of the settlement, the amount, and that the debt will be considered satisfied and no further collection activities are allowed.
  • Include a "paid as agreed" provision. Otherwise, the creditor is likely to report your account as "settled for less than full amount" which is much more damaging to your credit score.
  • Ask that they remove any late payments from your credit report, as well. Many won't do this, but it doesn't hurt to ask.

Refer to the Resource Library for an example of a settlement letter.

If you do decide to settle with an original creditor, keep in mind:

  1. You might receive a 1099 showing the difference between the account balance and the settlement amount as income. If so, you will be required to pay personal income tax on that amount. The better the settlement, the more taxes you might have to pay.
  2. Settling with an original creditor voids your guarantee that comes with my book.

Important Note: Never agree to make a payment, even a small, partial payment. Once you make that payment, you immediately reset the clock and the credit card company will not write off the debt for another six months. Once you stop making payments, don't make any more payments unless you plan to exit the debt relief process and go back to making monthly payments.

> Settling with Debt Collectors