Negotiating credit card debt can seem like an enticing proposition to debtors with nowhere else to turn. Debt negotiation, also called debt settlement, is a service that many may see advertised on the television or read about on an Internet company's website. However, what companies that negotiate credit card debt won't tell you is that this particular service comes at a hefty price, both to your finances and to your credit report.
About Debt Negotiation
Debt negotiation is a process by which a creditor agrees to take less than what the debtor owes, according to the National Foundation for Credit Counseling. Sometimes professional debt negotiators claim that they can reduce the amount owed by as much as 50 percent. After negotiating credit card debts to an amount to which the creditor is amenable, a debt settlement company puts in place a plan to pay the remaining debt. The NFCC states that repayment typically takes place between two and four years.
Debt Negotiation and Your Credit Report
According to the financial advisers at Credit.com, negotiated credit card debt is a strategy for those who already have nothing to lose but who simply want creditors off their back--in other words, those who already have bad credit. If you choose to use debt settlement when your payment history is still relatively healthy, it can be a damning blow to your credit score. The creditor reports negotiated credit card debt to the three major consumer reporting agencies, Experian, Equifax and TransUnion. This record negatively affects a consumer's credit report for seven years, the same amount of time it would have had the creditor reported the debt as charged off or sent to a collections agency.
Hidden Fees
A caveat of using a professional debt negotiator or debt settlement company is that the consumer often doesn't know how much of his or her payments go toward the remaining debt owed and how much the company puts in its pockets. Debt settlement companies have various ways of structuring their fees, according to the NFCC. Some are based on your total amount of debt and others will be based on the amount of debt that was reduced from the original balances. Fees under the latter model might reach as high as 35 percent. Companies might charge a monthly administrative charge and "front load" their fees. This means they get their cut first, before your money begins to go to any of your creditors.
Other Debt Negotiation Pitfalls
There are other ways in which debt settlement company services can cost the consumer. According to the NFCC, the company might suggest that you stop making credit card payments while negotiations are underway. During this time, interest and penalty fees continue to grow on the now-delinquent accounts. In certain states, creditors may file a civil suit against you to recover the amount due. If the amount of "forgiven" debt is $600 or more, the Internal Revenue Service will probably require you to pay income tax on the negotiated amount, the NFCC reports. Finally, the biggest pitfall of using a debt settlement company is that many are scams. In September 2008, the Federal Trade Commission closed four debt-negotiation companies for failing to deliver on their promises, leading their customers to bankruptcy.
Settling Debt Yourself
There's no service a debt settlement company can perform that you can't provide for yourself for free. Credit card companies usually do not give deference to a debt settlement company over the consumer who works with them one-on-one, according to the NFCC. But should you choose to pay for a company to negotiate your credit card debt, the NFCC advises researching its reputation through your local Better Business Bureau and your state's Attorney General's Office.
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