What Is Credit Card Debt Settlement And How Does It Work?

When you are unable to repay the total credit card bill, and default on it, the credit card provider may try to collect a part of the outstanding amount from you. Credit card debt settlement is a mutual agreement between you (a cardholder) and the credit card provider to forgive a portion of the outstanding credit card amount you owe in exchange for repaying the remaining amount at the earliest.

By opting for a credit card debt settlement, you can get rid of the debt faster as the credit card company agrees not to charge the interest anymore. On the other hand, credit card provider secures whatever amount they can receive from you as, looking at your financial situation, they think you might not be able to repay the dues in future and may default the entire amount.

While settling your credit card debt by making a partial payment seems a good deal, it does more harm than good to the cardholder.

How does credit card debt settlement work?

As discussed above, a credit card debt settlement is when a credit card company agrees with you to make a repayment of a portion of the total dues and forgives the other portion. While in most situations credit card providers ask for a lump sum repayment, they may agree to repayment in instalments as per their terms and conditions and the specific agreement made with you.

Whether you have made an impulsive purchase or facing a financial emergency and are unable to make the repayment of your credit card dues, you can approach the credit card provider to discuss the possible options. Sometimes, in case of no repayment or any communication from your side, a credit card company may approach you to settle your credit card account.

If, after trying all the ways of making a repayment, you and the credit card company can come to the conclusion that credit card settlement is the only option left, the credit card company will come to an agreement with you to pay a specific amount. You may negotiate with the company on the interest rate or repayment amount, considering your financial situation and affordability.

While negotiating with the credit card company, keep in mind that while some credit card companies allow you to repay the agreed amount in instalments, most companies will require you to pay it in a lump sum.

Suppose, a few months back, you made a big purchase with your credit card. While you were supposed to repay the credit card bill from your next month's salary, you had to spend that salary on some medical emergency in the family. Since you already have several personal loan and credit card EMIs going on, it seems difficult to get a new loan or convert your purchase into a credit card EMI.

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The next month you lost your job due to the company's decision to lay off employees for cost-cutting. Now, it's been 2-3 months that you have not paid the bill, and after adding the interest rate, the total dues are Rs 2 lakhs.

Now, since you are jobless, the credit card company may think that you will not be able to repay such a high amount and may offer you to settle your debt. The credit card company asks you to repay Rs 1,50,000 (the amount will vary depending upon the situation and the credit card company's terms).

If you pay Rs 1,50,000 from the full and final settlement that you will receive from your employer or through any other source of income, you will not have to pay the remaining Rs 50,000, as it will be forgiven by the credit card company.

How does credit card debt settlement affect you?

You might feel that credit card debt settlement is a good option as you do not have to pay the full amount. However, as stated earlier, it can do more harm to you than good. Here are some points you must keep in mind when you opt for a credit card settlement:

• The credit card company reports the settlement to the credit bureaus. Hence, credit card settlement can drastically affect your credit score. In case you have a loan or credit card requirement in the future, you might not be able to get it due to a poor credit score.

• After the settlement of credit card dues, the credit card company usually closes your credit card account. So, you will no more have access to your credit card. Besides, the credit card company will probably not offer you a new credit card in the future.

• Depending upon the settlement amount, it can take years to improve your credit score once you have settled your debt.

• If you opt for a credit card settlement through a debt settlement agency or any other third party, you will have to pay their fees/commission. So, even if your debt is settled, you pay high fees to the middleman.

What are the alternatives to credit card debt settlement?

Since credit card debt settlement severely impacts your credit score, it is never a good idea to opt for the settlement. But what other options can you consider when you cannot afford the repayment? Here are some options you may consider instead of opting for a credit card settlement:

• You can try for a credit card balance transfer. It will give you more repayment period in hand and a lower interest rate compared to your existing card.

• Liquidating your existing assets or investments, such as real estate property, mutual funds, fixed deposits, gold, etc., may not sound like a good idea, but it is better to sell your assets/investments instead of putting yourself in a debt trap.

• If you have an asset/investment but do not want to liquidate it, then you can use it as collateral to avail of a secured loan. It can be the best borrowing option as such secured loans come with an affordable interest rate. You can opt for a loan against gold, property, car, mutual funds, insurance policy, fixed deposit, etc. However, take note that defaulting on such a loan can make you lose your asset/investment, as the lender holds the right to liquidate your asset/investment to recover the outstanding amount in case of default.

• A personal loan can be a good option when you are struggling to pay your credit card dues. It can be availed of with minimum documentation and without any collateral, so you do not have to worry about losing your asset. However, as you might be aware, personal loans carry very high interest rates.

To conclude:

Credit cards allow you to purchase the products and services you cannot afford in cash at the moment, but you can pay in the near future. However, sticking with financial discipline is vital to use your credit card smartly. You should use your credit card only after analysing the use of the product/service and the need to swipe the card. Moreover, before swiping your credit card, make sure you have a repayment plan.

Instead of swiping your credit card for big purchases, it makes sense to make a financial plan to buy a product/service and invest in carefully selected mutual funds.  PersonalFN's SMART Fund Explorer can help you achieve your financial goals by investing in equity mutual funds. You can select any of your financial goals from the dropdown option, the time horizon to achieve that goal, the amount you need as of today, and choose the lump sum or SIP amount you can invest. Once you enter your email id and click on submit, the SMART Fund Explorer will provide you with two plans which you can choose from based on your risk appetite.

Warm Regards,
Ketki Jadhav
Content Writer