A June 15 article in the New York Times set the tone for the week by stating that "deliverance" has arrived for those mired in credit card debt in the form of forgiveness on delinquent accounts.



As they confront unprecedented numbers of troubled customers, credit card companies are increasingly doing something they have historically scorned: settling delinquent accounts for substantially less than the amount owed.

The article goes on to suggest that credit card issuers have "revised internal guidelines to give front-line employees the power to cut deals with employers", and describes how the smug-looking man whose picture accompanies the article was able to settle his $5,486 debt to HSBC (NYSE:HBC) by offering to pay half the balance.

Are Creditors Caving In to Economic Pressure?
Many struggling borrowers will surely jump at the chance to erase half their debt. But while it may well be true that credit card companies are becoming more flexible on settling delinquent accounts, credit card holders should not get the impression that some small victory has been achieved against credit issuers.


The truth is, credit card companies don't negotiate with borrowers; what they do is make calculated business decisions, which, in the interest of their bottom line, generally don't benefit customers. This is because when it comes to bargaining power, consumers who try to take on credit issuers don't have a leg to stand on.

Take Edward McClelland, the man featured in Monday's New York Times piece. He was making "fitful" payments on his $5,486 balance, which had been cancelled for delinquency. HSBC, his credit card issuer, agreed to let him pay half. Sounds like a a sweet deal for Mr. McClelland, right?

Well, not exactly. What the article fails to mention is that it's unlikely that Mr. McClelland got off scot-free. Unfortunately, the same cannot be said for HSBC.

The Cost of Forgiveness
The Federal Reserve recently reported that credit card debt that was past due had hit the highest rate since the Fed began tracking this number in 1991 - 6.5%. So, while credit card issuers may be more willing to cut their losses, doing so is a calculated decision – one that hurts them much less than it hurts individual cardholders. (To learn more about debt forgiveness, see Negotiating A Debt Settlement.)

In the case of a $5,000 debt, consider how much Mr. McClelland had to pay before his account became delinquent and he became a candidate for settlement. According to a May 2009 report by the Pew Health group, when credit card accounts become past due, penalty interest rate increases and late fees averaging $39 are the norm.

The median penalty interest rate was 28% per year, which is 14% higher than non-penalized interest rates and adds $140 per year in interest charges to each $1,000 owed by the card holder. The report also analyzed more than 400 credit card products in the U.S. and found that 82% of credit card issuers were allowed to impose indefinite penalty interest rate hikes. In other words, the penalty can continue to be applied to the card holder even when he or she has paid off his or her debts on the card. Even if the card holder is only delinquent on one credit card, other issuers are free to raise their rates as well, as the borrower is now deemed as a higher overall risk.

When viewed in this light, it comes as no surprise that HSBC is willing to forgive what amounts to chump change on Mr. McClelland's delinquent account; the company has already collected its pound of flesh in the form of fees and exorbitant interest charges. And if Mr. McClelland applies to open another card with HSBC, they may be able to continue to charge him the highest possible interest rate (indefinitely!) because of the blemish his delinquency has created on his credit score.



Uncle Sam: An Unforgiving Guy
But it doesn't end there. While HSBC will write off its loss on Mr. McClelland's account, he will not be able to get rid of it so easily. According to CreditCards.com, forgiven debt is often taxable, and consumers who'd assumed they'd shed their financial shackles may see that debt resurface again in the form of a 1099-C "cancellation of debt notice" from the IRS. Yes, the IRS often considers "forgiven" debt as income, and creditors who agree to accept as little $600 less than the full balance of debt are required to file 1099-C forms with the IRS. (For more insight, see No Debt Forgiveness For The Tax Man.)


Finally, the credit card gets the last laugh by slashing the card holder's credit rating, ensuring that any borrower who chooses to settle a debt will also have to settle for much higher rates on any credit card or loan for years to come.

While it's impossible to say exactly how much a settled account will affect your score, according to MyFico.com, 35% of your score is based on payment history. A delinquency of any kind will pull this portion of your score down – it may go down more based on the length of the delinquency and the amount owed. And may take as long as seven years to clear your name.


Myth: Busted!
Negotiation implies a bargain with advantages for both sides. This is not the case when dealing with credit card companies, which never enter any agreement they haven't already calculated to be more beneficial for them than for you. This isn't to say that you shouldn't settle a debt, but if you do manage to have a portion of your balance forgiven, you should consider it a reprieve, not absolution.

Related Articles
  1. Credit & Loans

    10 Reasons To Use Your Credit Card

    There are several benefits to paying with credit instead of debit, if you use a credit card responsibly.
  2. Credit & Loans

    5 Extreme Ways To Raise Your Credit Score

    Desperate to rebuild your credit score because you can’t obtain a loan with a decent interest rate? Here are some extreme options to try.
  3. Investing News

    What Does the Fire Monkey Mean for Your Portfolio?

    The Chinese new year this year corresponds to the monkey, a quick-witted, playful, tricky figure that means well but has a penchant for causing trouble.
  4. Personal Finance

    The Top 5 Personal Finance Experts to Follow in 2016

    Here is a look at five money and investing experts who can help you reach your financial goals for 2016.
  5. Credit & Loans

    Top 5 Reasons Why People Go Bankrupt

    The biggest cause of bankruptcy in the United States is medical expenses.
  6. Economics

    What is a Trade Credit?

    Trade credit means that a customer purchases goods from a seller who allows the purchaser to pay for those goods at a later time.
  7. Home & Auto

    What to Do When You Can No Longer Afford Your Car

    Life is full of unexpected and undesired events, like layoffs or divorce. Unfortunately, these events can sometimes make your car payment unaffordable.
  8. Insurance

    Cashing In Your Life Insurance

    In tough economic times, tapping into a life insurance policy can provide a needed source of funds.
  9. Investing

    Amazon Financing Now in the U.K.: Is America Next?

    Amazon has unveiled a great credit product in the U.K. Will America be the next country to have access to this financing option?
  10. Credit & Loans

    Why You Should Use Your Credit Card For Purchases

    Responsible credit card users who always pay off their monthly balances should use their cards to buy everything.
RELATED FAQS
  1. Can a debt collector contact me about a debt that's no longer on my credit report?

    According to Experian, a debt collector is permitted to contact a consumer about a debt that is no longer on the consumer's ... Read Full Answer >>
  2. How can you pay your Walmart credit card?

    Holders of Walmart credit cards can make payments on their balances due by mail, online or at Walmart and Sam's Club stores. ... Read Full Answer >>
  3. Are personal loans considered income?

    Personal loans are not considered income for the borrower unless the loan is forgiven. In other words, you cannot be taxed ... Read Full Answer >>
  4. Are secured personal loans better than unsecured loans?

    Secured loans are better for the borrower than unsecured loans because the loan terms are more agreeable. Often, the interest ... Read Full Answer >>
  5. Can personal loans be included in bankruptcy?

    Personal loans from friends, family and employers fall under common categories of debt that can be discharged in the case ... Read Full Answer >>
  6. Is Apple Pay safe and free?

    Apple Pay is a mobile payment system created by Apple to reduce the number of times shoppers and buyers have to pay for goods ... Read Full Answer >>
Trading Center