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I have pretty awful credit rating (570 last I checked) as a result of a foreclosure and a massive amount of credit card debt. One of the credit cards (BofA) to who I owe 17k has offered a settlement - e.g. pay off the account for 12k.

However, this will go on my credit record.

Putting aside for a second the question of where I will actually obtain $12k from, is it a good idea to accept the settlement in my situation?

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First, forget about your credit rating. That will come back once you're out of default and back on your feet.

Keep in mind that the write-off is considered taxable income, so you'll be owing the IRS and your State (if its an income tax state) money on that.

I don't think that you can ignore the second question. If you're going to end up robbing Peter to pay Paul, I don't see the point of trading an unsecured, dischargeable debt for another debt and a non-dischargeable IRS obligation. If you can't make payments on $17k, you can't make payments on $12k either. Note that when the IRS doesn't get paid, they seize assets from your accounts and garnish your wages, and charge hefty fees for the privilege.

If I were in your situation and had the ability to make payments, I would try to get written agreements from the unsecured creditors to do the following:

  • Take you out of default status and get rid of penalty interest. (ie. start paying 15% instead of the 30% or more that you are paying now)
  • Commit to making a specific payment.
  • Freeze your credit limit to prevent the accrual of new fees.

You have a very short window to make this deal with BoA. If they are ready to cut you a 30% deal, the next step will be selling it to collections.

If I were unable to get those types of settlements or make the payments, I'd immediately start looking into bankruptcy and getting on with my life. A Chapter 13 bankruptcy will stop the accrual of interest and penalties, stop the collection calls and leave you with $0 debt in 36 months. If you go this route, try to keep one credit line that you've had for a few years (like a store credit card) open... this will make things easier later on.

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    While it is true that forgiven debt is considered income you aren't going to be taxed 100% of the $5000 difference, you will be taxed at your marginal rate and considering the OP's credit he probably isn't in a very high tax bracket right now. Paying 15% of $5000 is better than 100% of $5000. – stoj Jan 12 '11 at 13:56
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    @stoj There's some background of which you may not be aware. He is likely in a high tax bracket with his $170k income: money.stackexchange.com/questions/5543/… – George Marian Jan 13 '11 at 0:33
  • That does change things a bit. Chapter 13 may be the best way to go especially if the foreclosure was a recourse loan. – stoj Jan 13 '11 at 13:23
  • I wasn't aware of the background... but the issue of marital/child support will make it difficult to pay things down. But... bankruptcy is a public record, which may have implications for an executive making $170k. On the other hand, living in the hood and not refreshing cars while paying off debt could be an issue for some high-power jobs too. I hope things turn out well in the end. – duffbeer703 Jan 13 '11 at 17:21
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    The folks at the consumer credit counseling agency are against me taking the settlement, because, they argue that I am 3 years from paying off all my credit cards, but that the settlement will hang around my credit report for 7 years. I've told them, that in my opinion, my bad credit score has been hugely affected by the foreclosure, which will stay on the record another 5 years anyway. But they disagree. – NeedAdvice Jan 14 '11 at 21:39
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Well, your credit is already rather poor. I wouldn't ignore the impact to my credit, but that wouldn't be my main focus.

I would consider how much this is costing me on a monthly basis. Would I be better off having that money to spend on something else?

How likely is it that this debt will cause more problems for your credit rating? You may be better off taking the hit now and freeing yourself of this debt.

I would also take into consideration how much this credit card is costing me in interest and fees, along with how long it will take to pay-off. Again, it may be better to take a hit now then be slowly sucked dry.

Now, if the account is still open, I may consider trying to keep it. Since there is little chance you can open a decent one with such a poor credit score.

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Don't take the first settlement offer you receive unless it is between 30 to 40 percent off the current balance, which in your case is. Consider a non-profit agency to help you settle your debts. Non-profit agencies can help you settle your debts and restore your credit rating.

Security of Being a Recognized Non-Profit 
No Outrageous Promises 
Free Credit Counseling Services 
Debt Consolidation Loans on Offer

Even though you may feel safe because of the non-profit element of the organization you should ensure you know what you are getting into before signing on the dotted line.

You may find this useful

Loans are also an option for settling your credit card debt, but does not seems so in your case.

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With a foreclosure on your credit record, you're credit rating is already down the tank anyway, so I wouldn't use that as a reason against working out a settlement. If anything, it would prevent you from getting into debt further, which is probably not a big problem in your situation.

That said, my understanding of settlements is that you'll normally have to cough up the money straight away so the whole discussion is a little academic if you don't have the money.

If you do have the money and it gives you the necessary breathing room (and you're not taking it out of, say, your family's food budget), I'd probably take the settlement. If I had to borrow the money the question is really how much of a drop in the ocean the $5k less debt is.

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