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. 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.
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.)
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.
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.
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.