Friendly Advice: Approach Credit Card Debt Carefully

These days, it seems almost everyone has a friend, business associate or relative with credit-card debt problems. If that’s your situation, you might want to help them out.

What you might not want to do is pry into his or her personal finances. However, you may find the individual relieved to be able to talk about them. Here’s a brief guide with information you can offer to business colleagues, relatives or friends to help them ease their debt difficulties without selling assets or declaring bankruptcy.

The first step is to urge the person to sit down and calculate how much money comes in every month and how much is being spent on essentials such as housing, food, health care, insurance, car payments and education. What’s left over can be used to pay off the credit cards.

Then the person should add up the balances carried on those cards, including late payment and over-limit fees, and interest. By prioritizing the balances from lowest to highest, the person may see that some cards can be paid off relatively easily by becoming a little more frugal and paying more than the minimum monthly payments. For the less easily manageable balances, there are solutions, which include:

Direct Negotiations: The individual can contact the card issuers directly to explain the situation. The companies want to get as much of their money as they can and are often willing to work out a deal. Among the most common solutions are:

• Workout Arrangements: The bank or card issuer eliminates or lowers the interest rate and stops charging late and over-limit fees. The terms may be temporary until the person’s financial status improves, or permanent until the balance is paid off. The card issuer may also be willing to forgive past punitive fees.

Whether or not the plan affects the person’s credit score depends on what the issuer tells the credit bureaus. The score will be hurt if the credit line is cut. On the other hand, the credit score and history can be helped if the company reports that full payments are being made on time.

• Lump-sum Settlements: The creditor agrees to accept less than is owed and the debtor makes one payment or a series of three or four installments. The person should be certain that the amount agreed to will satisfy the entire bill. Settlements will hurt the person’s credit score because they’re considered bad debts.

Not everyone is a skilled negotiator or good with numbers, however, so the person in debt may want to use third-party options, which include:

Credit Counseling: Reputable credit-counseling organizations have certified and trained staff who will advise the person on how to manage money and debts, help develop a workable budget, and offer free educational materials and workshops. If the agency doesn’t offer to send free information about itself and its services without requiring details about the individual’s financial situation, look elsewhere.

Most financial advisers recommend consulting nonprofit counseling agencies. But check them out carefully. Some nonprofit credit-counseling organizations charge high fees or urge consumers to make “voluntary” contributions that can create more debt. A nonprofit organization shouldn’t charge anything until the debt is settled.

Debt Management Programs: This can be a confusing area with terms defined differently by the companies providing the services. The person should be clear about the services offered, the estimated time it will take to clear up the debts and how much money it’s going to cost. There are nonprofit and for-profit debt-management organizations and the fees vary widely. These organizations will take the same approaches as individuals would on their own, but they’re generally more skilled at negotiations. Typically, there are two types of programs:

1. Debt Management — The company tries to negotiate lower interest rates, waived fees, and a payment plan acceptable to the debtor and the card issuer. The total amount owed on all cards may or may not be consolidated into one monthly payment to the debt management company. If the money is paid to the organization, it will distribute payments to the creditors and deduct its fees. In some cases, the creditors and the debt-management organization are paid separately. Debt-management plans usually show up on credit reports and may lower credit scores.
   
2. Debt Negotiation — The creditor settles the debt for less than the amount owed, usually 50% or less. The debt-negotiating company may agree to work only on cards with balances that exceed a certain level. The person winds up owing less, but the settlement will hurt credit scores.

Words of Caution

People with unmanageable debt often try to resort to debt consolidation, asking a bank or financial institution to combine credit card or other debts into one loan. If that fails, there are companies that offer such loans, usually at relatively high interest rates. Shop around for the best rates.

In either case, the debtors may have to secure the loan with their homes, which means they run the risk of foreclosure if they fail to keep up with the payments.

Consolidation loans may sound appealing, but the lower payments may simply be the result of spreading the debt over a longer period of time. What’s more, in addition to interest on the loans, the person may have to pay “points.” One point is equal to one percent of the amount borrowed.

Debt settlements may have tax implications. Creditors must report forgiven debts of $600 or more to the IRS and the amount of canceled debt may be taxable. A person who has negotiated a reduction in credit card debt should talk to a tax professional. The amount canceled may qualify for tax-free treatment under the IRS insolvency exclusion.

And finally, bankruptcy should be a last-ditch method of solving debt problems. Although the person won’t have to repay certain debts, the bankruptcy proceeding stays on credit reports for 10 years, making it difficult to obtain credit, buy a home, get life insurance or, in some cases, get a job.

In both types of services, the payments to the card companies and the debt management companies are usually directly debited from checking accounts. The individual may also have to agree not to apply for or use any additional credit while participating in the programs, which can take four years or longer to complete. A person in debt should sign up for these plans only after a certified credit counselor has thoroughly reviewed the individual’s financial situation and offered customized money-management advice.

Copyright 2024

This article appeared in Walz Group’s April 22, 2024 issue of The Bottom Line e-newsletter, produced by TopLine Content Marketing. This content is for informational purposes only.