In a nutshell, a settlement is a negotiated agreement between a debtor and a lender in which the lender agrees to accept less than the full amount owed on the loan, like a credit card account. Typically, the lender requires a single lump sum payment of the settlement amount. However, you may be able to make the settlement payments over a few months. Once the agreed upon settlement amount is paid, the lender will cease all collections efforts on the debt.

These offers have historically been reserved for customers who have missed a few months worth of payments. However, in the face of high delinquency rates and the threat of higher levels of unpaid debt, credit card companies have begun to offer settlements to customers who are not as severely delinquent. There are even some stories about customers who have yet to miss any payments negotiating a settlement. Typically, these offers are only available if extended by the lender. However, you can certainly ask about one if you find yourself talking with a bill collector.

While getting a steep discount off of debt you owe sounds great, there are a few serious consequences to consider. First, a settlement will likely reflect negatively on your credit bureau report. While the credit card company will no longer try to collect the remaining debt, the account will likely be reported as “settled” rather than “paid in full”. A settled account may hurt your credit scores and make it difficult for you to borrow in the future. Second, if the amount that remains unpaid is $600 or more, it will be reported to the IRS as income. As such, you will have to pay income taxes on it. Finally, most credit card issuers who settle an account will not make any future loans to the customer who accepted it.

For these reasons, settling a debt with your credit card issuers for less than you owe is not a step to be taken lightly and may not make sense in certain circumstances. For example, if your current financial difficulty is likely to be short-term and you are currently able to make some payments, you may be better off contacting your credit card company to negotiate lower monthly payments and a reduced interest rate for six months or a year. The same pressures that are influencing the banks’ decisions to offer more settlements will also likely make them more flexible on other payment terms. This may help you to maintain your credit rating while you get through a challenging time.

Despite the negative consequences, a settlement may be right for you if you expect your current financial situation to be long-term and you have the cash on hand to make the deal (remember, you will be expected to make the payment very shortly after you agree to the settlement).

If you do decide to pursue a settlement arrangement, here are some tips to keep in mind. First, remember, this is a negotiation; Negotiate for the lowest settlement amount you can. Second, see if you can arrange to pay the amount over a period of a few months. Third, make sure you fully understand how the lender will report the debt on your credit bureau report once it is settled. Although unlikely, it is ideal if you can convince them to report it as “paid in full”. Finally, make sure you get any agreement in writing from the bank.

For much more information on collections and talking to bill collectors, take a few minutes to read my posts “Tips From a Former Bill Collector” and “Your Rights Under the Fair Debt Collections Practices Act”.