Debt Negotiation Pitfalls

Trying to negotiate down your credit card debt may leave you worse off than you were before.

Jan 28, 2014 at 2:00PM

It's tough being stuck with high-interest credit card debt. Negotiating your debt down so you can get rid of it can sound tempting. Debt negotiation may not be as easy or pain-free as you were led to believe, however. If you're considering debt negotiation, you'd do well to watch out for these pitfalls.

Paying too much to the debt negotiation company
You may pay more to debt negotiation companies than you expect before the party's over. You pay a fee when they negotiate your debt, of course. You may also pay ongoing fees and interest until you've paid off your account. By the time you add up all the fees, you may have been better off just paying your creditors instead.

Losing your money to slimy debt-negotiation companies
Debt negotiation companies are not all equal. The worst ones will tell you to stop paying your creditors and send all your money to them for several months. If you follow those instructions from a company you haven't done your homework on, you can wind up in big trouble. They may take your money and negotiate a settlement with your creditors -- after they take their cut -- or they may just disappear with your money.

They could even go out of business. Money held in a debt settlement company account is not insured by the FDIC.

Not qualifying for debt negotiation
Credit card companies are not in the business of paying money to merchants and not getting paid in return.

You must have a good reason that you should have your debt reduced. The creditors make decisions based on their own self interest. If you can afford to pay off your debt, you probably won't be allowed to have it magically cut in half.

Surprise! You still have debt
After the debt is settled with your original creditors, you may still owe the debt negotiation company. They may use all the money you sent them to negotiate the balances and then expect you to make payments on their fee.

Paying more for credit in the future
You'll pay more for credit after you settle your debts. That's because debt settlement can damage your credit score almost as much as a bankruptcy. After the debt negotiation, every creditor will see you as a greater risk and charge you accordingly. The higher interest rates will add up fast.

Finding out the whole thing was unnecessary
There are other ways to deal with debt that are less costly and damaging to your credit. You could call your credit card company when you're out of work, for example, and ask for "forbearance." That gives you time to make smaller payments or no payments at all while you look for a job. Credit card companies may put you on a hardship plan for other reasons as well, including serious illness or an accident.

You may also be surprised at how quickly you can pay off your debt the old-fashioned way, especially if you get good advice on how to go about it. If you need help getting out of debt, consider turning to a nonprofit credit-counseling organization.

You might have to pay tax on the forgiven debt
The credit card company that reduced your debt sends you and the IRS a Form 1099-C; this shows the amount of debt you've been forgiven. Unless you can show the IRS that you were insolvent, count on paying income tax on the forgiven amount.

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